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Deep Dive: Warren Buffett bucks Wall Street by adding more Kroger stock to his portfolio

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When investors think about the supermarket industry, dynamic growth probably doesn’t come to mind. But Berkshire Hathaway CEO Warren Buffett loves Kroger.

One reason may be that the stock is cheaply priced relative to earnings estimates. Another is that Kroger Co. KR is ramping up online sales; digital sales increased 16% in the fiscal first quarter ended May 22 from a year earlier and more than doubled from two years earlier. More growth could come from the food retailer’s plans to build fulfillment centers to handle digital orders.

Berkshire Hathaway Inc.
BRK.B,
-0.12%

BRK.A,
+0.06%

purchased nearly 11 million shares of Kroger in the second quarter, according to its latest 13F report with the Securities and Exchange Commission. That brings its stake to 61.8 million shares, or about 8.3% of shares outstanding as of May 22, the end of Kroger’s fiscal first quarter.

Read: Warren Buffett’s Berkshire Hathaway buys Kroger, cuts stakes in drug makers

Wall Street doesn’t like Kroger

While Berkshire appears fond of Kroger, which operates as Harris Teeter, Fred Keyer and King Soopers, among others, as well as Kroger, Wall Street is more skeptical.

Within the Russell 3000 Index, which represents about 98% of the U.S. stock market by market capitalization, there are only 10 companies in the “food retail” industry group, according to FactSet. Here they are, sorted by market capitalization, along with forward price-to-earnings ratios.

Company Market cap. ($mil) Forward P/E
Walmart Inc.
WMT,
-0.03%
$422,424 24.9
Kroger Co.
KR,
+4.58%
$32,467 15.0
Albertsons Cos. Inc. Class A
ACI,
+0.65%
$13,688 13.5
Sprouts Farmers Markets Inc.
SFM,
+2.52%
$2,767 12.3
Grocery Outlet Holding Corp.
GO,
+1.01%
$2,565 27.9
Weis Markets Inc.
WMK,
+1.47%
$1,502 N/A
Arko Corp.
ARKO,
-0.48%
$1,033 16.5
Ingles Markets Inc. Class A
IMKTA,
+0.62%
$917 N/A
Natural Grocers by Vitamin Cottage Inc.
NGVC,
+1.80%
$264 N/A
Village Super Market Inc. Class A
VLGEA,
+0.09%
$233 N/A
Source: FactSet

For comparison, the S&P 500 index
SPX,
-0.71%

has a weighted forward P/E of 21.4, according to FactSet.

There are no P/E ratios for four of these companies because consensus earnings estimates aren’t available. Three aren’t covered by any analysts polled by FactSet, while Natural Grocers by Vitamin Cottage Inc.
NGVC,
+1.80%

is covered by only one analyst.

For the six companies covered by at least four analysts, here’s a summary of ratings and price targets:

Company Share “buy” ratings Share  neutral ratings Share “sell” ratings Closing price – Aug. 16 Consensus price target implied 12-month upside potential
Walmart Inc.
WMT,
-0.03%
75% 19% 6% $152.34 $165.10 8%
Kroger Co.
KR,
+4.58%
21% 54% 25% $45.43 $38.49 -15%
Albertsons Cos. Inc. Class A
ACI,
+0.65%
55% 40% 5% $30.04 $25.28 -16%
Sprouts Farmers Markets Inc. 25% 50% 25% $24.55 $26.50 8%
Grocery Outlet Holding Corp. 33% 60% 7% $26.63 $34.36 29%
Arko Corp. 100% 0% 0% $8.15 $13.25 63%
Source: FactSet

Among these six stocks, Walmart Inc.
WMT,
-0.03%
,
Albertsons Cos.
ACI,
+0.65%

and Arko Corp.
ARKO,
-0.48%

have majority “buy” or equivalent ratings, with Albertson trading well above the consensus target price.

Two — Kroger and Sprouts Farmers Markets Inc.
SFM,
+2.52%

— have 25% “sell” or equivalent ratings. That is a dubious distinction, considering that analysts who work for brokerage firms tend to shy away from negative ratings. Only 5% of the S&P 500 have 25% or more “sell” ratings.

Here’s a look at sales estimates (in millions) for the group of six food retailers for calendar years going out to 2025, with projected compound annual growth rates (CAGR):

Company Projected sales CAGR Est. sales – 2020 Est. sales – 2021 Est. sales – 2022 Est. sales – 2023 Est. sales – 2024 Est. sales – 2025
Walmart Inc.
WMT,
-0.03%
2.2% $556,334 $555,252 $569,243 $589,791 $607,056 $619,743
Kroger Co.
KR,
+4.58%
2.2% $131,133 $132,473 $134,412 $136,506 $141,695 $146,252
Albertsons Cos. Inc. Class A
ACI,
+0.65%
1.8% $68,664 $67,714 $68,412 $70,006 $72,540 $75,056
Sprouts Farmers Markets Inc.
SFM,
+2.52%
5.6% $6,468 $6,202 $6,665 $7,230 $7,826 $8,491
Grocery Outlet Holding Corp.
GO,
+1.01%
7.4% $3,135 $3,104 $3,444 $3,842 $4,068 $4,477
Arko Corp.
ARKO,
-0.48%
18.3% $3,911 $7,366 $7,749 $8,299 $8,713 $9,060
Source: FactSet

For sales and earnings, we are using estimates for 2020 because some fiscal periods don’t even match calendar quarter-end dates.

Kroger is in the bottom half of that list.

Even if a company’s profits are increasing slowly, its earnings per share can be boosted if it buys back enough stock to lower the average share count. Kroger announced a new $1 billion share buyback program in June. This means the company’s board of directors is confident the supermarket chain will have plenty of free cash flow beyond what it will need to fund its planned digital transformation.

Here’s a set of estimates for earnings per share, with projected CAGR:

Company Projected EPS CAGR Est. net income – 2020 Est. net income – 2021 Est. net income – 2022 Est. net income – 2023 Est. net income – 2024 Est. net income – 2025
Walmart Inc.
WMT,
-0.03%
7.2% $5.44 $5.96 $6.30 $6.85 $7.38 $7.70
Kroger Co.
KR,
+4.58%
0.4% $3.37 $3.10 $3.06 $3.13 $3.36 $3.43
Albertsons Cos. Inc. Class A
ACI,
+0.65%
-1.1% $2.79 $2.36 $2.21 $2.34 $2.48 $2.63
Sprouts Farmers Markets Inc.
SFM,
+2.52%
6.7% $2.48 $1.97 $2.08 $2.34 $2.90 $3.43
Grocery Outlet Holding Corp.
GO,
+1.01%
3.9% $1.15 $0.88 $1.01 $1.14 $1.23 $1.39
Arko Corp.
ARKO,
-0.48%
24.7% $0.27 $0.35 $0.43 $0.53 $0.67 $0.81
Source: FactSet

As you can see, Kroger is expected to see an earnings decline. Rival Walmart is expected to achieve a respectable EPS CAGR.

So a lot is riding on Kroger’s big bet that people will increasingly shop for food online instead of walking the store aisles. Buffett is a believer, and when considering how much shopping habits have changed for non-food items, he may have picked another long-term winner.

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