We recently upgraded our recommendation on Kroger Company (KR) to Neutral from Underperform with a target price of $23.00.
Kroger’s dominant position among the nation’s largest grocery retailers enables the company to sustain top-line growth, expand store base and boost market share. The company’s fourth-quarter 2009 total revenue (including fuel center sales) rose 7.2% to $18,554.5 million.
Kroger’s customer-centric business model provides a strong value proposition to consumers. The company is well positioned to deliver higher earnings primarily through strong identical supermarket sales growth (sans fuel). Identical supermarket sales are expected to grow 2% to 3% in fiscal 2010, although down from an average growth of 4.1% achieved in the last three years, given the economic conditions.
Kroger’s management is also actively managing its capital, returning much of its free cash to shareholders via share buybacks and dividends. Since the inception of the dividend program in 2006, the company has increased its dividend every year. The dividend was last increased in fiscal 2009 by 5.5% to 9.5 cents a share. Kroger also repurchased 10.3 million shares aggregating $218.3 million.
However, the intensifying price war among grocery stores to lure budget-constrained consumers has compelled Kroger to cut prices, hurting its sales and margins. Consumers are now prioritizing their purchases, trading down to cheaper substitute brands and shopping for groceries at low-price leaders such as Wal-Mart Stores Inc. (WMT) and Costco Wholesale Corporation (COST).
Moreover, Kroger’s high debt-to-capitalization ratio (62.2%) could adversely affect its creditworthiness, making it more susceptible to the given economic conditions and competition.
Given its pros and cons, we prefer to be Neutral on Kroger.

Read the full analyst report on “KR”
Read the full analyst report on “WMT”
Read the full analyst report on “COST”
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