Kroger Buy Recommendation

1,002 views

Published on

Presentation on Kroger (KR) PT - $27

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
1,002
On SlideShare
0
From Embeds
0
Number of Embeds
2
Actions
Shares
0
Downloads
19
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide
  • Buy back pop?Announced with earnings – so this is uncertain.
  • 52% of convenience stores operate as subsidiaries were in company owned facilities87 convenience stores were operated through franchise agreements
  • 52% of convenience stores operate as subsidiaries were in company owned facilities87 convenience stores were operated through franchise agreements
  • 52% of convenience stores operate as subsidiaries were in company owned facilities87 convenience stores were operated through franchise agreements
  • 52% of convenience stores operate as subsidiaries were in company owned facilities87 convenience stores were operated through franchise agreements
  • Private Selections - Meals &pultry to ice cream and pizzas
  • SWY makes 14% of their own private label items
  • Heavily levered in a deteriorating credit market. However, no short term obligations until next yearCompeting in a much harder market, California, with Costco, Trader Joe’s and others
  • Safeway has lowered their business reinvestment – SWY halved their CapEx from FY2008 to FY2010
  • Kroger Buy Recommendation

    1. 1. The Kroger Co. (KR):DISCUSSION MATERIALSAndrew Boone
    2. 2. 1 Investment Merits  Kroger private label brands provide a competitive advantage  Additional fuel centers will increase customer traffic  Best in class super market with most defensive positioning  Superior data management  Improved market share  Buy: Price target of $xx.xxMERITS FALL 2011
    3. 3. 2 Kroger Co. Overview 2 year price history Miscellaneous considerations Market characteristics  Kroger Co. accounts for COGS using FIFO  Enterprise value:  Market cap: $13.05bn  52 week high: $25.85 (7/20/11)  52 week low: $20.53 (12/10/10)  Vol.: 3.067mm  Next earnings date: December 1st  Dividend yield: 1.9%OVERVIEW FALL 2011
    4. 4. 3 The Kroger Co. is… Stores Different Business Lines % of  Traditionally cater to customers in a 2.0-2.5 mile radius Stores revenue Total Supermarkets 2,460 94.0%  At the end of 2010, Kroger had 1,014 fuel centers attached to a supermarket Combination Food & Drug Store 2,128  Kroger operates more than 40 manufacturing plants Multi-Department Stores 125 Marketplace Stores 61  361 jewelry stores (149 in stores & 212 in shopping malls) Price Impact Warehouses 146 Convenience Stores 784 5.0%  Product of the 1999 takeover of Fred Meyer Jewelers Jewelry Stores 361 0.5% Other* N/A 0.5%  Historically, 95% of revenues come from supermarketsOVERVIEW FALL 2011
    5. 5. 4 Kroger has historically been… Stores 2007 2008 2009 2010 Stores Stores Stores Stores Total Supermarkets 2,486 2,482 2,468 2,460 Combination Food & Drug Store 2,183 2,169 2,143 2,128 Multi-Department Stores 123 124 125 125 Marketplace Stores 35 43 53 61 Price Impact Warehouses 145 146 147 146 Convenience Stores 782 771 777 784 Jew elry Stores 394 385 374 361 Different Business Lines Combination Food & Drug – Complete supermarket & pharmacy Multi-Department – Combo store with apparel & food departments Marketplace – Combo store with additional living and home goodsOVERVIEW Price Impact Warehouse – “No frills, low cost” shopping FALL 2011
