As Margin Threats Intensify, Kroger Shares May Be Past Their Expiration Date

There’s no reprieve in sight for Kroger Co KR, which last week fell 26.5 percent on lowered fiscal 2017 guidance and Amazon.com, Inc. AMZN's announcement that it will acquire Whole Foods Market, Inc. WFM.

Kroger's Take

For its part, the company told Benzinga, "We expect to continue to gain share" and that it will continue to adapt to the changing business landscape.

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Morgan Stanley analyst Vincent Sinisi is not so optimistic though, downgrading the company to Equal Weight with a price target reduced from $32 to $23.

Analyst's Commentary

Sinisi believes the lack of faith from investors is fair, given the uncertain outlook for the food retail sector as a whole (see Sinisi's track record).

“We believe there is increased structural margin risk within the sector and we have updated our estimates, [discounted cash flow] valuations and multiple bases accordingly,” said Sinisi. “We believe today's valuations are pricing in a no-growth scenario.”

The analyst forecasts near-flat earnings through fiscal 2020 and flat 2.6-percent EBIT margins afterward.

Sinisi stressed that he believed current grocery pricings with no growth are fair, although they will depend on how much the Amazon–Whole Foods combo will impact the sector.

Upside, Downside Risks

The noted upside and downside risks are essentially two sides of the same coin. Less-than-feared increases in competition would make for the upside and worse-than-feared margin pressures from greater competition characterize the potential downside.

Sinisi lowered price targets across the board for the food retail sector, including Smart & Final Stores Inc SFS, Sprouts Farmers Market Inc SFM, SUPERVALU INC. SVU and United Natural Foods, Inc. UNFI, by an average of 18 percent.

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