Grocery behemoth Kroger (KR 0.64%) has invested heavily in digital sales and delivery capabilities, yet it continues to struggle to regain market share, as my colleague Demitrios Kalogeropoulos observed in his recap of the company's fiscal first-quarter 2019 earnings, released on June 20.
Kroger is faced with a dual difficulty as intense grocery competition hampers its ability to improve identical-store sales, while investments in home delivery -- though mostly recorded on the balance sheet -- also furnish a slight drag on income statement profits.
With nearly 2,800 retail grocery stores under a variety of banners, Kroger possesses immense scale. The company's massive $121 billion in sales last year enabled it to generate a net profit of $3.1 billion. Yet an easier route to value creation may involve diversifying Kroger's revenue base, and improving operating profits through alternate ventures.
Image source: Getty Images.
As of Kroger's first-quarter 2019 report, a category of business that management calls "Alternative Profit Streams" will now be broken out in a supplemental detail schedule each quarter. The purpose is to help investors understand how these efforts, however diminutive in relation to the bottom line, are making Kroger a more profitable company.
The three major components of alternative profit streams are the company's "Kroger Personal Finance" (KPF), media, and customer data insights businesses.
KPF includes a wide variety of financial services that Kroger customers can avail, from Kroger-branded credit cards, to home mortgages offered via financial partners, to in-store money services including remittances and check cashing. The company's media services and customer data insights businesses enable vendors to market more efficiently to Kroger customers and gain customer purchasing insight through the transactional data that Kroger collects.
Alternative profit streams also include the company's quasi venture-capital investments in grocery-related technology companies and emerging grocery brands. Below is a helpful visual diagram which Kroger provided in its first supplemental report on alternative profit streams on June 20:
Image source: Kroger.
Formerly, revenue associated with each of these businesses was mostly recorded as an offset to general and administrative expenses. Because they haven't been material to Kroger's overall operations, the company treated revenue from these ventures as a reduction of overhead expense.
Yet now, in an effort to provide transparency, and, as management noted on the company's earnings conference call, to conform more closely to industry practice, the contribution generated by alternative profit streams will be recorded net of expenses within the gross margin category.
In other words, revenue will be grouped along with Kroger's other sales, and expenses will be classified as cost of sales, so that the total impact of alternative profit streams will improve Kroger's gross margin.
The company expects that alternative profit streams will add $100 million in incremental operating profit this year versus 2018. For context, Kroger's total operating profit in 2018 was $2.6 billion. Now $100 million may seem a trivial contribution to this total. But given its slim 2.2% operating margin, Kroger would have to sell the equivalent of $4.5 billion in additional groceries and fuel to match this year's net haul from alternative profit streams.
In giving this relatively tiny contributor of profit a more prominent role in the discussion of quarterly profits, Kroger is recognizing that investors can't value what they can't see. It's also sensible to make these fledgling efforts visible now, as accelerating future growth of viable profit streams may force investors to rethink the lack of premium attached to Kroger's shares. Kroger stock currently trades at a paltry 9 times forward one-year earnings, thus, any illumination of earnings potential can only help the grocery titan's market capitalization.
