A very strong business producing a lot of cash can be wonderful to own, but it comes with a key tradeoff.
American grocery giant Kroger (NYSE: KR) recently raised its dividend by a whopping 12%. It now pays its shareholders $0.29 per share per quarter -- or $1.16 annualized. Based on its recent share price of $47.00 per share, that’s a comfortable yield of nearly 2.5%.
Importantly, the dividend consumes less than 30% of the company’s earnings. That gives Kroger room to continue raising its payouts as long as its operations remain strong. From an investor’s perspective, it certainly is great news that Kroger is able to provide a combination of well-covered current income plus strong income growth. Indeed, it showcases how, even these uncertain economic times, people still have to eat.
How Kroger is making it work
Kroger’s position as America’s largest supermarket company is likely playing a role in its success. Because it’s large, it can benefit from its scale. That scale gives it the ability to negotiate good deals with its suppliers and spread its investments out over a large operating base. These days, those investments include things like automated grocery warehouses to better enable fresh food delivery.
Fresh food delivery has long been the toughest part of online order fulfillment. That’s a key reason why traditional food-focused stores like Kroger have remained strong even as so many other retailer types have fallen to online storefronts. Still, Kroger recognizes the trend towards digital and is heavily investing in both “Buy online, pick up at the store” and “order online for delivery” type technologies.
This all of the above and balanced approach is important, because food shopping will likely always involve some level of local touch. Many food items spoil quickly and are temperature sensitive. Also, a lot of food products vary in terms of size and condition, so some people will still want to shop in-person to make real-time decisions on things like which bananas or which gallon of milk they want.
Those factors mean that it is likely that the longer-term winners in the food business will be the ones that best merge the digital experience with the local one. Kroger’s large size, strong local presence in many markets, and significant investments into those digital technologies gives it a strong shot at being one of those longer-term winners.
Adding to its already hefty presence
On top of its existing strong infrastructure, Kroger is in the process of acquiring fellow grocery giant Albertsons (NYSE: ACI). While there are some antitrust legal concerns over whether the merger of the two companies would lead to higher prices due to lack of competition, those concerns probably won’t completely kill the deal.
In similar mergers, a typical resolution to antitrust concerns has been to allow the merger overall, but require a spinoff of some stores in markets where the combined company would have too much power. Kroger and Albertsons are preparing for their merger with the expectation that a similar resolution will be needed. As a result, investors should expect that the combined company won’t be quite as large as the two individual parts were, but it will still likely end up as a huge player in the industry.
All this, with reasonable fundamentals
Although Kroger is showing itself capable of driving decent growth in tough economic times, the grocery industry isn’t exactly Wall Street’s favorite at the moment. That gives investors a chance to buy the company for less than 11 times its anticipated future earnings. When you combine that reasonable valuation with a balance sheet that sports a debt to equity ratio below 2, you get a solid overall company worthy of consideration as a potential long-term investment.
At the time of publication, Chuck Saletta’s wife owned shares of Kroger.
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