As bizarre as it is to say, grocery chain Kroger (KR 0.60%) is one of 2020's hottest stocks.
Kroger attracted serious investor attention in February after Warren Buffett's Berkshire Hathaway disclosed that it had taken a stake in the company. Not long thereafter, COVID-19 was recognized as a pandemic, and investors fled toward safe-haven stocks. And as an essential-items retailer, Kroger's business is deemed as safe as they come.
Should you run with the herd into Kroger stock in hopes of becoming a millionaire? Not so fast.
The grocery business
The first thing you should know about a Kroger investment is that the grocery business is a high-volume/low-margin game. In 2019, Kroger had net income of $1.7 billion on a whopping $122 billion in net sales. And that profit margin wasn't a one-year anomaly or unusual. Here's a 10-year chart with a couple of other grocery chains for comparison.
The other thing about the grocery business is it's virtually a zero-sum game. After all, with the exception of a few self-sufficient homesteads, everyone already buys groceries from the store. Therefore, this is a highly competitive business featuring constant attempts to steal market share. Kroger has done quite well up to this point. The company estimates that it had around 12% market share as of 2018.
The COVID-19 pandemic has boosted grocery store sales of late. For Kroger, comparable-store sales surged 30% in March as shoppers prepared to ride out the coronavirus quarantines. That's a temporary bump, though, and shouldn't factor into a long-term investing thesis. And it won't be a profit boom for the company, either, considering that Kroger had to hire many new workers to meet the increased demand. Margins will likely stay thin.
But COVID-19 could have a more permanent effect on Kroger's business. There has been an industrywide increase in online grocery sales and parking-lot pickup. Many shoppers who have never used these services before are trying them for the first time, and may get hooked on the convenience. It stands to reason that grocery chains with strong existing delivery and pickup services will benefit the most, by stealing market share from chains without these services.
Kroger already excelled in this area. In the fourth quarter of 2019 (pre-coronavirus), digital sales grew 22% year over year, and pickup and delivery grew faster than digital sales overall. Therefore, I'd consider Kroger one of the better-positioned grocery chains for long-term success.
Not a growth stock
Being the best-positioned grocery business doesn't necessarily mean Kroger is a millionaire maker, though. Expect meager revenue growth even if it steals market share. And the company is only targeting 3% to 5% long-term growth in net earnings. So Kroger isn't going to be a growth stock minting millionaires. It will primarily increase shareholder value through share repurchases and dividends.
In 2019, Kroger returned $951 million to shareholders: $486 million was paid out as dividends, while the rest was used for share repurchases. Kroger raised its dividend in 2019 for the 13th consecutive year, making this a reliable dividend stock. The company plans to keep raising payouts for the foreseeable future.
Regarding share repurchases, they may be falling out of favor politically, and in some cases, they're a bad use of capital. But used responsibly, they can contribute to growth in earnings per share, which stimulates shareholder returns. By gradually reducing its share count over the last five years, Kroger has been able to grow EPS despite net income being down.
The term "millionaire maker" is subjective; it depends on how much capital was invested originally. But I like to think of millionaire maker stocks as the ones that go up 10 times in value. I really doubt that Kroger can offer that kind of return.
On the other hand, I also don't see a lot of long-term downside with Kroger. It's an essential business and it is likely here to stay. That's an attractive quality to find, especially if your investing goal is capital preservation in lieu of hypergrowth. With a stable business and a 2% dividend yield, Kroger stock could hold an important place in a diversified portfolio.