Foolish Forecast: Kroger Rolls Over

Time to roll your earnings calendars ahead one year, investors. Supermarketeer Kroger (NYSE:KR) reports its fiscal Q1 2006 earnings news tomorrow.

What analysts say:

• Buy, sell, or waffle? Sixteen analysts follow Kroger, with seven votes each going to buy and to hold, and two sells.
• Revenues. Analysts are looking for a 5.5% improvement in sales to $18.9 billion.
• Earnings. And a 5% improvement in profits to $0.42 per share.

What management says:
Kroger CEO David Dillon likes his company so much that he thinks more repurchases are in order. In May, the company announced that with less than $8 million remaining in its September 2004 stock buyback plan, it was re-upping the program and authorizing up to $500 million in further buybacks.

A producer of prodigious free cash flow (about $900 million last year), Kroger aims to use two-thirds of its cash for dividends and share repurchases, and the remaining third to pay down debt.

What management does:
Last week, TheWall Street Journal ran an article comparing Kroger to Wal-Mart (NYSE:WMT), depicting the two firms as bitter rivals for America's food dollars, yet noting that as other grocers less exposed to Wal-Mart withered, Kroger seemed to be thriving despite the pricing pressure leveled against it by the Bully of Bentonville. The numbers below back up the Journal's thesis. Kroger's gross margins are compressing, suggesting the effects that price competition can bring. At the same time, however, Kroger's done an admirable job of controlling its operating costs. With sales rising 8.2% in the last six-month period, selling, general, and administrative expenses rose just 4.7%. Result: For the last 12-month period, Kroger is back in black.

One Fool says:
Kroger may well be holding its own against Wal-Mart for now. But with Wal-Mart earning profit margins twice as fat as Kroger's, I wouldn't want to be holding Kroger common equity if Wal-Mart decides to get into a full-fledged grocery price war: Lean as it is, Wal-Mart still has more fat it can cut before hitting meat.

Yet even if the situation doesn't devolve to that level, I have my doubts that Kroger can reward shareholders from the stock's current level. With analysts predicting Kroger will grow profits at 8% per annum long-term, and the stock selling for a trailing price-to-free cash flow of twice that, the valuation simply doesn't look compelling to me. Maybe if it offered a coupon ...

Competitors:

• A&P (NYSE:GAP)
• Albertsons (NYSE:ABS)
• Ingles Markets (NASDAQ:IMKTa)
• Marsh Supermarkets (NASDAQ:MARSa)
• SUPERVALU (NYSE:SVU)

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Fool contributor Rich Smith does not own shares of any company named above.