Kroger’s 4Q EBIT Margins and EPS Ahead of Consensus; Shares Fairly Valued

Kroger KR reported fourth-quarter positive identical-store sales growth within its guidance range, improving EBIT margins, and earnings per share ahead of consensus. Moreover, management provided fiscal 2013 earnings guidance ahead of current Street expectations. The stock is now trading at our published USD 30 fair value estimate. However, we plan to increase our fair value estimate to account for fourth-quarter EBIT margins and updated guidance above our forecast, as well as adjustments for the time value of money since we last updated our discounted cash flow model.

Kroger does not have an economic moat, but unlike its traditional grocery industry peers, the company continues to drive consistent market share gains. This is the reason we place Kroger’s moat trend at stable, rather than negative, as is the case for most of the other supermarket operators in our coverage space.

The company posted, excluding fuel, a 3% identical-store, or ID, sales increase in the fourth quarter, within its 3.0%-3.5% guidance range. Kroger has now reported positive ID sales for 37 straight quarters, which is in stark contrast to the flat to negative ID sales for at Supervalu SVU and Safeway SWY over the past three or so years. For the year ID sales (excluding fuel) increased 3.5%. Identicalstore sales on a sequential and two-year rate basis did decelerate 20 and 30 basis points, respectively. Excluding fuel, the two-year ID sales rate slowed to 7.9%, down from 8.2% in the prior quarter, but remains well ahead of industry peers. Management expects ID sales in the 2.5%-3.5% range for the fiscal 2013, which likely takes into account slowing inflation.

Overall consolidated gross margin rates increased to 20.9% this quarter, up about 13 basis points from the year-ago period. The slight gross margin gain coupled with 75 basis points of overall expense leverage moved consolidated operating margins to 3.4% this quarter, up from 2.5% (excluding certain one-time items) last year. Management and consensus frequently parse out the impact of gasoline, but we have a different view because fuel sales are a crucial part of Kroger’s business model that drives customer traffic, so we include that in our margin analysis. For the fiscal 2012 year, EBIT margins improved 20 basis points to 2.2%, better than the 2.0% reported in 2011.

The company generated fourth-quarter operating EPS of USD 0.86, which excludes USD 0.02 per share for certain one-time tax benefits, but includes USD 0.11 from an extra week this year versus last year. We do not know if the USD 0.69 EPS consensus mean estimate included the extra week impact, but even without, Kroger delivered significant earnings upside this quarter. On a GAAP basis, the company reported USD 2.77 in EPS, which includes the discrete tax item of USD 0.02 per diluted share in the fourth quarter and USD 0.14 per diluted share benefit from the credit card settlement and a reduction in the UFCW pension accrual in the third quarter. Management updated EPS guidance for fiscal 2013 to a range of USD 2.71-USD 2.79, ahead of the current USD 2.66 EPS consensus estimate. We believe that target is achievable based on 2.5% ID sales, slightly better EBIT margins, and further share repurchases. We plan to update our model accordingly.

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Justin focuses on tech and internet news.