News and Commentary: Kroger Looking Sharp After Big Q2 Meal

Kroger Looking Sharp After Big Q2 Meal

By Richard McCaffery (TMF Gibson)
September 14, 1999

Grocery retail king Kroger (NYSE: KR) reported record Q2 diluted earnings per share (EPS), excluding all merger-related costs and an extraordinary item, of $0.24 today -- about 26% higher than last year's results and on par with analyst estimates.

Chief Executive Joseph Pichler said manufacturing performance and new merchandising programs drove higher sales and earnings. Comparable store sales for the quarter jumped 3.6% and identical store sales, which only include stores that haven't been expanded or relocated, grew 2.6%. Total sales grew 6.2% to $10.3 billion.

It's the first quarter Kroger has reported results since its $13 billion merger with Fred Meyer in May. The combination created the nation's largest chain of grocery retail stores. Based in Cincinnati, Kroger now operates 2,192 grocery stores, 796 convenience stores, 380 jewelry stores, and 43 food processing plants in the South, Midwest, and West.

Pichler is optimistic the company will meet year-end estimates of $1.15 per share, and he expects to save $40 million in 1999 (down from the original estimate of $75 million) as a result of efficiencies gained through the merger. Within three years, the combination should save Kroger $225 million annually, Pichler said. In a low-margin business like grocery retail, every dollar counts.

Yet, adjusted for splits, Kroger's shares have tumbled 31% since spring. How so? Largely, it's because analysts were confused about where to put Q2 estimates after the merger. In a good-humored research report issued August 23 -- entitled "We Analysts Can Be Miserable Forecasters" -- Merrill Lynch First Vice President Mark Husson attributed the summer sell-off to the street's misinterpretation of a Q2 adjustment. The difficulty of forecasting was compounded by the merger, seasonality, and Kroger's adoption of a new fiscal year, Husson said in his report.

He goes on to say the company is managing operations well, trimming its cost structure, and starting to realize the benefits of coupling with Fred Meyer. He said the company is selling at its lowest valuation in several years and rates it a "buy."

With Kroger trading at a 1999 P/E of 21 and a 2000 P/E of 17.7, Husson might be right. In addition, Kroger's trailing price-to-sales ratio is 0.45. In other words, each share is trading at a discount to the sales it will generate. Put another way, each share is generating $52.97 in sales, yet selling for around $24.19.

Competitor Safeway (NYSE: SWY) is trading at a 1999 P/E of 23.6 and at a price-to-sales ratio of 0.91. Each share is generating $49.22 in sales and is trading around $44.56. Kroger, therefore, may be worth another look.

One word of caution: Since the merger was just completed, investors don't have much more than a couple quarters of income statements to look at. A thorough study of the combined balance sheets and cash flow statements is in order as soon as Kroger makes it available.

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