For many years, shareholders of Kansas City Southern earned meager returns while the railroad business struggled and the profits went towards the purchase of seemingly unrelated businesses like the the Janus Capital Group. For most people looking upon the sprawling railroad conglomerate in 1984, there wasn’t a lot to like. Only 6% returns on capital. No record of meaningful dividend growth. And the deployment of excess profits into an obscure mutual fund group with only thirty investors (albeit thirty wealthy investors as the total assets invested exceeded $500,000,000). If online investing existed in the mid 1980s, there is no stock screener you could have run or objective criteria you could have employed that would have alerted you to Kansas City Southern as a potentially lucrative investment.
Instead, you would have to take the bucket-and-shovel approach of digging through the statement and examining the growth of this mutual fund asset that was ballooning in value but sharing no income with the parent Kansas City Southern corporation. It was the equivalent of an off-balance sheet asset because the 1990s mutual fund explosion that saw the launch of the Janus Venture Fund, the Janus Twenty Fund, the opening of the institutional brokerage arm, the launch of the Janus Worldwide Fund, the Janus Enterprise Fund, the Janus Overseas Fund, and the Janus Aspen Series was created to offer equity-bond mixes for retirement accounts and to serve as the asset mix that undergird insurance policies.
The growth of Janus was never clear until Kansas City Southern decided to spin it off in 2000. The result? You have a situation where value investors that were able to spot the market inefficiency relating to Kansas City Southern ended up compounding their initial investment at 23.5% annualized since 1987, turning a $25,000 initial investment into $9,558,662 over that same time frame. The darling of Wall Street, Apple, has compounded at 17.6% over the same time frame, turning $25,000 into $2,366,459.
Those investors that missed out on Kansas City Southern in the 1980s and 1990s might find their appetite slaked by considering Kroger stock today. Kroger has a rich history of doing things beyond core grocery store operations to generate substantial long-term returns. To avoid a takeover in 1988, it paid a $40 special dividend in August 1988 and then a $8.50 debenture (which is a bond certificate issued by Kroger that paid a fixed rate but would offer no recourse in the event of bankruptcy because it would be the last class of creditors to receive payment excepting the common stockholders) in December 1988.
If you chose to reinvest, you benefitted from a sextupling of your share count that got to earn higher dividend and reap greater capital gains as the business grew throughout the 1990s and 2000s. For instance, Kroger’s dividend has increased from $0.52 in 2004 to $2 in 2015. At last tally, an investor in Kroger before the 1988 super dividend payments generated 17.2% annual returns that have grown $25,000 into $2,186,749. It appears to be a stodgy grocer, but the investment story is much more impressive.
It’s also more than just a grocer. Yes, it operates 2,625 stores that carry the Kroger name which most people know (and it operates these markets well, occupying the number one or number two sales spot in 38 of the 44 largest markets in which it has set up shop). But it also has 792 convenience stores that run under the following six divisions: Quik Stop Markets, Smith’s Express, Loaf N’ Jug, Kwik Shop, Turkey Hill Minit Markets, and Tom Thumb Food Stores. Each of these subsidiaries maintain their own management teams that receive bonuses tied to reaching growth objectives, a decentralized strategy that is similar to General Electric, Berkshire Hathaway, and Johnson & Johnson in maintaining a focused approach even as the size of the enterprise threatens to become unwieldy.
And there are two additional assets sitting on the balance sheet. One is a series of private label food groups that sell directly to Kroger and the six subsidiaries, and another is an unrelated business that was acquired in May 1999: Fred Meyer Jewelrers. At last count, Kroger owns 326 Fred Meyer locations operating throughout the United States.
Kroger has never been something to catch much attention from investors. The high debt burden that was used to fund the $48.50 poison pill dividend in 1988 became a perpetual part of the balance sheet. Kroger froze its dividend and eliminated it entirely in the 1990s before resuming it in 2006. It still has almost $12 billion in debt on the balance sheet right now, and makes about $1.9 billion in annual profits. It reminds me of Anheuser-Busch in some ways–it carried higher than average debt for much of its corporate history, assumed an enormous amount of debt for a one-time event, and has paid down the debt to the point that the obligations straddle the line between “high but reasonable” and “uncomfortable.”
Kroger stopped paying dividends in the 1990s because interest rates got high and it wanted to get the debt down to a manageable level, so it redirected the dividend cash to debt servicing instead. That is probably not a risk now, as the current dividend is only 20% of profits and earnings are growing at a fast 11% annual clip. The grocery business is thriving, delivering 5% annual sales growth (based on same-store sales results, Kroger management has outperformed Wal-Mart management since 2007, a statistic that may not seem intuitively obvious).
However, sales of the corporation itself have been 12% over the past five years. This beats Wal-Mart. This beats Target. This beats the grocery peers because Kroger is much more than the namesake grocery–the other six subsidiaries, the private labels, and the jewelry stores have provided the power for earnings to quadruple in eleven years.
Oftentimes, I encounter investors who are skittish about investing in the retail sector of the economy because of the historical struggles of firms like A&P and Woolworth to go from omnipresent and perduring to leaving behind a legacy that consists of nothing more than a clever John Updike short story. Kroger seems like an intelligent compromise for entering the sector. You may one day get the private label, jewelry store, and convenience store spinoffs similar to the spate of spinoffs that preceded Sears before the downfall. Furthermore, the grocery business itself is doing quite well, as Kroger has top market positions and is growing sales by a healthy single-digit clip (no small feat for the industry). There are a few components on the Kroger balance sheet beyond the mere grocery store business that make it a good candidate for those that want to emulate Kansas City Southern at best or at least settle for an alternative to Wal-Mart.
Originally posted 2015-12-22 04:32:03.