Guidance. It’s the cruel mistress of the markets. Analyst and management expectations of what should/could happen, often trump the real numbers – even if the reported number is good. It’s here that long-term investors can often find great deals on stocks that have ‘missed’ and seen their share prices fall.
A great example of this is grocery super chain Kroger (KR ).
Kroger has been riding high on some pretty lofty earnings and growth expectations in recent years. And KR has done a good job of hitting those targets. However, a recent slip up when looking at its forward guidance has sent the stock plunging. That’s exactly the drop needed for investors who are looking to score a great dividend growth stock on the cheap.
Clean up in Aisle Seven
The grocery store business is typically low margined and boring, but Kroger has managed to play that ‘boring’ business like a fiddle. Perhaps a tad bit too well. Given its previous torrid growth and rapidly growing sales, investors and analysts have been expecting a lot from the nation’s largest pure-grocery retailer. After all, this is the same company that has had 50 straight quarters of sales growth with shares rising over 200% in the last five years.
So when Kroger announced its full-year guidance figures recently, investors ran for the hills. Excluding fuel, KR’s management expects same-store sales to grow at 2.5% to 3.5% this year. However, the problem is that analysts thought Kroger would perform around 4.5% in sales growth.
The drop in sales potential comes at a time when Kroger’s competitors are becoming fiercer.
There are really no differences in underlying products when it comes to grocery items: A brand of laundry detergent or cookie is exactly the same at any store. So when major rival Wal-Mart (WMT ) started cutting prices, while other store chains – such as Albertson’s and Safeway – have started refreshing their shopping experiences to better compete, investors panicked.
As a result, shares of KR are down around 23% this year, all because of ‘bad’ guidance.
The Future Still Looks Promising at KR
Despite the guidance miss, Kroger’s future still looks pretty rosy.
For starters, Kroger is the largest pure-play grocery-store operator in the country. You’re looking at thousands of stores encompassing roughly 24 different local and regional brands, with those various brands hitting a range of different income and demographic levels. You have high-end organic and natural-food seekers to lower-priced bargain shoppers. And while analysts may have balked at Kroger’s sales estimates, in reality, they aren’t too shabby for the ‘boring’ grocery business. Even less so when you consider that Kroger already does $100 billion in sales each year.
Tacking on 3.5% to $100 billion is a pretty impressive feat.
But Kroger still might have more ways to grow its revenue and earnings beyond that newly expected amount. Namely, its other storefronts.
Tucked inside its vast grocery store empire are more than 780 convenience stores. While traditionally a place to get gas and soda, KR is transforming these stores into something else. Kroger has already started offering fresh produce at many of these locations turning them into mini stop-n-shops. In other words, urban-Kroger locations. The goal is to bridge the gap between a customer’s regular shopping trip and needed refill items during the week. While these c-stores only account for 4% of Kroger’s current sales, Wall Street analysts aren’t realizing their potential to be a major driver of future earnings.
And speaking of urban stores, Kroger has another ace up its sleeve with its purchase of around 700 stores from Walgreen’s (WBA ). Due to its pending merger with Rite Aid, Walgreen’s must rid itself of 700 stores and KR is emerging as the number one bidder. Like its c-stores, the purchases will give Kroger vast exposure to urban real estate, which gives them prime locations to add smaller-format stores. Rumors have already begun to fly that Kroger will keep the stores as higher-margined pharmacies, and leverage its own current grocery-store pharmacy operations. Having that many stores instantly makes it one of the largest players in the sector.
Dividend Growth Ahead
Because of the recent guidance miss, KR shares can now be had for around 15 times earnings. That’s pretty cheap. Cheap enough to get the attention of dividend growth investors.
Clearly, Kroger has the ability to keep cash flows, earnings and sales growing right along, despite poor guidance numbers. And that growth will be reflected in its dividend. Already, KR has a long history of increasing its payout. But with a low payout ratio of just 20%, and the ability to grow its earnings/sales through its new initiatives, dividend investors should be pleased.
The Bottom Line
Kroger’s recent guidance flub really wasn’t an issue for the long term. It still has plenty of ways to grow its earnings and dividends down the road. For investors, the recent downturn in its share price could be a great buying signal and opportunity to load up on shares of the mega-retailer.
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