    6. 6. 5 Investment Merits  Kroger private label brands provide a competitive advantageMERITS FALL 2011
    7. 7. 6 Kroger does a cost analysis for each private label good and manufactures 40% of these products Percent of consumers who agreed with the following statements about private label goods (Source: Mintel) Store brand products are of better quality today than they were five years 44.0% ago I compare the ingredients listed in store brand products with the name brand 42.0% versions I would recommend a store brand product 39.0% I purchase store brand products only because I want to save money – but I’d 35.0% rather purchase name brands I don’t feel like I’m giving anything up (e.g. flavor, quality, prestige) by using 34.0% store brands I trust the ingredients of name brand products more than store brand 23.0% I think it’s worth paying more for name brand products 19.0% U.S. private label sales (Source: Mintel) 70,000 12.0% 60,000 10.0% 50,000 Sales 8.0% ($mm) 40,000 6.0% 30,000 4.0% 20,000 AnnualPRIVATE LABEL 2.0% Growth % 10,000 0 0.0% 2005A 2006A 2007A 2008A 2009A 2010E 2011E 2012E 2013E 2014E FALL 2011
    8. 8. 7 Unemployment has shackled consumer spending and will keep consumers watching spending US unemployment (source: Bureau of Labor Statistics) Private label as % of US supermarket sales Jan. 2008-Sept. 2011 (Source: Nielsen, Credit Suisse)PRIVATE LABEL FALL 2011
    9. 9. 8 Three tiered branding structure provides exposures shopping demographics • “Best” quality brand Private • Offers 1,000 Private Selection Items Selection • “Better” tier • 13 new categories Banner Brands • Moderation Pillar allows shoppers an easy way to find healthy items • “Good” tier Value • Basic products priced to fit in budgets Brand  27% of grocery sales were from  Private label units sold have private label goods in 2010, from increased to 35% of all groceryPRIVATE LABEL 2007 numbers of 26% sales in 2010, from 32% in 2007 FALL 2011
    10. 10. 9 Kroger manufactures 40% of their own products: vertical structure improves logistics and margins Labor Manufacturing facilities  99.8% of shoppers buy a corporate brand  18 dairies product every 12 weeks  10 deli or bakery plants  Big K cola received new packaging and added Ralphs as a distribution line  5 grocery plants  Kroger does a price analysis when deciding  3 beverage plants whether to manufacture or outsource  2 meat plants  2 cheese plantsPRIVATE LABEL FALL 2011
    11. 11. 10 Investment Merits  Additional fuel centers will increase customer trafficMERITS FALL 2011
    12. 12. 11 Same store sales have been buoyed by the addition of fuel sales but still have room to grow Supermarket and fuel center units 3,000 45.0% 2,500 Total 41.2% 40.0% supermarkets 2,000 36.2% 35.0% Attached fuel centers 1,500 31.5% 30.0% 1,000 Percent of supermarkets 28.0% with fuel 25.0% 500 centers 0 20.0% 2007 2008 2009 2010  Fuel provides virtually no margins but as gas  Kroger loyalty points allow shoppers to gain prices remain high, it drives consumers to further discounts as they spend more dollars take advantage of the Kroger’s low fuel prices on grocery sales - $100 spent on groceriesFUEL CENTERS and shop for groceries at the store allow for a $.10 discount per gallon of gas FALL 2011
