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Examining Kroger’s (KR) Dividend History and the Growth of its Business

Kroger (KR) was thrust into the public spotlight when it was reported that billionaire Warren Buffett purchased almost 19 million shares. Buffett has built his fortune on stocks with dividends, and looking at the KR dividend history we might be able to see why he’s interested in this grocer.

Kroger, or officially The Kroger Co (ticker symbol KR), has been paying an increasing dividend for 14+ years (as of October 2020).

The latest dividend increase for KR was from a quarterly dividend of $0.16 for June 1, 2020, to one of $0.18 for September 1, 2020. That represented a growth rate of 12.5%, which falls in-line with the company’s 5 year growth rate (of 12.03% per year).

To understand how the company has been able to grow its dividend at such a superior rate, and if the company should be able to maintain this level of increases for the future, it’s prudent to look at the company’s (KR) dividend history and the history of the growth of its business.

Starting with Kroger’s Management

Kroger has been run by CEO W. Rodney McMullen since his election on January 1, 2014. At age 59, McMullen has retained great control over the company, also having become elected to be Chairman of the Board in 2015 after a very long tenure with Kroger (starting as a part time stock clerk in 1978!).

Though Kroger’s 5 year track record of stock performance hasn’t been great compared to the S&P 500, at -9.41% vs +72.57%, since fiscal year 2015 the company has reduced diluted shares outstanding from 993 million to 805 million (-18.9%), and again has grown that dividend fantastically over the same time period (76.5% in total).

Management’s own words on their strategy moving forward, or “Our Path to Delivering Consistent and Attractive Total Shareholder Return”, is the following uses of profits/ free cash flows:

Our financial strategy is to continue to use our strong free cash flow to invest in the business to drive long-term sustainable growth through the identification of high-return projects that support our strategy. We will allocate capital toward driving profitable sales growth in stores and digital, improving productivity, and building a seamless digital ecosystem and supply chain. At the same time, we are committed to maintaining our net debt to adjusted EBITDA range of 2.30 to 2.50 in order to keep our current investment-grade debt rating. We also expect to continue to grow our dividend over time, reflecting the confidence we have in our free cash flow, and will continue to return excess cash to investors via share repurchases. We expect our model to deliver improved operating results over time and continued strong free cash flow, which will translate into a consistently strong and attractive total shareholder return over the long-term of 8% to 11%. Our full-year 2019 results demonstrated clear progress toward delivering on this model. Restock Kroger is the right strategic framework to deliver both our 2020 guidance and to position Kroger for sustainable growth and total shareholder return.

One of the things that management has done to increase total shareholder return for Kroger has been to focus on ROIC, or Return on Invested Capital. By focusing on efficiency rather than solely volume (higher store count), the company is able to sustain KR’s dividend increases while still growing modestly, and funneling free cash flow into share buybacks as well.

A focus on ROIC means cutting bait on projects (stores) that are less efficient from a free cash flow and profit standpoint, and reinvesting those into better paying projects (stores). And if the opportunities in the market don’t reflect any sort of sufficient ROIC, the company instead will pay dividends, buyback stock, or keep the cash, as the company has shown with its recent track record.

In fact, the proof of those actions is in this graphic:

As we can see, store count for Kroger is actually down since 2017, with the amount of stores closed generally outpacing those opened over the 3 year period, with the number of acquired stores making up a minimal amount compared to store count totals (2,757 at 2019).

Looking back to beginning of CEO McMullen’s tenure, we can see a similar trend.

Though total store count from 2014 to 2016 increased from 2,625 to 2,796, a large majority of this was attributable to the 159 acquired in 2015. You can see where I highlighted in red that Kroger has been churning stores, closing low performing stores and opening or relocating new stores to earn a better ROIC over time.

The Feasibility of KR Dividend Increases in the Future

A casual investor might wonder why Kroger doesn’t just open many more new stores to produce enough free cash flow to continue Kroger’s long history of dividend growth.

After all, a company like Walmart ($WMT) has over 4,500 stores just in the U.S. alone, where Kroger only has 2,757.

And it comes back to ROIC again, and the realities of a maturing industry and the consequences of investing in low return projects.

The results of Operating Income for Walmart U.S. say it all.

  • 2020 = $17,380 million
  • 2019 = $17,386 million
  • 2018 = $16,995 million
  • 2017 = $17,745 million
  • 2016 = $19,087 million

That’s really bad growth numbers over the last 3 years, and negative growth over the last 5.

While the stock for Walmart has returned +114.10% for shareholders compared to +72.57% for the S&P500, much of this growth is due to other business segments such as Walmart International.

Also, though the stock price for Walmart has done well, management doesn’t seem to have made total shareholder yield (in the form of dividends and buybacks) as much of a priority as a company like Kroger has done.

For Walmart shareholders, they’ve had to deal with a dividend history characterized with meandering growth (only 2% annually over the last 5 years), especially compared to the fantastic dividend history of KR.

Also, the share buybacks for Walmart have been decent but not as aggressive as for Kroger shareholders. Walmart’s diluted shares outstanding over the last 5 years have only decreased by -11.6% (almost half as much as Kroger’s).

The positives of growth focus are that Wall Street tends to reward that over the short term, but total shareholder return can often be determined by shareholder friendly management over the long term.

To understand KR’s dividend history and the future of its dividend prospects is to understand the company’s management, and why their shareholder focus can be a superior model in a variety of ways.

