Once-Wilted Grocery Stocks Show Signs of Rebound

 | May 16, 2017 | 10:00 AM EDT
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Food prices jumped 0.5% in March, the largest monthly increase in three years, as reported by the Labor Department. Food sellers have been hurt by falling prices over the last year, so the rebound, which caps three straight months of steady gains, should be welcome news to grocers that have struggled to maintain profit margins amid fierce price wars.

The activist fund Jana Partners took on a 9% stake in Whole Food Markets (WFM) earlier this year and forced it to shuffle its board of directors and make other changes to boost results. Whole Foods has been trying to shake its reputation as an expensive place to shop, focusing on its smaller 365-brand stores, which sell less expensive products.

In April, the stock spiked on rumors of a possible takeover by the private-equity owners of the giant Albertson's chain.

Health food supermarket chain Sprouts Farmers Markets (SFM) was also a recent subject of speculation by the same private-equity owners, a deal that hasn't happened but would add organic products to brands Albertson's already owns, such as Von's and Safeway.

Whole Foods has been stumbling as lower-cost rivals like Kroger (KR) go the other direction, trying to appeal to shoppers who want higher-quality, fresher products. Kroger shares are down 11.9% since the end of last year, but have recently started to bounce back, and many see it as an undervalued stock ready to rise.

To find investment opportunities in the grocery aisle, I utilized a series of fundamentally based quantitative models that are constructed around the stock-picking methods by or about great investors, including Warren Buffett, Peter Lynch and a number of other successful strategists.

The recent decline in Kroger's stock is one reason why the shares score high based on the investment method outlined by James O'Shaughnessy. The O'Shaughnessy method rewards stocks of large-cap companies with free cash flow and high dividends. One of the key investment criteria in the model is cash flow per share, which must be greater than the mean of the market cash flow per share. Kroger's cash flow is $4.71 vs. $1.71 for the overall market.

Kroger, which has nearly 2,800 stores across the country, has built itself through acquisitions over the years and was the subject of speculation it could also do a deal for Whole Foods, though that may be just wishful thinking.

The stock carries a price-to-earnings ratio of 14, compared to 17 for grocery rival Walmart (WMT) , 31 for warehouse retailer Costco COST, and 177 for Amazon (AMZN) , the e-commerce giant that has been trying to elbow in on grocery delivery.

Traditional grocery stores are also under pressure from startup meal-kit delivery services like Blue Apron, HelloFresh and Home Chef, a still-small part of the overall industry but one that threatens to disrupt because of their appeal to the lucrative upper-income customer segment, according to Morningstar research. Blue Apron could potentially launch an initial public offering in the future, and Walmart, Kroger and Amazon are seen as potential acquirers in this space, Morningstar says.

Here are some other stocks that score well in our guru-based investment models:

Sprouts Farmers Market: With 256 stores in 14 states, this is a relatively smaller specialty retailer that sits squarely in the model based on Peter Lynch's method outlined his book One Up on Wall Street. The company is considered a "fast grower" based on the Lynch model. Lynch uncovered growth stocks with reasonable valuations using the PE/G ratio, which compares the stock's price-to-earnings ratio to the growth rate. Anything under 1.0 is favorable. Sprouts carries a PE/G of 0.69.

Weis Market (WMK) : Another relatively small retailer, with just over 200 stores in the mid-Atlantic region. It scores well based on Kenneth Fisher's Super Stocks formula, with a low price-to-sales of 0.5 that indicates it is a deeply undervalued stock. The stock yields 2.2%, which is decent.

Village Super Market (VLGEA) is the smallest stock of the lot with just a $250 million market cap. The company operates 29 ShopRite supermarkets in various locales in New Jersey and surrounding states. The Fisher model also ranks this stock highly, in part due to the ultra-low P/S ratio of 0.15. The company's debt-to-equity of 15.8% along with positive free cash flow per shares adds to the attractiveness of this small-cap name.

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