Last fall, grocery chain Kroger (NYSE:KR) announced a plan to modernize its business to keep up with consumer preferences. Part of the plan, dubbed Restock Kroger, aims to expand the business in new directions by off-loading its convenience store segment.
As it turns out, there are long-term motivations behind this divestment. Here's what you need to know.
In February, Kroger confirmed it had decided to go ahead with the sale of its nearly 800 convenience stores. Privately owned EG Group, based in the U.K., will be making the purchase for $2.15 billion, and it should be finalized by the end of the first quarter of 2018. The stores generated $4 billion in revenue in 2016, about 3% of total sales for Kroger that year.
Speaking on the rationale of the decision last fall, CFO Mike Schlotman said:
Our convenience stores are strong, successful, and growing, with the potential to grow even more. We want to look at all options to ensure this part of the business is meeting its full potential. Considering the current premium multiples for convenience stores, we feel it is our obligation as a management team to undertake this review.
Kroger made its intentions clear about the same time Warren Buffett's Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B) announced it was purchasing private truck stop and convenience store chain Pilot Flying J last fall. Stocks similar to Pilot Flying J, like TravelCenters of America, Murphy USA, and Casey's General Store, reacted positively to the news, so Kroger saw an opportunity to cash in on a segment of its business it no longer views as part of its future. In line with that, Schlotman said on the fourth-quarter earnings call with investors that the company plans to use the proceeds to pay down debt and repurchase shares.
Out with the old, in with the new
Though profitable, the convenience store segment is not in line with the direction Kroger is headed. Though it is the largest grocery chain in the nation -- serving a reported 60 million American households last year -- disruption arrived to the industry when Amazon purchased Whole Foods last year. Other major players in grocery like Walmart have also aggressively added new digital shopping capabilities for customers.
Kroger has a digital business, too, and it has so far been successful. Digital sales increased 90% last year, but only two-thirds of its customers have access to digital shopping so far. Part of Restock Kroger was to get rid of distractions -- like convenience stores -- to refocus efforts on building a modern shopping experience at its core business. That involves offering customers choices, including digital shopping, pick-up, and delivery, and growing what the company calls "alternative revenues" like advertising. Also in the mix is expanding its private-label brands, both food brands or newer departments for Kroger like home goods and apparel.
All of this sounds exciting, but Kroger is merely playing catch-up to its better-equipped rivals in 21st century retailing. Revenue and same-store sales excluding fuel grew 6.4% and 1.5%, respectively, last year, but profitability took a hit as earnings per share only grew 2%. Doing battle with Amazon is costly.
The sale of its convenience stores could go a long way in helping fund that fight, though, and Kroger has plenty of free cash flow to help out as well. After a big pullback in the stock after its end-of-2017 report and a clearer vision for the future, now could be a good time to reevaluate the stock.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Nicholas Rossolillo has no position in any of the stocks mentioned. His clients have positions in the stocks mentioned. The Motley Fool owns shares of and recommends Amazon, Berkshire Hathaway (B shares), and Casey's General Stores. The Motley Fool is short shares of Kroger. The Motley Fool has a disclosure policy.