Deutsche Bank Says Buy Walmart, Sell Kroger As Grocery Landscape Shifts

This morning, Deutsche Bank analyst Paul Trussell downgraded Kroger (KR) to Sell while upgrading Walmart (WMT) to Buy. The analyst argued that its strategies will likely be significantly more costly than Kroger and consensus are currently forecasting. On the other hand, Trussell believes Walmart is now in a position to accelerate market share gains in grocery while also growing EBIT dollars and expanding its return on investment.

SELL KROGER: In a research note to investors this morning, Deutsche Bank’s Trussell downgraded Kroger to Sell from Hold and lowered his price target on the shares to $24 from $30. Kroger’s strategy to aggressively expand e-commerce capabilities, optimize space within its current footprint, and compete on price “will likely be significantly more costly” than the company and consensus are currently forecasting, he contended. While the analyst noted he is “on board” with the majority of steps that management has outlined as part of its Restock Kroger plan, and believes that the company may be one of the winners in food retail over the long-term, Trussell pointed out that it will likely be “quite challenging” to grow profits as it plays “from a position of weakness”. Consequently, he is now modeling operating income falling well short of current targets. Further, the analyst argued that he sees areas where Kroger may need to get more aggressive and speed up its pace of investments, such as grocery pickup or the Ocado partnership. Second quarter results were a “major warning flag” and suggest that 2018 earnings per share is at risk, while the shares still trade at an above-average premium, albeit down from recent highs, he added.

BUY WALMART: In a separate note, Deutsche Bank’s Trussell upgraded Walmart to Buy from Hold and raised his price target on the shares to $113 from $89. The analyst told investors that the retailer is reaping returns on the many years of investment in e-commerce and customer service and that he believes Walmart is now in a position to accelerate market share gains in grocery while also growing EBIT dollars and expanding return on investment. Moreover, Trussell noted that channel checks suggest continued sales momentum and ongoing improvements in execution. Overall, Trussell said he believes Walmart’s portfolio of assets is differentiated in the “rapidly changing” retail landscape. Heading into the upcoming Investment Community Meeting, the analyst expects management to sound bullish, particularly around trends in the U.S. business, reiterating the 40% growth for the U.S. online business for the current year, with a target of about 30% in FY19. Trussell also expects the online conversation to shift to a global level as Walmart is now the 77% owner of the largest player in the Indian e-commerce market. Wage pressure should persist in FY19, he contended, given the tight labor market and competitors moving up their wage rates. However, the analyst noted he does not expect the retailer to match Amazon’s (AMZN) $15/hour minimum wage rate as the employees impacted by Amazon’s wage raise are mostly in distribution centers and Whole Foods locations are in urban centers where wages are above Walmart’s $11/hour.