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Robert Stephens, CFA
Robert Stephens, CFA
Articles (80) 

Why Kroger’s Stock Price Could Deliver Further Gains

The company’s growth plan may boost its financial outlook

December 05, 2018 | About:

Focusing on improved omnichannel capabilities could boost the Kroger (NYSE:KR) stock price. The company is investing in its digital capacity, as well as its supply chain, through deals with a variety of businesses and new initiatives. It is also focusing its efforts on higher-margin own brands, while increasing its exposure to growing markets such as China.

Its store optimization program and the potential for higher margins from the increasing popularity of its own-brand goods could improve its financial performance. This could help it to overcome a recently reported margin decline, as well as sales growth that was behind rivals. Having risen 9% in the last year versus a 3% gain for the S&P 500 index, it seems to have investment potential.

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Omnichannel opportunities

A focus on providing a seamless shopping experience could boost Kroger’s financial outlook. It has merged with Home Chef as it seeks to utilize the data it collects about customers in order to provide personalized food inspiration and recipe ideas.

It has launched a new direct-to-customer shipping platform called Ship, which has been available in five markets since August. It intends to launch in further markets over future months. Ship offers customers a curated selection of over 4,500 own-branded products that are not available anywhere else online. It also includes over 50,000 grocery and household essentials which, according to company data, have proven popular among customers. A driverless delivery test with Nuro may also provide expansion in its home delivery service, as well as improved customer satisfaction and loyalty.

In the second quarter of the year, the company’s digital sales grew 50%. It is increasing its seamless coverage area, which has now reached 80% of customers from 75% in the first quarter. It has introduced ClickList, which is a paid service that allows customers to buy products online and pick them up in store. The company is also investing in its digital capacity through the establishment of a new digital headquarters which is expected to increase its digital team from 600 employees to 1,000 employees by 2020.

Growth potential

A deal with Alibaba to sell Simple Truth branded goods in China could catalyze the company’s financial prospects. Simple Truth is the company’s second-biggest own-brand by sales. The deal provides Kroger with access to Alibaba (NYSE:BABA)’s Tmall, with it offering exposure to 500 million potential customers with minimal costs incurred by the company. A deal to integrate some of Ocado’s online grocery technologies into its stores across the U.S. could help to further accelerate its core business.

Since launching Ship in August, 41 of the top 50 items sold are the company’s own brands. Likewise, four of the top five items sold on ClickList are the company’s own-branded products. In the most recent quarter, own-branded products made up 28.2% of unit sales, with their growth continuing to outpace the company’s wider sales growth. Since own-brand goods generally have relatively high margins, their increasing popularity could translate into higher levels of profitability.

Risks

The investment being made in the company’s digital capacity and in its seamless shopping experience has weighed on margins. In the second quarter, its gross margin declined 36 basis points versus the same period of the previous year to 21.3%. Its comparative sales growth was relatively weak in the same quarter. Comparative sales increased by less than 2%, which is down on sector peer Walmart (NYSE:WMT)’s 3.4% rise in the U.S. during the most recent quarter.

The company, though, accelerated its investment in store optimization in the second quarter. This caused short-term disruption while the work is ongoing. Without it, the company estimates that same-store sales would have been above 2%. Over the second half of the fiscal year, the company expects that store optimization will boost sales growth as renovations improve the customer experience. High growth in its lower-margin pharmacy business also diluted its margin in the second quarter. Growth in higher-margin own-brand products could offset this in future quarters.

Outlook

Investment in a seamless shopping experience could boost the company’s financial outlook. It is ramping up its digital capabilities through increased resources in this area. Improved delivery and collection options could also improve customer satisfaction.

The deal with Alibaba could increase the company’s total addressable market without causing higher costs. Its own-brand products continue to prove popular and may positively impact on margins. This may help to counter weaker margins in the second quarter, while a store optimization program may boost comparable sales after a relatively disappointing second quarter.

Having outperformed the S&P 500 in the last year, Kroger appears to offer further capital growth potential.


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