    13. 13. 12 Same Store Sales show Kroger continuing to win Same Store Sales (Source: Factset) 12.0% 10.0% 8.0% 6.0% Kroger 4.0% Safeway 2.0% SuperValu 0.0% Wal-Mart (2.0%) 2006 2007 2008 2009 2010 Costco (4.0%) (6.0%) (8.0%) Percent of stores with attached fuel centers (Wal-Mart and SuperValu do not disclose fuel center count) 70.0% 65.0% 60.0% 55.0% 50.0% 45.0% Kroger 40.0% Safeway 35.0% 30.0% Costco 25.0%FUEL CENTERS 20.0% 15.0% 2008 2009 2010 FALL 2011
    14. 14. 13 Investment Merits  Best in class super market with most defensive positioning  Superior data management  Improved market shareMERITS FALL 2011
    15. 15. 14 Exclusive DunnHumbyUSA partnership allows Kroger insights into consumer trends Customer Loyalty Card Program  50% of US households have a Kroger  Base capital projects on feedback loyalty card received from DunnHumby to ensure that Kroger remains client focused  90% of purchases at stores use a loyalty card “We’ve been doing this for, I don’t know, I guess six years now and if you look at the trend over time, we’ve had tremendous improvement in terms of being able to engage with the customer in a way that they appreciate and need better and better. And it’s something that every quarter we get better but we’re constantly working with dunnhumby and our merchandising teams to figure out how to even get better from where we are.” - Kroger Management Team (2011 Q2 earnings call)BEST IN CLASS FALL 2011
    16. 16. Superior market share allows for superior economies of 15 scale and lower prices that continues to drive consumers to Kroger units Weighted Average Market Share (Source: Metro Market Studies) 30.0% 27.0% 24.0% 21.0% 18.0% 15.0% Kroger Safeway Supervalu (Excluding Save-A- Lot) Average basket size for Kroger is 14% lower than Safeway, 18% belowBEST IN CLASS Harris Tweeter, and only 6% more expensive than Wal-Mart* FALL 2011 *Source: Wall St. Research
    17. 17. 16 Discounted Cash Flow (avg of two methods $27.03) Perpetuity Sum 25,046.2 Debt 6,962.0 Assumptions Cash 643.0 Growth 4.0% Pension Underfunding 973.0 Gross margin 75.4% Equity Value 17,754.2 OG&A step $550.0 Price per share $29.73 CapEx as % of 2.6% Multiples sales Depreciation as % Equity Value 21,803.4 11.8% Debt 6,962.0 of beginning assets Tax 33.0% Cash 643.0 Shares 597.1 Pension Underfunding 973.0 Equity Value 14,511.4 Price per share $24.30 Discount Rate Discount Rate 12.5% 11.5% 10.5% 10.0% 9.5% 8.5% 7.5% 6.5% 12.5% 11.5% 10.5% 10.0% 9.5% 8.5% 7.5% 6.5% Terminal Multiple Terminal Growth 1.5% $12.02 $15.12 $18.95 $21.22 $23.79 $30.07 $38.54 $50.48 4.50x $16.09 $17.67 $19.36 $20.25 $21.16 $23.10 $25.17 $27.38 2.0% $13.41 $16.85 $21.14 $23.70 $26.63 $33.88 $43.86 $58.41 4.75x $17.25 $18.90 $20.66 $21.59 $22.55 $24.57 $26.73 $29.05 2.5% $14.94 $18.76 $23.60 $26.52 $29.87 $38.32 $50.26 $68.31 5.00x $18.40 $20.12 $21.96 $22.93 $23.93 $26.04 $28.30 $30.72 3.0% $16.63 $20.91 $26.38 $29.73 $33.61 $43.57 $58.07 $81.04 5.25x $19.55 $21.35 $23.27 $24.27 $25.32 $27.52 $29.87 $32.39 3.5% $18.51 $23.32 $29.57 $33.44 $37.98 $49.87 $67.84 $98.01 5.50x $20.71 $22.57 $24.57 $25.62 $26.70 $28.99 $31.44 $34.06VALUATION 4.0% $20.61 $26.06 $33.24 $37.77 $43.14 $57.57 $80.40 $121.78 5.75x $21.86 $23.80 $25.87 $26.96 $28.09 $30.46 $33.00 $35.73 4.5% $22.98 $29.18 $37.53 $42.88 $49.34 $67.19 $97.15 $157.42 6.00x $23.01 $25.02 $27.17 $28.30 $29.47 $31.93 $34.57 $37.40 FALL 2011
