KR

Publicly traded companies mentioned herein: Kroger Co/The (KR), Walmart Inc (WMT)

Highlights

The presenter is long shares of The Kroger Co (KR), the second largest US grocer after WMT, with the view that pandemic-driven adoption of online grocery shopping has stabilized after a much-needed digestion period and is now positioned to grow at a more sustainable pace. This creates an increasingly widening gap between scaled (KR, WMT, etc.) and subscale players; subscale players can’t invest in omnichannel and will likely use third-party online partners, which is unprofitable for the grocers, whereas scaled grocers like KR and WMT have already invested heavily and will benefit from continued online growth. On top of that, KR and WMT now have well-developed, needle-moving advertising platforms that generate higher margins than traditionally lower margin core grocery business. In 2022, KR generated $5.1B of adjusted FIFO operating profits on $148B of revenue, and $1.2B of the operating profits came from KR’s alternative profit businesses, mainly Kroger Personal Finance and its advertising platform (Kroger Precision Marketing). Despite the structural change in the industry, the market continues to value KR as a sleepy, legacy grocer at 6x EBITDA and 11x EPS compared to its historical range of 5.5x – 7.5x EBITDA and 10x – 15x EPS. The valuation is also compelling given the gap has widened vs. the market and WMT. Additionally, he expects a generally positive pricing environment for grocers, whereas bears think there may be outright deflation by late 2023. In the aggregate, he sees an attractive risk/reward setup at the current $49 share price with 2023 upside to $75 and downside limited to $45.