Kroger (KR) remains highly profitable and is in our opinion a valuable long-term investment for dividend income as well as market value capital gain. Kroger’s longevity and consistency will remain in place in the coming years. The most recent earnings were painful, but Kroger’s strategic developments and large market presence will give them an edge in the grocery industry for years to come. While there are 'scary' and 'new' headwinds in the form of strong industry competitors, we think these fears are overblown.

We are of the opinion that Kroger shares are in value territory and are a bargain the closer they get to $20. At $20 a share, or below, the shares are a quintessential BAD BEAT Investing^TM DEEP VALUE play. We see them as undervalued based on even modest quantitative forecasts. 

What did we see as the highlights in the most recent quarter?

The key takeaways to be aware of are that sales are growing, margins were slightly pressured, and earnings are expanding.

Sales

Total sales increased 12.4% to $31.0 billion in the fourth quarter compared to $27.6 billion for the same period last year. Total sales, excluding fuel and the 53^rdweek, increased 2.7% in the fourth quarter over the same period last year. For the year, total sales increased 6.4% to $122.7 billion in 2017 compared to $115.3 billion in 2016. Excluding fuel, the 53^rd week and the Modern Health merger, total sales increased 2.2% in 2017 compared to 2016.

Margins

Gross margin was 21.9% of sales for the fourth quarter. Excluding fuel, the 53^rdweek and the LIFO credit and charge, gross margin decreased 31 basis points from the same period last year. Gross margin was 22.0% of sales in 2017. Excluding fuel, the 53^rd week, the Modern Health merger and the LIFO charge and credit, gross margin decreased 19 basis points compared to 2016.

Earnings

Net earnings for the fourth quarter totaled $854 million, or $0.96 per diluted share. Adjusted net earnings for the fourth quarter totaled $562 million, or $0.63 per diluted share Net earnings in the same period last year were $506 million, or $0.53 per diluted share. Net earnings for 2017 totaled $1.9 billion, or $2.09 per diluted share. Adjusted net earnings totaled $1.9 billion, or $2.04 per diluted share. Net earnings in 2016 were $2.0 billion, or $2.05 per diluted share. Excluding the 2016 restructuring of certain multi-employer pension obligations, adjusted net earnings in 2016 were $2.0 billion, or $2.12 per diluted share.

Outlook

Kroger is targeting identical supermarket sales growth, excluding fuel, to range from 1.5% to 2.0% in 2018. Comparable same-store sales had been trending lower, but we think that this The company expects net earnings to range from $1.95 to $2.15 per diluted share for 2018. This was a bit weaker than expected, but also is why we see value.

At $24 a share, the stock is attractive at 12.3 times forward earnings using the low end of this guidance. We think $20 is the sweet spot if it gets that low. Using the high end of guidance, entry at $20 would imply a 9.3 forward price-to-earnings ratio. This is cheap. Price-to-sales would be 0.14, which is disgustingly cheap. Let us not forget the company pays a dividend of 12.5 cents quarterly, or $0.50 per year. This translates to a 2.5% yield. There is also a massive new buyback program, boosting shareholder value.