Investors Still Unsure What’s in Store for Kroger

When supermarket giant Kroger Co. bought Ralphs Grocery and its parent Fred Meyer Inc. this spring, Wall Street hailed the deal and predicted even greater heights for the company.

So why do investors keep punishing Kroger’s stock?

After climbing to $34 a share in mid-March, Kroger’s stock has since tumbled 28% even though the company and industry analysts keep saying the Cincinnati-based chain’s earnings are set to grow even faster with Fred Meyer in the fold.

The slump is all the more notable because Kroger’s stock has been a standout performer in recent years. The stock has more than tripled in price since mid-1994, far outpacing not only its peer group but also the bellwether Standard & Poor’s 500 index.

But two main factors are now depressing the shares, analysts say: Supermarket stocks in general have been out of favor all year, and Kroger’s acquisition of Fred Meyer is still in such an early stage that investors are struggling to evaluate Kroger’s potential.

Indeed, it wasn’t until Tuesday that investors got their first look at a set of quarterly results for Kroger since it bought Fred Meyer in late May for $8 billion in stock. Kroger also assumed about $5 billion of Fred Meyer debt.

Kroger said profit for its fiscal second quarter ended Aug. 14 rose 26% from a year earlier, to 24 cents per diluted share, excluding costs related to the merger and other one-time items. The results matched analysts’ consensus forecast for Kroger, but even the analysts conceded beforehand that they were largely guessing because they, too, hadn’t yet seen how well Kroger was absorbing Fred Meyer.

Hence, “nobody wanted to own the stock in advance” of the announcement, said analyst Mark Husson of Merrill Lynch & Co. in New York. But after the results were announced, Kroger’s stock gained 94 cents, to close at $24.63 a share, in New York Stock Exchange composite trading.

And Kroger itself is saying its growth will pick up next year. Kroger’s chief executive, Joseph Pichler, told an industry conference last week that it expects its earnings per share to grow 16% to 18% annually starting in 2000, up from its recent 13% to 15% growth.

Pichler also said that by the third anniversary of the merger, “I am very confident that Kroger will achieve the $225 million” of annual cost savings that the Fred Meyer deal is expected to generate.

“Long term, Kroger is a great story,” said analyst Lisa Cartwright of J.P. Morgan Securities Inc. in New York. “But short term, you’re going to have some digestion issues with the [Fred Meyer] deal.”

Kroger now operates 2,192 grocery stores--including 302 Ralphs outlets and 82 Food 4 Less stores that were formerly under Fred Meyer’s ownership--along with 796 convenience stores, 380 jewelry stores and 43 food-processing plants, a stable of sites that stretches coast to coast across 31 states. The addition of Fred Meyer also gave Kroger annual sales of $43 billion.

Kroger bought Fred Meyer for the same reasons other major supermarket chains--including Albertsons Inc. and Safeway Inc.--have been buying other chains. With the industry grappling with slow sales growth, they’ve been merging to gain market share and to grow profits by wringing excess costs out of their combined operations. That’s crucial in an industry that earns only a penny or two for every $1 of sales.

The chains also believe that their bigger size will help them wrestle better terms from food makers and other suppliers. And the stores are trying to stay ahead of escalating competition from discount mass merchants, such as Wal-Mart Stores Inc., that are filling more of their aisles with groceries.

Kroger also bought Fred Meyer to gain entry to the lucrative California market via Ralphs and Food 4 Less and to diversify somewhat by acquiring the Fred Meyer stores themselves, which sell a variety of general merchandise besides food.

The merger trend really picked up steam last year--Kroger announced its deal with Fred Meyer in October 1998--and investors bid supermarket stocks sharply higher. But as the merged companies began going through the grinding process of melding their operations, investors’ interest waned.

Also, with the U.S. economy so strong and growth stocks such as technology issues so popular, “defensive” stocks such as grocery chains aren’t as appealing these days, analysts said.

But Husson of Merrill Lynch said he’s still bullish on Kroger, in good part because of the chain’s reputation for running efficient, profitable stores. “Clearly, if Kroger and Fred Meyer do everything they say they’re going to do, you will see three years of 18% earnings-per-share growth per year,” he said. “That’s far from dull, I would argue.”

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Investors have pushed Kroger Co.’s stock steadily lower this year even though analysts expect the giant supermarket chain to benefit from its purchase of Fred Meyer.

Tuesday: $24.63

Source: Bridge News