Kroger shares are begging to be bought

Key Points

• Kroger had a solid Q3 and issued favorable guidance but no news on the Albertson's merger.
• Deal or no deal, this stock is a value for income growth investors. 
• Analysts support the market and see it moving higher over the next year. 

The price action in Kroger NYSE: KR has been under pressure for more than a year as it struggles to close the deal with Albertson’s NYSE: ACI. Deal or not, the stock trades at a deep value and offers substantial gains for investors. On the one hand, we have a company about to merge with Albertson’s and become more competitive with Walmart NYSE: WMT, Sam’s Club and Costco NASDAQ: COST, which have been gaining share in grocery. 

On the other hand, we have a company whose balance sheet and capital position have been vastly improved in preparation for merging and can deliver robust capital returns should the merger fail. In both cases, Kroger is a blue-chip dividend growth stock trading at only 9X earnings, paying more than 2.5% with a double-digit distribution CAGR and analysts' support. It’s also trading above and showing support at critical resistance with bullish catalysts on the horizon. 

From the Q3 earnings release: “Kroger expects to continue to generate strong free cash flow and remains committed to investing in the business to drive long-term sustainable net earnings growth, as well as maintaining its current investment grade debt rating.”

Kroger has a solid quarter; the margin is impressive

Kroger had a solid Q3 with revenue of $33.96 billion, falling only -0.7% compared to last year. The revenue is stronger than expected, but the strength is slim, about 17 bps above the Marketbeat.com consensus estimate, and compounded by a widening margin. Comp sales ex-fuel fell -0.6%; digital grew by 11%, with delivery up 20%. 

The gross margin is where this company report shines. The gross margin increased by 300 basis points on business quality. Strength in private label Our Brands sales and sourcing benefits were only partially offset by costs and shrinkage. The SG&A expense also increased but a slim 32 basis points, leaving the adjusted earnings at $0.95 or up $0.07 YOY and 320 basis points better than expected. 

Guidance is also favorable, including the outlook for earnings. The company expects FY 2024 results in a range with the consensus near the low end and may be cautious. The takeaway is that cash flow is sound, better than expected and creating value for shareholders. 

The balance sheet is in the best position Kroger has seen in a long time. The decision to suspend share repurchases helped the company increase cash and short-term securities by nearly 200% while paying dividends and maintaining consistent debt levels. The net result is a net-debt-to-EBITDA ratio of 1.4X, down 20 bps YOY, and well below the 2.3X to 2.5%X target. 

The Albertson’s merger, what’s going on? 

The merger with Albertson’s is still in play and in its final innings. The two grocery giants certified compliance with the FTC in mid-November and await final approval. The FTC has made two requests so far to get the deal to pass, and another may be coming. As it is, the merger isn’t expected to close before February 2024 and may be delayed again. 

The analysts are Holding on to this stock ahead of the merger. The consensus of 12 tracked by Marketbeat is a firm Hold that has been steady for more than a year. The price target is also stable at nearly $52.50 and implies a 13% upside for the market. A move to the consensus target would put this stock at a new multi-year high and confirm the trend put in place back in 2019. 

The technical outlook: Kroger trades at solid support

The price action in KR has been bobbing along a strong support level in anticipation of the upcoming merger. Numerous tests and confirmations mark the support level, which is consistent with the low end of the analysts' target range. This market will unlikely fall through this level without a major change in the fundamentals, which doesn't appear likely now. Assuming the merger is completed or called off, this stock could advance to retest the 2022 highs by the middle of 2024.