Kroger Partners With Walgreens to Keep Amazon at Bay

With its purchase of Whole Foods last year, Amazon’s (NASDAQ:AMZN) outsized cross-market presence has cast a shadow over the retail grocery business, forcing competitors to change the way they conduct business. One traditional grocer that has admirably risen to the challenge is Kroger (NYSE:KR). Earlier in the year, the company made significant changes to its long-held business model and implemented both improved inventory controls and dramatically increased its online business.

For the past year, the company has aggressively transformed its shelving structure and inventory stocking, while working with suppliers to drive costs down. Kroger has partnered with British online grocer Ocado Group (LSE:OCDO) to operate its automated warehouses and handle its online orders. These changes are in addition to the deliveries the grocer already offers through third-party vendors. The company has also invested heavily in technology to facilitate its automation processes with online ordering so that operations are conducted efficiently and in a cost-effective manner. As part of its efforts to broaden its presence and find new revenue streams, Kroger contracted recently with Alibaba (NYSE:BABA) to sell its goods online in China.

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Though the battle with Amazon is far from over, so far, the company’s revamping of its business operations to respond to the growing popularity of e-commerce shopping has shown positive results. Kroger is now looking to enhance and extend its previous initiatives by venturing with giant retail pharmacy chain Walgreens (NASDAQ:WBA).

Kroger announced it plans to sell groceries in dedicated sections in some 13 Walgreens stores by early next year. The agreement is an attempt by both companies to respond to the recent entry of online retail giant Amazon into the grocery, prepared foods and pharmacy businesses and to help them retain their loyal customers.

Amazon flexed its muscle recently, as it made its entry into the traditional pharmacy chain business with its $1 billion bid for online pharmacy company PillPack. This threat prompted talks between Walgreens and health insurers to take reciprocal equity stakes. Pharmacy chain CVS (NYSE:CVS) responded to the imminent threat to its long-established market presence by concluding a $70 billion merger with insurer Aetna.

Clearly, the traditional pharmacy and retail chain grocers have taken Amazon’s potential encroachment efforts into their respective businesses seriously.

The amount of square footage Walgreens will dedicate to Kroger is substantial, as they test the concept by stocking Kroger’s recently purchased Home Chef meal kits and its other private label brands. Walgreens will provide approximately 4,000-square-foot displays for produce and Kroger specialty items. This allocation amounts to almost one-third of the average Walgreens floor space. The agreement also provides flexibility for Kroger customers, as they will be able to pick up their online grocery orders at designated Walgreens stores.

This enhances Kroger’s broader strategy of emphasizing more popular products and store-brand goods. The agreement with Walgreens helps expand the home brands exposure to a significantly larger pool of consumers. Both companies initially plan on operating and shelving the Kroger specialty branded sections together. The impetus for the partnering is that, in general, private-label products are more profitable for grocers than sales of goods made by other companies.

This strategy of leveraging retail chains large, nation-wide geographic presence to increase online sales and enhance the overall customer experience has been adopted by other brick-and-mortar retailers such as Target (NYSE:TGT). As Target’s recent earnings show, it is an effective strategy for dealing with Amazon’s pre-existing lead in online sales.

Kroger reported third-quarter earnings on Thursday that were in line with its guidance and strategic plans for expansion. Although the stock was down 1%, that could be explained by the overall market downturn as well as the company’s continued investments in its expansion and automated inventory efforts.

The company beat analysts’ expectations for most measures, but same-store sales were slightly off for the same period last year. However, this slight drop was more than offset by its continuing strong showing in online sales, which were up 60%. Net income decreased to $317 million, or 39 cents per share, from last year’s $397 million, or 44 cents per share. Earnings per share came to 48 cents, besting the consensus of 43 cents per share.

For comparison purposes, a review of Kroger’s second-quarter results is instructive. For the quarter, the company beat analysts’ expectations by posting stronger-than-expected earnings and sales growth. Kroger reported $37.5 billion in revenue for its previous quarter ending in May, up from $36.3 billion in the prior-year quarter. Earnings per share doubled to 73 cents per share from 32 cents.

Although the stock is slightly down, the overall results indicate the company’s efforts to date at transformation, have been successful.

Disclosure: I have no position in any of the securities referenced in this article.

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