The Kroger Co. (KR) delivered excellent results this month for its fiscal third quarter, driven by a stellar 5% increase in same-store sales.

Management raised its guidance for the remainder of the year off the strong quarter, prompting analysts to revise estimates higher and sending the stock to a Zacks No. 2 rank ("buy"). As it generates strong free cash flow, management has been rewarding shareholders through stock buybacks and dividend hikes. It currently yields 1.9%.

 

Kroger is the largest traditional grocery retailer in the country with 2,439 supermarkets in 31 states. It was founded in 1883 and is headquartered in Cincinnati, Ohio. It has a market cap of $13.7 billion.

 

Third quarter results

Kroger reported earnings per share at 33 cents for its third quarter, a penny above the same quarter last year and beating the Zacks Consensus Estimate by 2 cents.

 

Sales rose 5%, excluding volatile fuel sales, driven by a stellar 5% increase in same-store sales. This marked the 32nd consecutive quarterly increase in same-store sales.

 

The gross margin declined 34 basis points year-over-year due to food inflation. But this was offset by a 29 basis point decrease in operating, general and administrative expenses as a percentage of sales due to operating leverage.

 

Outlook

Management raised its guidance for the remainder of 2011 following the strong results. The company now expects to earn between $1.95 and $2 a share, up from previous guidance of $1.85 to $1.90.

 

This prompted analysts to revise their estimates higher for both 2011 and 2012, sending the stock to a Zacks No. 2 Rank ("buy"). Analysts have also been raising estimates over the last few days after Kroger and its workers' union agreed on a new pension deal, which is expected to be accretive to EPS in 2012.

 

The Zacks Consensus Estimate for 2011 is now $1.99, within guidance, and representing 13% growth over 2010 EPS. The 2012 consensus estimate is currently $2.20, corresponding with 11% EPS growth.

 

Returning value to shareholders

Kroger generates strong free cash flow, which it has used to return more than $1.8 billion over the last four quarters through share buybacks and dividends.

 

In the third quarter alone, the company spent $471.2 million repurchasing 21 million shares of stock.  And in November, Kroger raised its quarterly dividend by 10%. It currently yields a solid 1.9%.

 

Valuation

Valuation looks very reasonable for KR. Shares trade at just 10.8 times 12-month forward earnings, a discount to the industry average of 12.9 times forward earnings, and a discount to its 10-year median of 12.4 times earnings. Based on a five-year EPS growth rate of 9.5%, it sports a PEG ratio of 1.1.

 

The bottom line

With rising estimates, solid growth projections, shareholder-friendly​ management and reasonable valuation, Kroger offers a lot to like.

 

Todd Bunton is the Growth & Income Stock Strategist for Zacks Investment Research and Co-Editor of the Reitmeister Value Investor.

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