2 Top Grocery Stocks to Buy

In times of high inflation and economic volatility, grocery stores are among the businesses that offer investors safe, predictable havens. Although consumer habits change during economic downturns, the demand for food and household essentials remains more or less constant. Two of the top grocery stocks to consider buying in today’s market are Target and Kroger, but what makes them special?

Target

Discount and grocery store chain Target (NYSE:TGT) has been heavily embattled since mid-2022 when it reported sharply lower operating profits related to excessive inventories.

Down more than 10 percent YTD, Target now looks as if it may be oversold. This could provide long-term investors an attractive buying opportunity before a potential upward rebound.

The primary bull case for Target rests on its apparent undervaluation at today’s prices. At just 16.2 times forward earnings and 1.05 times earnings growth, Target shows marked signs of trading at a discount to its intrinsic value.

The median analyst price forecast for the stock is $170, about 27.6 percent above the most recent price of $133.08.

Given Target’s projected forward earnings of $10.25 per share and potential for further earnings growth if its profit margins rebound, this forecast seems to be supported by a conservative discounted cash flow analysis.

This value case is bolstered by the company’s underlying fundamentals. Even as share prices declined throughout 2022, Target’s sales and traffic remained essentially flat from Q1 2022 to Q1 2023.

Operating income margin fell modestly from 5.3 percent to 5.2 percent, while gross margins rose from 25.7 percent to 26.3 percent. Diluted earnings per share shrank 4.8 percent from $2.16 to $2.05, but this dip hardly justifies the selloff target has seen over the same period.

Solid Dividend Can Be Trusted?

Target is appealing to long-term investors because of its large and stable dividend. Target is among the dividend kings, having increased its annual distribution for 52 consecutive years.

Today, each share of Target pays $4.32 annually. This equates to a yield of 3.24 percent, more than double the 1.52 percent average of the stocks in the broader S&P 500. Over the last 10 years, Target has increased its dividend at a compounded annual rate of 11.6 percent.

A final point in Target’s favor for long-term investors is the fact that the stock may be attractively discounted as a result of cyclical declines in consumer spending. Inflation has hit the stock hard, sending it down approximately 50 percent since its high in 2021.

In the most recent earnings report, Target emphasized strong consumer essentials purchases, including groceries, while seeing its sales of home goods and other discretionary items lag. Over the past year, the company has drawn down its inventories of these discretionary product categories by about 25 percent.

This does not mean, however, that Target’s woes will be permanent. Current projections suggest that inflation will cool to slightly above 2 percent by 2024 and stabilize at that level for most of the remaining present decade.

This easing of inflation could bolster consumer confidence and allow Target to rebuild its discretionary product revenues. Even without a full recovery, the value argument for Target remains compelling.

It’s worth acknowledging, however, that Target is far from a risk-free value proposition. The company estimates that shrink will impair its total profits by as much as $500 million this year, though management claims it is developing strategies to counter the growing problem of widespread retail theft.

Persistent inflation or a mild recession beginning later in the year could also exert unexpected downward pressure on earnings.

Kroger

Kroger (NYSE:KR) is one of America’s largest grocers, ranking number three in market share behind only Walmart and Costco. However, it has not sold off like Target; instead Kroger has advanced just 6.2 percent YTD.

As such, the stock may present a buying opportunity for investors seeking to capitalize on the start of a new bull market that has carried many other stocks considerably higher.

Unlike Target, Kroger has seen its earnings grow robustly over the past year. EPS for FY2022 was $3.06, compared to just $2.17 in 2021.

Total revenues rose from $137.9 billion to $148.3 billion, and administrative expenses dropped by 19 basis points. Taking these factors into account, Kroger appears undervalued.

This view is supported by the company’s incredibly low price-to-cash-flow ratio of 4.97 and forward P/E ratio of 10.52.

Kroger’s price-to-earnings-growth ratio is 1.83, which is somewhat high and would normally indicate potential overvaluation.

In Kroger’s case, however, the 3 to 5 year expected earnings growth rate of about 7.4 percent likely outweighs the short-term expectation of flat earnings. The median target price for Kroger is $51.70, 9.2 percent higher than its current price.

Kroger Is No Dividend King But…

While Kroger isn’t among the dividend kings, it has been steadily raising its dividend for the last 17 years. Kroger currently yields 2.19 percent and pays $1.04 per share annually.

It’s also worth noting that Kroger may be a superior choice for dividend growth investors. Although its yield is considerably below that of Target, Kroger has raised its dividend at an annualized rate of 13.9 percent over the past 10 years.

Even more importantly, Kroger’s payout ratio is still just 29.8 percent, compared to Target’s 73.6 percent. As such, Kroger’s management appears to have much more room to increase distributions in the near term.

Another point in Kroger’s favor is its seemingly strong moat in the grocery business. While Walmart and Costco have larger market shares, Kroger’s competitive advantage comes largely from the value proposition offered by its private-label products.

These products, which offer much higher margins than brand-name alternatives, are popular options for consumers during economically difficult times. This was evidenced in Kroger’s Q4 results, as private label sales grew 10.1 percent compared to just 6.2 percent across all product categories, excluding fuel.

Although it is a legacy company, Kroger is also advancing a new growth strategy driven by fresh foods and digital sales convenience. Over the long term, this strategy may help Kroger gain market share among consumers.

Finally, Kroger generates an industry-leading return on equity for its shareholders. Kroger’s reported ROE over the past 12 months was 30.96 percent, beating out Walmart and Costco with 21.3 percent and 28.18 percent, respectively.

One significant risk factor for Kroger is its somewhat elevated debt load, which at 1.11 times equity is concerning for a company that will likely not see explosive earnings growth in the near future. Management has paused share buybacks to focus on reducing the company’s debt load, but it may take quite some time to reduce Kroger’s debts to a conservative level.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.