Why Kroger Focuses on ROIC Rather than New Stores

You can’t compare the number of grocery stores in the United States with something like the number of fast food restaurants in the country, either. For example, there are the following number of QSR (quick serve restaurants) throughout the U.S.:

  • Subway: 24,798
  • Starbucks: 14,825
  • McDonald’s: 13,914
  • Dunkin Donuts: 9,419
  • Pizza Hut: 7,456

The reality is that every single one of those companies above are either 100% franchised or have a significant percentage of their stores as franchised, which allows for the “growth at all cost” strategy.

Take Dunkin Donuts, for example.

Dunkin’s corporate structure is a simple holding company that relies on a 100% franchise model. Rather than gather up the capital to develop and operate a new restaurant, Dunkin simply franchises their brand and recipes to another person like a small business owner. That franchisee is the one who takes the risks, puts up the capital, and deals with the day to day operations—while Dunkin collects royalty and rent checks as time goes on.

It’s not exactly a predatory environment, but rather like a win-win.

An enterprising small business owner or entrepreneur gets instant access to a brand that took decades to build, which brings instant demand and profits for the restaurant.

The franchisor, Dunkin, gets to deploy capital at highly efficient rates (high ROIC), which allows them to use high amounts of free cash flow to produce high total shareholder return (through dividends and buybacks) instead of using it on capital-intensive projects like opening and maintaining a restaurant.

That’s where Kroger comes in.

Since franchising is not a model currently in wide use in the U.S. grocery industry, the company must own and operate the vast majority of their grocery stores.

That can be capital intensive, and so the way to stay efficient with that is to only invest in high ROIC projects, which translates to a very selective number of stores and locations in the grocery store business.

Kroger’s Business and Dividend Strategy

We can see the targeted focus of Kroger to be evident in the footprint of the company throughout the United States.

From the company’s 2019 Fact Sheet:

These charts show that the company is located throughout 25 states (and the District of Columbia) under a variety of value banners (like Food 4 Less) and premium banners (like Harris Teeter).

Comparing the list against some important demographic trends and statistics can help to provide context on the company’s strategy.

From my blog post on Seeking Alpha showing the latest population statistics from the US Census Bureau, the top 10 Most Populous States include the following:

Highest population growth in numbers (rather than percentages) include:

Going back to the Kroger fact book, we can see the following ranks for each of the top states (by number of stores) for the company.

  • California: #1 most populous
  • Texas: #2 most populous, #1 top numeric growth
  • Ohio: #7 most populous
  • Georgia: #8 most populous, #5 top numeric growth
  • Indiana: not in either top 10
  • Colorado: #7 top numeric growth
  • North Carolina: #9 most populous, #4 top numeric growth

This simple comparison shows how the company seems to be targeting states in the top 5 or top 10 out of all 50 states in either total numeric growth or total population. Moving down the list, you’ll see other states that also rank high in one of these categories, such as Arizona and Michigan—which seems to show a strategy very coordinated with population trends and statistics.

Also of note is the increase in North Carolina (+4) from Y/E 2018 to Y/E 2019, and the decrease in Ohio and California (-4), the two latter which are states which have not had strong population growth trends since 2010.

From what I gather with this, it looks that the company sees some of their biggest markets as pretty much mature already—at least from a total store count perspective. The fact that growth in total stores has mainly been concentrated on a few states (North Carolina and Virginia) from 2018 to 2019, it lends to this idea of matured penetration elsewhere.

Reviewing the Top 10 Most Populous States charts one more time, the only states which aren’t currently heavily targeted by Kroger include:

  • Florida (just 1 store)
  • New York
  • Pennsylvania

Within the highest population growth (numeric) top 10 states, Kroger has a meaningful presence in all of them (except for Florida as mentioned already), with maybe a little bit of underinvestment in Nevada and South Carolina (46 and 40 stores).

But, a state like Nevada only has a current population of around 3 million even with its high numeric growth, and the company did open 2 stores in South Carolina…

So the company does appear to be paying attention to some of the more impactful population trends, and adjusting their store counts accordingly.

Whether that’s a chicken or an egg thing, meaning that the company is targeting population growth or that population growth tends to lead to better operating results, or not—Kroger’s management has been outspoken about focusing on ROIC, and has acted accordingly from what this data shows.

Final KR Dividend History Data, and Investor Takeaway

From Seeking Alpha, a graph that helps to visualize the great, consistent growth that Kroger has maintained in their dividend payments is available on their website:

Let me also show you a breakdown with each of the company’s previous dividend payments (since 2006):

Click to zoom

Since Kroger initiated their dividend, the dividend has almost tripled in 14 years. The company appears poised to continue its high dividend payments, and the COVID-19 lockdowns have helped provide a short term boon to free cash flows.

If Kroger has displayed prudence with their capital allocation in the past, investors would think that the company would be likely to continue that into the future.

The question remains whether the increased ROIC focus can maintain high enough growth rates over the years to sustain the fantastic KR dividend history–in the absence of higher store counts (assuming the company continues such a strategy).

Note: I’ll end this article with the caveat that it’s been reported that one of Buffett’s investment managers who works under him purchased the stake in Kroger, and not Buffett himself.

Certain investments in Berkshire have been delegated to his team of investment managers, which is why Berkshire can report new investment holdings in stocks like Kroger even though Buffett himself didn’t make the trade.

But though Buffett has called grocery stores a “tough business”, the KR dividend is an important metric to consider for long term investors interested in the stock.

Berkshire did add more Kroger at the end of June 2020, and so there’s reasons to be optimistic about the company in addition to everything I mentioned in this post (KR dividend history, total shareholder return, ROIC focus, etc).