Investors are watching the supermarket industry closely after online megaretailer Amazon (AMZN +2.05%) dove into the space by snapping up Whole Foods.
Against that major market shakeup, Kroger (KR 3.35%), the country's largest supermarket chain, is set to post its second-quarter earnings results on Friday, Sept, 8. Considering the stock's sharp drop so far this year, Wall Street isn't expecting good news out of the leading supermarket chain.
Image source: Getty Images.
A return to growth
There's a good reason for the pessimism. After all, Kroger's growth pace has hit a wall over the last several quarters. Through late last year, the company had enjoyed a streak of over 12 years of comparable-store sales gains, including an impressive run at 5% or better. That changed recently, and the chain has now endured two straight quarters of declining comps.
Chart by author. Data source: Kroger filings.
CEO Rodney McMullen and his team said in June that they were encouraged by an uptick in sales trends. Despite the slightly negative result in the first quarter, comps were positive over the final weeks of the period. Growth remained in positive territory for the early part of the second quarter, too. If that momentum held, investors should see a return to comps gains this week. On the other hand, slipping customer traffic would likely produce Kroger's third consecutive quarter of decreasing comps.
Market share struggles
Wal-Mart (WMT 1.80%) is Kroger's chief rival in most of its big metro markets. With help from a strategic shift toward competing on price, the supermarket chain has managed to chip away at the retailing titan's share over the last decade. Wal-Mart's business is seeing a solid rebound lately, though, having just posted another quarter of positive customer traffic and rising comps. In addition, Kroger is facing increasing competition from non-traditional sources of groceries, including small-format stores and online retailers.
The best metric to watch in judging Kroger's ability to fend off all these threats is its customer base. The pool of loyal households rose by 3% last quarter, which indicated slightly improved market share. However, management warned that Kroger's actual share might be flat, or slipping, after accounting for non-traditional sales. Executives will provide a key update on their market position, and which way it is moving, in Friday's announcement.
Price investments
Pricing is one of the best weapons a retailer can use to fight off active competition in a sluggish industry. The good news for investors is that Kroger is ideally positioned to compete on this basis. After all, the company has plowed billions of dollars into lowering prices over the past 15 years, with help from an integrated business model and a deep portfolio of corporate brands that account for almost one third of sales volume today.
KR Gross Profit Margin (TTM) data by YCharts.
This strategy has left Kroger with lower profitability, but it also means less opportunity for rivals. For example, Whole Foods' gross margin is a full 10 percentage points above Kroger's, so even sharp price cuts by Amazon aren't likely to knock Kroger out of the game.
Still, investors are bracing for a drawn-out pricing battle that reduces Kroger's earning potential at least into next year. Management pulled back their profit outlook recently while telling investors, "we have no intention of giving up the momentum we've gained on low prices." Maintaining that price leadership and market share is critical to the health of the Kroger's business. But it should result in a second straight year of declining earnings compared to the retailer's long-term target of annual growth of between 8% and 11%.
