Investors aren’t sure what to make of Kroger‘s (NYSE:KR) business right now. Yes, the chain enjoyed record growth in 2020 as the pandemic lifted demand for essentials like groceries and home cleaning supplies. But the supermarket giant was losing market share to rivals like Walmart ((NYSE:WMT)) before COVID-19 struck, and it might return to that disappointing trend as the virus threat recedes.
Still, there are some good reasons to believe Kroger is on a fundamentally stronger path today, one that will generate solid returns for shareholders. Let’s look at a few factors that point to a brighter future for the business in 2021 and beyond.
1. Engaged shoppers
The recipe for retailing success today has two main elements, both of which are best illustrated by Target‘s ((NYSE:TGT)) runaway growth in 2020. Shoppers are looking for a great shopping experience that combines online conveniences with the speed of in-store pickup. They also want access to a wide selection of high-quality, exclusive merchandise.
Kroger’s success in these areas is reflected in its market share wins against Walmart in recent quarters, with sales up 11% through early November. The chain credits its e-commerce platform, plus popular in-store brands like Simple Truth, for delivering that improved growth. Kroger is on pace to boost comparable-store sales by around 14% in fiscal 2020, compared to management’s initial target of less than 3%. High customer satisfaction suggests it has a good shot at keeping many of those new households once stay-at-home trends settle back down to normal over the next few quarters.
2. Rising margins
Kroger isn’t nearly as profitable as Target, but the grocer’s latest results suggest it could be approaching the kind of earnings surge that has supported that stock’s rally. Operating profit is up to $2.9 billion, or 2.9% of sales through the first three quarters of 2020 compared to $1.7 billion, or 1.8%, a year earlier.
Kroger should notch more gains here over the next few quarters as it boosts efficiency in the e-commerce niche. Walmart and Target have both walked that path, with help from rising prices and reduced promotions for ultra-fast fulfillment options like same-day delivery. There’s every reason to expect Kroger to benefit from the same moves in 2021, assuming consumer spending trends stay strong.
3. Gushing cash returns
Kroger has been accumulating cash through the pandemic even as earnings are set to rise over 50% this fiscal year. Management’s main use for these resources is to reinvest in the business through initiatives like store remodels and improvements to the online selling platform. Yet, even after meeting these needs there’s cash to spare right now, with debt recently plunging to below two times adjusted earnings last quarter.
That positive trend supported Kroger’s 13% dividend increase in 2020, and investors can expect to receive more cash through dividends and stock repurchases that will supplement their investment returns this year. It’s also good news for the business that CEO Rodney McMullen and his team are free to pursue potentially game-changing acquisitions like their buyout of Harris Teeter back in 2013.
Altogether, these factors have set the stage for impressive operating results after Kroger deals with the immediate slowdown from 2020’s COVID-19 spike. And, while the supermarket chain isn’t currently enjoying the profitability surge that Target has seen, or the level of growth that Costco (NASDAQ:COST) is posting, these gaps are reflected in a far more modestly valued stock.
Kroger is selling for just 0.2 times sales today compared to over 0.7 times for many of its peers. With such a low valuation, the consumer staples giant would only need to outperform by a slight margin to generate healthy long-term returns for shareholders. Investors shouldn’t pass on that attractive balance between risk and potential reward.