Deep Dive: Warren Buffett bucks Wall Street with Kroger stock pick

Berkshire Hathaway Inc.
BRK.B,
-0.32%

BRK.A,
-0.20%
purchased nearly 11 million shares of Kroger in the second quarter, according to its latest 13F report with the Securities and Exchange Commission. That brings its stake to 61.8 million shares, or about 8.3% of shares outstanding as of May 22, the end of Kroger’s fiscal first quarter.

Read: Warren Buffett’s Berkshire Hathaway buys Kroger, cuts stakes in drug makers

Wall Street doesn’t like Kroger

While Berkshire appears fond of Kroger, which operates as Harris Teeter, Fred Keyer and King Soopers, among others, as well as Kroger, Wall Street is more skeptical.

Within the Russell 3000 Index, which represents about 98% of the U.S. stock market by market capitalization, there are only 10 companies in the “food retail” industry group, according to FactSet. Here they are, sorted by market capitalization, along with forward price-to-earnings ratios.

For comparison, the S&P 500 index
SPX,
-1.02%
has a weighted forward P/E of 21.4, according to FactSet.

There are no P/E ratios for four of these companies because consensus earnings estimates aren’t available. Three aren’t covered by any analysts polled by FactSet, while Natural Grocers by Vitamin Cottage Inc.
NGVC,
+0.77%
is covered by only one analyst.

For the six companies covered by at least four analysts, here’s a summary of ratings and price targets:

Among these six stocks, Walmart Inc.
WMT,
+0.04%,
Albertsons Cos.
ACI,
+0.24%
and Arko Corp.
ARKO,
-1.63%
have majority “buy” or equivalent ratings, with Albertson trading well above the consensus target price.

Two — Kroger and Sprouts Farmers Markets Inc.
SFM,
+2.21%
— have 25% “sell” or equivalent ratings. That is a dubious distinction, considering that analysts who work for brokerage firms tend to shy away from negative ratings. Only 5% of the S&P 500 have 25% or more “sell” ratings.

Here’s a look at sales estimates (in millions) for the group of six food retailers for calendar years going out to 2025, with projected compound annual growth rates (CAGR):

For sales and earnings, we are using estimates for 2020 because some fiscal periods don’t even match calendar quarter-end dates.

Kroger is in the bottom half of that list.

Even if a company’s profits are increasing slowly, its earnings per share can be boosted if it buys back enough stock to lower the average share count. Kroger announced a new $1 billion share buyback program in June. This means the company’s board of directors is confident the supermarket chain will have plenty of free cash flow beyond what it will need to fund its planned digital transformation.

Here’s a set of estimates for earnings per share, with projected CAGR:

As you can see, Kroger is expected to see an earnings decline. Rival Walmart is expected to achieve a respectable EPS CAGR.

So a lot is riding on Kroger’s big bet that people will increasingly shop for food online instead of walking the store aisles. Buffett is a believer, and when considering how much shopping habits have changed for non-food items, he may have picked another long-term winner.

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