    18. 18. 17 Comparable companies* The Kroger Co. Fiscal Enterprise Price / EPS Enterprise Value / Company Name Period Value LTM FY1 NTM Sales EBIT EBITDA The Kroger Co. (kr-us) 08/2011 19,557.7 11.92 11.74 10.96 0.22x 8.6x 5.0x Peer Summary Analysis Mean - 73,637.8 12.07 12.49 12.00 0.36x 11.1x 15.9x Median - 21,472.6 11.96 11.39 10.61 0.32x 10.7x 9.0x Peer Universe (4 comps) Costco Wholesale Corp. (COST) 04/2011 32,074.6 25.38 21.03 20.70 0.38x 13.5x 10.0x SUPERVALU, Inc. (SVU) 06/2011 8,384.8 (1.05) 6.15 6.09 0.23x - 40.9x Wal-M art Stores, Inc. (WM T) 07/2011 243,221.2 11.64 12.22 11.49 0.57x 10.7x 8.0x Safeway, Inc. (SWY-US) 06/2011 10,870.7 12.29 10.57 9.73 0.26x 9.2x 4.7xVALUATION Source: Factset FALL 2011 *Downloaded 10/10/2011
    19. 19. Supervalu (SVU) Good The bad – Heavily levered  Cheap (6.1x NTM EPS) SVU SWY KR  $1.87bn goodwill impairment made Debt 5,553.0 4,490.0 7,662.0 numbers seem much worse at a superficial LTM Interest 535.0 286.8 449.0 level EBITDA 1,833.0 2,366.0 3,716.0  Has experience improving margins, however EBIT 894.0 1177.6 2,200.0 this may be due to a smaller reinvestment in stores – they halved CapEx from FY2009 Debt/EBITDA 3.0x 1.9x 2.1x yet developed 132 new stores in FY2011 EBIT/Interest 1.7x 4.1x 4.9x Pension plan  Plan assets are as of February 26th, 2011 - Plan at Feb. 27, 2010 S&P 500 is down 9.5% over this time frame Total pension assets $1,896.0 Total PBO 2,663.0  A 25bps reduction in the discount rate Underfunded status (767.0) would increase pension expense by $10mm Discount rate 6.0%  Discount rate derived by AA corporate Expected return on assets 7.8% % in equities 53.5%VALUATION % in P/E & real estate 10.8% % in fixed income 35.6% FALL 2011
    20. 20. Safeway (SWY) The Good – Safeway has produced superior margins The bad – Heavily levered  Safeway trades at 12.3x LTM EPS (11.9x KR) SWY SVU WMT COST KR and at 9.7x NTM EPS (10.9x KR) and 4.7x EV/EBITDA (5x KR) Gross FY0 28.3% 22.5% 24.7% 12.8% 20.3%  Debt to EV is .46x for Safeway (.38x KR) Gross FY-1 28.6% 22.4% 24.8% 12.7% 21.2%  KR should trade a premium because of their EBITDA Margin ID sales. While SWY has better margins, I 5.8% 4.9% 7.3% 3.7% 4.5% FYO believe the most price conscious shopper is EBITDA Margin being driven to KR stores (average KR 6.4% 5.4% 6.9% 3.6% 4.8% FY-1 basket is 14% cheaper*) The Bad – Safeway has been consistently produced disappointing identical store sales 3.0% 8.0% 2.0% 6.0% 1.0% 4.0% 0.0% 2.0% Kroger (1.0%) 0.0% Safeway (2.0%) (2.0%) SuperValu (3.0%) (4.0%) (4.0%) Wal-Mart (5.0%) (6.0%)VALUATION (8.0%) 2006 2007 2008 2009 2010 FALL 2011 *Source: Wall St. Research
    21. 21. Wal-Mart (WMT) The Good – EM growth WMT vs. KR New sq ft (mm) in FY12  Wal-Mart had a massive price roll back last Sub-Saharan Africa 17.2 spring that did not effect KR same store LatAm 13.2 sales at all. Asia 8.2  Same store sales for WMT have not Other 4.3 exceeded 1% in 10 consecutive quarters  WMT trades at 8x EV/EBITDA (5x KR) & The international segment accounted for 26.1% 11.5x NTM EPS (11x KR). With it’s superior of FY2011 net sales margins & better ID sales it should receive a premium The Bad - We are seeing the maturation of WMT for the US segment – No where else to grow 3850 180 3800 160 3750 140 3700 3650 120 3600 100 3550 Stores - End of Year 80 3500 Net Opened Stores 60 3450 40 3400 3350 20VALUATION 3300 0 FY2007 FY2008 FY2009 FY2010 FY2011 FALL 2011
