Ever since it was announced that The Kroger Co. (NYSE:KR) would be acquiring Albertsons Companies, Inc. (ACI) in a multi-billion-dollar transaction to create one of the largest food retailers in the country, I have been of the opinion that there is a relatively high probability that the deal will fall through. In fact, in early February of this year, I even said that, because of regulatory concerns, it looked almost certain that the transaction would never be completed. In that article, I made the claim that there was close to a 0% probability of the deal being completed. This led me to reiterate my 'strong buy' rating for Albertsons because, while the deal going through would result in significant short-term upside, shares looked significantly undervalued even if the company continued operating on its own.
In that same article, I reiterated my 'buy' rating for Kroger. This is based on how shares were priced and the additional value that could be captured from completing its acquisition of Albertsons. Subsequent to that article, I did write an article dedicated to Albertsons alone in April. This involved financial results for the final quarter of 2023. It also covered a deal announced between it, Kroger, and C&S Wholesale Grocers by which the C&S would acquire additional stores in order to appease regulators. But I have not done a standalone reassessment of Kroger for some time.
Given that I think that the deal probably will not be completed, it would make sense to re-evaluate Kroger as well. Digging into the most recent data provided, I do see a picture that is somewhat mixed. But when you consider how shares are priced, it's difficult to imagine a scenario where the stock experience is much in the way of downside. In fact, I view this as a favorable risk-to-reward opportunity that justifies a 'buy' rating, with or without its pending transaction with Albertsons being completed.
Shopping for a bargain
In terms of market presence, Kroger is one of the largest retailers on the face of the planet. The company has a market capitalization as of this writing of $39.12 billion. But the sheer size of the company can only be understood when looking at financial results for a complete fiscal year. Revenue in 2023, for instance, came in at a whopping $150.04 billion. That represents a 1.2% increase over the $148.26 billion the company generated in 2022. Admittedly, there are some adjustments that should be made to this figure. First and foremost, in 2023, the company benefited from an extra operating week. In addition to this, the company has extensive operations dedicated to selling fuel from its gas stations. Margin associated with fuel sales is often very small, though revenue can be tremendous. And because of the volatility in the fuel industry, it would make sense to remove this from the equation in order to get a more normalized understanding of how things are going.
Stripping out these items, we ended up with revenue in 2023 of $130.99 billion. That is still 1.1% above the $129.63 billion generated in 2022. According to management, same-store sales, or what management calls identical sales, inched up by only 0.9%. But if we exclude fuel from the equation and adjust for the fact that, in 2023, the company did not have pharmacy sales associated with the termination of its agreement with Express Scripts that ended in 2022, identical sales would have risen by 2.3%. It is worth noting that the company is a leader in digital sales. Last year, $12 billion worth of revenue came from these operations. Examples include sales associated with products that are ordered online and picked up at the company's stores, or that it delivers to customers. The delivery operations of the company performed particularly well, jumping 25% year over year. For those not familiar, these solutions include orders that are delivered to customers from retail store locations, as well as customer fulfillment centers and sales that are placed through third-party platforms.
Even though revenue increased, profitability for the company pulled back from $2.24 billion to $2.16 billion. However, there are certain adjustments that would be appropriate to make. Merger-related costs in 2023, for instance, totaled $268 million. That was up from $34 million in 2022. The company also booked a $1.16 billion settlement charge involving opioid litigation. That was up drastically from the $67 million reported one year earlier. There were other adjustments as well. But on an adjusted basis, which also would include the extra operating week for the company, net income would have risen from $3.10 billion in 2022 to $3.34 billion last year. Other profitability metrics grew as well. Operating cash flow jumped from $4.50 billion to $6.79 billion. But unfortunately, once we adjust for changes in working capital, we get a decline from $7.69 billion to $5.98 billion. Lastly, EBITDA for the business managed to fall from $8.08 billion to $7.95 billion.
We do not yet have any data covering the 2024 fiscal year. But management has come out with guidance for the year. This guidance assumes that the transaction involving Albertsons will not be completed. Even though a specific estimate for revenue has not been provided, management did say that identical sales should grow by between 0.25% and 1.75% year over year. Management also anticipates adjusted profits of between $4.30 and $4.50 on a per share basis. That would imply adjusted income, at the midpoint, of about $3.19 billion. Management also expects adjusted operating income of between $5.9 billion and $6.3 billion. At the midpoint, this should translate to EBITDA of around $8.11 billion.
Using these metrics, I was able to value the company as shown in the chart above. While the stock may not be the cheapest relative to earnings, it does look attractively priced on a cash flow basis. I love seeing companies trade at cash flow multiples that are in the mid to high-single digit range. It definitely indicates potential exists. In the table below, I then compared the firm to five similar enterprises. On a price-to-earnings basis, Kroger ended up being cheaper than all but one of the five companies that I compared it to. This number rises slightly to two of the five when using both the price-to-operating cash flow approach and the EV-to-EBITDA approach. This place is a company near the lower end of the spectrum on a valuation basis.
Company Price / Earnings Price / Operating Cash Flow EV / EBITDA The Kroger Co. 11.8 6.5 6.1 Albertsons Companies, Inc. ((ACI)) 9.3 4.5 4.3 Metro Inc. (OTCPK:MTRAF) 17.1 10.8 9.8 Casey's General Stores, Inc. (CASY) 26.6 14.7 13.8 J Sainsbury plc (OTCQX:JSAIY) 50.1 3.5 3.3 Sprouts Farmers Market, Inc. (SFM) 27.3 16.1 11.5
Takeaway
As much as I would love to see the transaction between Kroger and Albertsons come to fruition, investors would be wise to value the companies on a standalone basis just in case the worst comes to pass. I am much more bullish on Albertsons than I am on Kroger. But when you consider how cheap Kroger is and the fact that the company continues to grow, I do believe that it justifies a good degree of optimism. So while it may not be the most attractive opportunity on the market and may have some mixed results from time to time, I think that the company makes for a solid 'buy' candidate at this point in time.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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