Zacks_Analysts' Blog : Kroger is Neutral - Analyst Blog

A dominant position among the nation’s largest grocery retailers enables The Kroger Company (KR) to sustain growth in its top line, expand its store base and boost its market share. The company’s strong corporate and national brands have helped gain customers’ loyalty.

Kroger’s customer-centric business model provides a strong value proposition to consumers and positions it well to deliver higher earnings, primarily through strong identical supermarket sales growth (sans fuel). Identical supermarket sales are expected to grow 3% to 4% in fiscal 2011 compared with 2.8% in fiscal 2010. The company aims to achieve annual earnings per share growth of 6% to 8% over a period of 3 to 5 years.

Management continues to deploy capital to concentrate more on remodeling, merchandising, and other viable projects. These include nearly 25 to 35 major capital projects comprising new stores, expansions and relocations, and 130 to 140 remodels. Management expects fiscal 2011 capital expenditure to be between $1.7 billion and $1.9 billion.

Kroger’s management is also actively managing its capital, returning much of its free cash to shareholders via share buybacks and dividends. The company expects to generate shareholders return of 8% to 10% over a period of 3 to 5 years.

The grocery business is highly competitive and fragmented, and Kroger faces intense competition from big players, like Supervalu Inc. (SVU), other conventional and specialty gourmet retailers with respect to price, store expansion and promotional activities to drive traffic. This might dent the company’s sales and margins. Moreover, sluggish economic recovery and rising food and fuel prices may affect consumer shopping patterns.

Higher debt-to-capitalization ratio also remains a matter of concern. Kroger ended fiscal 2010 with long-term debt (including obligations under capital leases and financial obligations) of $7,891.7 million, reflecting a high debt-to-capitalization ratio of 59.8%, which could adversely affect the company’s credit worthiness and make it more susceptible to the macroeconomic factors and competitive pressure.

Kroger, which faces stiff competition from Wal-Mart Stores Inc. (WMT) and Whole Foods Market Inc. (WFMI), operates approximately 2,458 supermarkets and multi-department stores in 31 states under approximately 24 local banners. Kroger’s shares maintain a Zacks #3 Rank, which translates into a short-term Hold recommendation. Moreover, we have a long-term Neutral rating on the stock.