    22. 22. 21 Risks Increased margin pressure Pension Obligation  KR is subject to union labor. SWY, COST and SVU do  Pension short fall was $973mm at January 29th, as well but WMT does not 2011 − KR will renegotiate contracts with workers in  Discount rate was 5.6%. If the discount rate was to California, Memphis and West Virginia over the be lowered by 1% it would increase PBO by $342mm remainder of 2011  Kroger investments more aggressively with their  KR has successfully passed along price increases to pension assets consumers. However, management specifically chose to contract gross margins. Margin  Poor performance will squeeze profitability contraction may hamper financial performance  Similar to SVU but better capitalized Higher hurdles Pension asset allocation 2010  KR has experienced higher hurdles due to superior Global equity securities 22.1% historical numbers Emerging market equity securities 9.4%  Multiples may contract if past growth is not Investment grade debt securities 12.2% maintained High yield debt securities 13.6%  Much of the historical growth has been due to Private equity 6.3% KR’s ability to pass through inflationary pressure Hedge funds 23.1% Real estate 2.4% Other 10.9%RISKS FALL 2011
    23. 23. Amazon (AMZN):Everyone’s retailerAPPENDIX
    24. 24. 23 Real growth vs. nominal growth 8.0% 6.0% Nominal Same Store Sales 4.0% 2.0% Real Same Store Sales 0.0% (2.0%) 2006 2007 2008 2009 2010REVENUE FALL 2011
    25. 25. 24 Discounted Cash Flow ($27.03) In Millions 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 TV Rev $76,148.0 $76,733.0 $82,127.0 $88,548.2 $92,090.1 $95,773.7 $99,604.6 $103,588.8 $107,732.4 $112,041.7 $115,402.9 COGS 58,012.0 58,429.0 63,354.0 69,082.2 71,767.4 74,638.1 77,623.6 80,728.5 83,957.7 87,316.0 89,935.5 Gross Margin 18,136.0 18,304.0 18,773.0 19,465.9 20,322.7 21,135.6 21,981.0 22,860.3 23,774.7 24,725.7 25,467.5 Gross Margin 23.8% 23.9% 22.9% 22.0% 22.1% 22.1% 22.1% 22.1% 22.1% 22.1% 22.1% SG&A 14,229.0 14,527.0 14,948.0 15,516.0 16,066.0 16,616.0 17,166.0 17,716.0 18,266.0 18,816.0 19,366.0 Depreciation 1,443.0 1,525.0 1,600.0 1,746.0 1,662.3 1,748.3 1,835.5 1,924.1 2,014.5 2,106.9 2,106.9 Operating Profit 2,464.0 2,252.0 2,225.0 2,203.9 2,594.4 2,771.3 2,979.6 3,220.2 3,494.2 3,802.8 3,994.6 EBIT Margin 3.2% 2.9% 2.7% 2.5% 2.8% 2.9% 3.0% 3.1% 3.2% 3.4% 3.5% One time items (12.0) (1,161.0) (43.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0 Tax 717.0 532.0 601.0 658.6 856.2 914.5 983.3 1,062.7 1,153.1 1,254.9 1,318.2 NOPAT 1,735.0 559.0 1,581.0 1,545.3 1,738.3 1,856.8 1,996.3 2,157.5 2,341.1 2,547.9 2,676.4 Working Capital (259.0) 73.0 370.0 (508.0) (83.7) (87.0) (90.5) (94.1) (97.9) (101.8) 0 Depreciation 1,443.0 1,525.0 1,600.0 1,746.0 1,662.3 1,748.3 1,835.5 1,924.1 2,014.5 2,106.9 2,106.9 CapEx (2,149.0) (2,297.0) (1,919.0) (1,634.0) (2,394.3) (2,490.1) (2,589.7) (2,693.3) (2,801.0) (2,913.1) (2,106.9) Free Cash Flow 770.0 (140.0) 1,632.0 1,149.3 922.5 1,027.9 1,151.6 1,294.2 1,456.7 1,639.9 2,676.4 Present Value Multiplier 0.98 0.85 0.77 0.70 0.64 0.58 0.53 0.53 49.1 780.8 790.9 805.5 823.0 842.1 861.8 20,093.1REVENUE FALL 2011

    ×