THE HEDGEYE EDGE
Our decision to go long KR combines the fundamental turnaround and MPP actions by the company.
- Starting with fundamentals (Sales, Gross Margin, EBIT, EPS), where we saw a marked improvement in 3Q17 on a one year basis. Looking out to CY2018, KR has a favorable setup with easy comparisons due to their poor performance and extreme deflation over the past 18 months.
- We are looking for sales to improve on the heels of investments into the business which will enable long-term operating profit and EPS growth as they gain greater leverage in their model.
- Recently, KR announced that they have withdrawn from the Central States Pension Fund, effective on December 10, 2017. The company will record a one-time non-cash charge of approximately $410M in the fourth quarter, to remove 1,800 active associates from the plan. This is a big step in the right direction, but they have more work to do on the pension front.
THE FUNDAMENTAL STORY
KR is embarking on an aggressive turnaround initiative using data to modify and customize stores for each particular geography. But winning the grocery wars will have to go far beyond getting the shelf sets right. Kroger’s online ordering platform, ‘Clicklist’ recently went through a round of improvements to elevate the visuals and functionality.
Kroger is also expanding their efforts in delivery through third party partnerships. As of their 3Q17 earnings conference call they had delivery available in 300 locations and expect to continue to expand this offering in 2018 through a “unique relationship” with Instacart among other partners. KR has been behind on these key initiatives, but we believe KR plays in a sweet spot within conventional supermarkets catering to a wider range of demographics versus its largest competitor, which will allow them to gain considerable traction.
Furthermore, KR’s larger store size versus the likes of Whole Foods is more conducive to creating a warehouse type space within the store. As they continue to evolve within the Future of Food Retail we could see them shifting center of store items into a pick-and-collect type model, which will be a huge time saver for the consumer and a labor savings for the store.
Kroger also has a number of other fundamental positives going for it:
- Strong private label offering that comes at a higher margin
- Stealing share from independents
- Potential c-store asset sale
- Taking a heavy-handed approach with suppliers
- Food at home inflation
BEING PROACTIVE ON MPP’S
There has been news floating around that KR was attempting to get out of the Central States Pension Fund since last summer when Kroger participants sued the plan because they wanted to leave to start a new one (ARTICLE HERE). Now that the action is official, it is further proof Kroger is taking their pension liabilities seriously.
KR has taken a number of actions over the last year to shore up their pension liabilities; from taking a bigger portion of liabilities onto their balance sheet, issuing $1B of debt to shore up company-sponsored plans, and now paying a $410M withdrawal liability to remove 1,800 active associates from the Central States Pension Fund, just to name a few.
Going back to our original SHORT KR black book from May 2016, we had stated, based on precedent withdrawals, that their liability could have been anywhere from ~$25K to ~$300K per participant. This withdrawal comes out to about $227K per participant, well within the range.
For the time being, with interest rates rising and the S&P 500 near all-time highs, the KR pension issue will take a back seat to improving fundamentals.
ONE-YEAR TRAILING CHART
