Kroger's Outstanding Performance Is Set to Continue

A key acquisition, more products, and uncertainty among peers can take Kroger higher.

May 12, 2014 at 8:56AM

Kroger (NYSE:KR), one of the largest grocery retailers and the biggest supermarket operator in the U.S., has been on a roll, with shares up 17% year to date. The growing demand for organic and natural products and grocery items has led Kroger to jump onto the organic foods bandwagon. Moreover, with the acquisition of Harris Teeter Supermarkets complete, Kroger is set to continue its growth momentum.

However, Kroger needs to watch out for competition from the likes of Safeway (NYSE:SWY) in the supermarket space and Whole Foods Market (NASDAQ:WFM) in the organic foods market. Let's see how Kroger stacks up against its peers and whether investors should consider buying this stock.

Recent results have been strong
In the fourth quarter of fiscal 2013, Kroger came up with strong results. The company's identical-supermarket sales grew for the 41st consecutive quarter, rising 4.3% versus the prior-year period. The sustained identical-sales growth was possible due to its customer-friendly business model. As a result, for the full fiscal year Kroger's earnings per share grew 13% year over year, and it returned $928 million to shareholders through share buybacks and dividends.

Why the growth should continue
Going forward, Kroger's innovations, as a part of its customer-first approach, should drive growth. For example, the faster-checkout initiative that it implemented for enhancing customer experience is panning out well. In addition, Kroger is bolstering its product portfolio. It introduced 937 new products in fiscal 2013, including 100 new Simple Truth items. Simple Truth is Kroger's organic foods brand, and it continues to grow at an impressive clip. The brand is expected to be worth $1 billion by the end of fiscal 2014.

In addition, as part of its digital initiatives, Kroger announced the acquisition of digital-coupon marketing provider YOU Technology. This acquisition will bridge Kroger's physical and digital operations. On top of that, the company will be able to benefit directly from grocery retailers like Safeway and SUPERVALU in addition to other YOU Technology clients like Dr Pepper, PepsiCo, and Unilever.

Another growth driver will be the new markets that Kroger is moving into as a result of the Harris Teeter acquisition. The company's penetration into areas with high median incomes, such as Northern Virginia and the North Carolina's Research Triangle area, will offer good growth prospects going forward. Citing operational efficiencies, Harris Teeter cut prices on more than 1,000 items; this will go a long way in attracting more shoppers as compared to Safeway, which increased prices recently.

Safeway's moves
Safeway, the No. 2 supermarket chain, reported 1.8% year-over-year growth in identical-store sales as a result of a 1.6% increase in price per item in the first quarter of fiscal 2014. The persistent rumors regarding the acquisition of Safeway have been put to rest--it has been formally announced that Safeway will merge with Cerberus Capital Management's Albertsons in a deal worth $9 billion. This deal is expected to close in the fourth quarter of fiscal 2014.

This will result in a newly formed company with 2,400 stores in a market that's harshly competitive. The presence of discount retailers, club warehouses, and big grocers such as Kroger will present significant headwinds for the newly formed company.

What's Whole Foods up to?
Whole Foods, on the other hand, has been facing increasing competition from other food retailers jumping into the organic and natural foods market. In April, big-box chain Wal-Mart Stores announced  that it would carry Wild Oats organic food products, claiming that it will save customers "25[%] or more" compared to other national brand organic products.

In the long term, this might hurt Whole Foods. Wal-Mart isn't the only one trying to unseat Whole Foods as the leader in the organic foods category. However, Whole Foods' co-CEO, Walter Robb, told CNBC that this isn't a serious worry as its customer base doesn't overlap much with Wal-Mart's. "There's going to be more players in the space," he said.

Moreover, Whole Foods' growth projections are also decent. With 56 new leases signed over the last 12 months, and a record 114 stores in its development pipeline, it is aiming to cross the 500-store mark in 2017. Revenue is projected to approach $25 billion over the next five years. Over the long term, the company is projecting demand for 1,200 Whole Foods Market stores in the U.S. alone. Thus, it seems unfazed by Wal-Mart's foray into the organic market space. 

Bottom line
Kroger looks rock solid right now. The company is focusing on the fast-growing organic foods market and is making the right acquisitions. Also, an expansion of its product portfolio and a wide network of stores should help it perform better than Whole Foods. Also, since Safeway's future after its merger with Albertsons is not yet clear, Kroger will have one less player to contend with for the time being. Hence, Kroger looks like a solid investment proposition going forward.

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John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Shirish Mudholkar has no position in any stocks mentioned. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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