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Is Betting Against The U.S. Consumer A Good Move?

By Elliott H. Gue, on Dec. 15, 2014

From the early 1980s until the beginning of the Great Recession in 2007, conventional wisdom held that investors should never bet against the US consumer.

For almost three decades, a steady decline in US interest rates and lending standards supported a consumer spending spree despite relatively stagnant wages.

The indefatigable US consumer helped to pull the US economy from recessions in 1991 and 2001. In fact, despite the Sept. 11 terrorist attacks and a plummeting stock market in the wake of the tech bust, personal consumption expenditures—a good proxy for consumer spending on goods and services—remained in positive territory throughout 2001.

Over the 24 months ended Dec. 31, 2003, quarterly US economic growth averaged almost 3 percent, with consumer spending accounting for the bulk of that growth.

(Click graph to enlarge.)PCE and US GDP

The 2007-09 credit crisis, housing market collapse and Great Recession marked the peak of the US consumer boom.

When real estate prices topped out and started to tumble, consumers could no longer tap their home equity to finance discretionary spending. And the worst financial crisis since the 1930s prompted banks and other lenders to tighten their credit standards, further crimping consumers’ buying power.

In the aftermath, consumers refocused on paying down debt and saving money, removing a key tailwind for retailers and consumer-discretionary stocks.

(Click graph to enlarge.)US Personal Savings Rate

As we detailed in Will Retailers Rally Because of Lower Oil Prices?, the long-term shift in savings rates and credit conditions suggest that selectivity is crucial when investing in stocks leveraged to consumer spending. However, falling oil, natural-gas and agricultural prices are a positive for the US economy and some high-quality names in the group.

Here’s a look at two retailers that should outperform in this environment.

Kroger (NYSE: KR)

The second-largest food retailer in the US, Kroger generates about $98 billion in annual sales from its 2,600 locations spread across 31 states. The company operates convenience stores and supermarkets under a number of different brand names including Tom Thumb, Kroger and Harris Teeter.

In Kroger’s most recent earnings call, management raised its full-year guidance for earnings per share and sales growth at stores open for at least one year. CEO Rodney McMullen also noted that increased consumer confidence has manifested itself in actual sales trends and customers’ comments in internal surveys.

The recent decline in energy costs should boost spending among lower-income consumers, an important demographic for mass-market grocery store chains.

Besides ongoing improvement in consumer confidence, Kroger also offers exposure to several company-specific upside catalysts, including the success of the firm’s Simple Truth corporate brand, which specializes in natural and organic foods.

(Click graph to enlarge.)US Sales of Organic and Natural Foods

Sales of natural and organic foods are projected to reach $100 billion in the US this year, up from $90 billion in 2013 and $61 billion five years ago. This impressive momentum makes natural and organic products the fastest-growing segment in the grocer industry.

Private labels like Simple Truth usually carry higher profit margins for grocery store chains than goods from prominent brands.

Kroger launched Simple Truth in January 2013 and expects the label to reach $1 billion in sales by the start of 2015. Sales of these items continue to grow at a double-digit rate, and the company continues to expand the shelf and floor space allocated to the label to take advantage of robust consumer demand.

All told, private-label brands account for about one-quarter of Kroger’s sales—above the industry average of 20 percent. This proportion should continue to grow as the Simple Truth line expands and the firm rolls out its value-conscious options under the “P$$T: Check This Out” label.

The $2.5 billion acquisition of Harris Teeter, completed at the beginning of this year, also appears to be on track. The deal pushes Kroger into several new markets and offers significant opportunities for expansion over the next few years; prior to the deal, Harris Teeter had plans to expand its store footprint over the next few years.

Finally, Kroger remains at the forefront of a technology revolution in the grocery business.

The company has partnered with analytics firm Dunnhumby to better understand consumers’ spending patterns and develop targeted promotions for specific customer groups.

And Harris Teeter already had a rapidly growing e-commerce business allowing consumers to purchase items online and pick them up at stores. Kroger is looking at ways to introduce popular service at more of its locations.

These drivers should enable Kroger to grow its earnings at an average annual rate of 8 percent to 11 percent in coming years while returning capital to shareholders via buybacks and dividend increases.

The company has reduced its float to less than 500 million shares from more than 723 million at the end of 2006, and has grown its dividend at an annualized pace of 13.3 percent over the past five years.


Elliott H. Gue is founder and chief editor of Capitalist Times and Energy & Income Advisor.

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