What happened?
Shares of Kroger (KR +2.57%) dropped 12.1% in September due to a poorly received earnings report and difficult overall market conditions. Despite beating analyst estimates and raising guidance, shares of the grocer fell more than 8% on Sept. 10 following its second-quarter earnings release. The S&P 500 index dropped 4.65% in the month as capital flowed out of the stock market, driving Kroger's price down even further.
KR total return level data by YCharts.
So what?
While Kroger's sales and profits impressed, analysts and investors were less enthused about the company's profit margin. Grocery stores operate with narrow gross margins, and minor disturbances can have major impacts on the bottom line. Kroger's gross margin was 21.4% in the most recent quarter, down from 22.8% last year. The company cited pricing pressure, merchandising expenses, and supply chain disruptions as factors contributing to the reduced margins.
Image source: Getty Images
As we've seen with so many other companies this quarter, inflation is creating uncertainty. These problems seem unlikely to get resolved overnight, so investors are looking forward skeptically. Kroger specifically mentioned a slight rise in customer volume as some consumers are stocking up in response to rising COVID-19 cases, which should really be a temporary impact for the grocer. If sales pull back in the next few quarters while the pricing issues remain, the bottom line will be at risk.
What now?
Kroger's long-term prospects remain unchanged, but investors need to think about the current challenges facing the stock, as well as its valuation. These supply chain issues should eventually be solved, but that will take until 2022 at the earliest. It will also take some time for retailers and grocers to fully digest this year's input price changes. Grocers are highly competitive, so they need to learn which higher input prices can be passed along to consumers. That makes the next few quarters uncertain for Kroger.
Its forward P/E ratio is 12.1, which is in the middle of its historical range and roughly comparable to its peer group. The stock's enterprise-value-to-EBITDA ratio is fairly high at 8.67, and its 2.1% dividend yield looks pretty average compared to other dividend stocks. Despite falling more than 12% this month, Kroger stock hasn't become incredibly cheap. This stock is appropriate for investors seeking more defensive positions in their portfolio or for long-term income investors. In any case, shareholders shouldn't be shocked by volatility related to inflationary pressures in the short term.
