How Healthy Are Supermarkets?

• Citi conducted its September survey of 59 store managers at stores that directly compete with Kroger Co KR, its top pick Buy.
• The analysts concluded “that supermarket margin conditions don’t appear to have changed much in the month of August so we shouldn’t see a major degradation in margins YOY.”
• They also note that Kroger remains an attractive investment option at current valuations.

In a report issued Thursday, Citi analyst Alvin C Concepcion shares some takeaways from the firm’s September survey of supermarket managers.

Kroger Still Strong

Kroger recently disclosed healthy ID sales trends (at 5.3 percent) in the third quarter -- through 9/11. Tougher sequential year-over-year comparisons will probably have an impact on the remainder of the third quarter results, so Citi continues to model 4.5 percent ID sales for the period.

Concepcion adds, “Given Kroger has shown a strong ability to operate well in this current environment, we have increased confidence that it should be able to achieve our estimates.”

In terms of valuation, Kroger also looks quite attractive, since its stock trades at a 13 percent discount -on a ‘16 P/E basis- to Costco Wholesale Corporation COST and Wal-Mart Stores, Inc. WMT (Consensus) despite Citi’s forecast of ~130 percent faster EPS growth and ~58 faster same store sales growth – compared to consensus estimates for the peer group for the next three years.

“Relative to a broader food retail peer group, shares trade at a 2% discount on a '16 P/E basis despite KR expected to grow EPS 32% faster and SSS 64% faster over the next 3 years versus consensus estimates for the peer group,” the expert concludes.

The Competitors

According to the research note, supermarkets competing with Kroger seem to have seen sales grow in August, largely driven by discounts, an ameliorating economic situation, and better service.

Overall, the survey suggests that the margin environment remains pretty much unchanged – and rational.

Finally, the analyst notes that a healthy industry backdrop may also bode well for Sprouts Farmers Market Inc SFM. However, he adds, it is not as clear since Citi’s survey didn’t specifically look into the natural/organic category.

Disclosure: Javier Hasse holds no positions in any of the securities mentioned above.