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Investing, Stocks  | March 22, 2019

Shares of Kroger (NYSE:KR) fell off a cliff in early March after America’s largest grocer reported fourth quarter numbers that sharply missed both revenue and profit estimates. The fiscal 2019 guide also missed consensus profit estimates. The double whammy of poor Q4 numbers and a weak 2019 guide spooked investors, and Kroger stock fell from $29 to below $25 in response.

This big drop in Kroger stock is an opportunity. In the big picture, Kroger has staying power as America’s largest and favorite grocer and that positioning guarantees this company healthy revenue and profit growth for the foreseeable future.

At just 11-times forward earnings, Kroger isn’t priced for healthy growth. It’s priced for no growth. This discrepancy can’t last forever. Eventually, the valuation will correct higher. When it does, Kroger stock will rise to levels above $30.

It also helps that Kroger now near the bottom-end of a well defined multi-year trading range. Historically speaking, any time Kroger stock gets this low, it doesn’t stay this low for long.

Thus, at $25, Kroger looks good here. The stock looks both fundamentally overvalued and technically oversold. It may take time for the reversal to happen. But, make no mistake, it is coming. By the end of 2019, prices above $30 look both achievable and fundamentally supported for KR stock.

The Fundamentals Are Good

The big picture fundamentals supporting Kroger stock are very good. In a nutshell, all those concerns that Amazon (NASDAQ:AMZN) was going to eat Kroger alive in the grocery sector after the Whole Foods acquisition were grossly overstated. Ever since then, Kroger has rattled off back-to-back years of positive comparable sales and revenue growth. The company is expected to report another positive top-line year in 2019.

In other words, the Amazon threat hasn’t really affected Kroger’s traffic, sales, or reach. Instead, if you shopped at Kroger grocery stores a few years back, chances are high that you still shop there today. Why? Because grocery stores are sticky. Consumers like going to the same grocery store.

They like knowing what to buy, knowing where those things are located in the store, knowing where to park, and seeing familiar faces. Consumers don’t want to give up that familiarity or convenience for slightly cheaper (but still relatively expensive) Whole Foods prices.

As such, Amazon hasn’t really made a splash in this market. Sure, there’s the Walmart(NYSE:WMT) and Target (NYSE:TGT) threats. But, those threats have been around for a long time, too, and they haven’t had much impact on Kroger’s sales or traffic either.

Again, this comes back to familiarity and convenience, two things that are very important to the grocery shopping experience and which give grocery stores immensely sticky customer bases.

Because of this, Kroger today remains America’s largest grocer despite the multiple competitive threats that have emerged over the past several years. Also because of this, and because of Kroger’s resilient track record of continued growth, Kroger should remain America’s largest grocer for the foreseeable future.

That positioning alone guarantees Kroger healthy revenue growth for the next several years.

The Stock Is Undervalued and Oversold

Given Kroger’s healthy big picture fundamentals, its stock is fundamentally undervalued at current levels.

Right now, KR stock is trading at just 11-forward earnings, versus a five year average forward multiple of 15 and a market average forward multiple of 16. In other words, Kroger is really cheap. This cheapness only makes sense if profit growth will be muted over the next several years.

It won’t be. To be sure, margins are struggling right now. But, these struggles have a lot to do with fuel prices, and nothing to do with the long term fundamentals. Once fuel headwinds normalize, margins should normalize, too, and profits should grow thanks to healthy revenue growth, stable margins, and big buybacks.

From a numbers perspective, I think some combination of low single digit revenue growth, stable margins, and big buybacks will push EPS towards $3.20 by fiscal 2025. Based on a historically average 15 forward multiple, that implies a fiscal 2024 price target for Kroger stock of $48.

Discounted back by 8% per year (2 points below my normal 10% yield to account for the yield), that equates to a fiscal 2019 price target between $32 and 33. Thus, below $25, KR stock looks materially undervalued.

The stock is also oversold here. Over the past several years, the lower-$20’s have provided a solid line of defense for the stock on sell offs. In September 2017, a drop in KR stock to $20 led to a rally to $30 by January 2018. In March 2018, a drop in KR stock to $23 led to a rally to $32 by September 2018.

History should repeat itself here, given stable long term fundamentals. As such, the March 2019 drop in Kroger stock to the lower-$20’s should likewise end in a rally towards $30 over the next several months.

Bottom Line on Kroger Stock

Kroger is supported by stable and healthy long-term fundamentals. Those fundamentals imply that this company will remain the leader in the stable growth U.S. grocery industry for a lot longer.

That stability isn’t priced into KR stock today. Instead, KR stock is undervalued and oversold against a healthy fundamental backdrop. That set-up makes this dip in Kroger look like an attractive buying opportunity.

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