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Robert Stephens, CFA
Robert Stephens, CFA
Articles (231) 

Why Kroger Offers Good Value for Money

The retailer could deliver a stock price recovery

June 24, 2019 | About:

Kroger (NYSE:KR)'s improving the customer experience and investing in its digital offering could boost its future prospects. The retailer has a pipeline of new own-brand products, while it is expanding the availability of its omnichannel offering to increase the size of its potential customer base. The company is also seeking to adapt to changing consumer tastes, with an increasing focus on sustainability. As part of this, it is investing heavily in innovative partnerships.

Having declined 23% in the last year versus a rise of 8% for the S&P 500, the company appears to offer good value for money.

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Increasing investment

Investment in new products could enhance the customer experience through offering a wider range of choice. In the most recent quarter, for example, Kroger introduced 219 own-brand items. It delivered $225 million in incremental sales in the last quarter. Further new own-brand product releases are expected to take place over the medium term, and may help to differentiate the company’s offering from that of rivals.

The company is investing in its omnichannel experience, as it seeks to align itself more closely with evolving consumer tastes. In the most recent quarter, it expanded its coverage area so that 93% of its customers are now able to shop for pickup or delivery, as well as visit a local brick-and-mortar store. By the end of the current fiscal year, the company expects that all U.S. consumers will be able to shop with the company through either its website or in a local store. Since digital sales increased 42% in the most recent quarter, further investment in its omnichannel experience is likely to have a high return.

Customer experience

The company is building stronger relationships with partners in order to enhance its competitive advantage through having an improved customer experience. For example, it is partnering with innovative businesses such as Walgreens (NASDAQ:WBA) and Home Chef. This is offering greater flexibility to customers, as well as a wider range of new products. The partnership with Ocado (LSE:OCDO) includes a customer fulfilment center that was opened last quarter. It features the latest in logistics technology that means Kroger’s customers will receive their fresher food faster than they would through many of its rivals.

A number of initiatives that are focused on sustainability are being rolled out by Kroger. They include an exclusive partnership with durable packing expert, Loop (NASDAQ:LOOP). Its system reduces single-use plastics through cleaning and sanitizing empty packaging that can then be sent back to the supplier to be used again. Through aligning itself with evolving consumer tastes on sustainability, the company may be able to improve loyalty and widen its economic moat.

Risks

The company’s performance in the most recent quarter was disappointing. Total sales excluding fuel increased just 2% from the same period of the previous year. Gross margin declined 40 basis points to 22.2% as a result of a challenging competitive environment within its pharmacy division. Kroger’s financial prospects are expected to continue to be pressured by inefficient health care and pension costs that are not faced by all of its competitors. With U.S. retail sales growing only 1.1% in the last nine months and consumer disposable incomes due to be negatively impacted by tariffs placed on products across the retail industry, the company’s sales growth could remain low in the short term.

In response, the business is seeking to enhance the service levels that it provides to customers in order to improve their loyalty. A key part of this is investing in staff pay and opportunities, recently announcing an average hourly pay rate of over $20. The company is also investing in its Feed Your Future education assistance program. This is contributing to higher employee retention, which could produce improved levels of customer service.

Outlook

In the 2021 fiscal year, the company is forecast to deliver a rise in earnings per share of 9%. Since it trades on a forward price-earnings ratio of 10.2 using its current year’s earnings per share forecast, it seems to offer a wide margin of safety.

With further investment in its omnichannel experience, and in enhancing the customer experience, the business could generate improving financial performance.

Its focus on aligning itself with changing customer tastes, and in building partnerships to increase innovation, could strengthen its competitive position.

Having underperformed the S&P 500 by 31% in the last year, the stock could offer recovery potential.

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