Recent growth initiatives appear to be bearing fruit at Kroger (KR 0.94%), the nation's largest traditional food retailer, where management has made several moves surrounding e-commerce to defend and increase market share. The highly competitive grocery industry has been engaged in a battle for online shoppers in the post-Amazon.com (AMZN -1.64%) world, and as Walmart (WMT 1.32%), Target (TGT -0.70%), Costco (COST 0.17%), and their retail peers make critical investments in their digital businesses, Kroger is putting up a commendable fight by expanding its online footprint on multiple fronts.
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Online sales drive a return to growth
Kroger, which operates more than 2,700 stores across 35 states under names including Ralph's, Food 4 Less, and Harris Teeter, caught the attention of investors last week when it reported its second-quarter results. Identical-store sales increased by 2.2% following three straight quarters of declines, surpassing the 2% mark for the first time since 2016. Adjusted EPS of $0.44 beat the FactSet consensus estimate of $0.41. The results could be partly attributed to higher-than-expected inflation, private-label expansion, and store renovations, but digital sales growth of 31% was perhaps the most compelling data point.
During the quarter, Kroger expanded its pickup and delivery service locations to 1,780 and 2,225, respectively. This digital footprint now covers 95% of Kroger households, with that number expected to hit 100% by year's end.
Big-data analytics fuel e-commerce push
The grocery industry is experiencing a major fundamental shift, with an increasing focus on online shopping and the use of technology to expand digital growth opportunities. Kroger is no stranger to employing technology to drive sales results; the company is considered an industry-leading innovator, with a successful track record of using big-data analytics to offer popular promotions and fill its shelves with the products customers want.
Its customer-analytics platform is the powerful engine behind its surging online sales. Kroger's e-commerce sales rose by 49%, 90%, and 58% in fiscal 2016, 2017, and 2018 respectively and are on pace for another year of stellar growth. The company's 84.51 technology, named after the geographic coordinates of its Cincinnati headquarters, delivered a billion digital coupons to customers in calendar 2018.
Automated warehouses support online growth
In conjunction with last week's earnings report, Kroger also announced Dallas as the site of its latest high-tech fulfillment center. Through its strategic partnership with Ocado, a dedicated online grocery retailer, the company is attacking the online grocery trend by building up to 20 automated warehouses around the country. The 350,000-square-foot Dallas facility, which includes digital and robotic capabilities, is the company's fifth such warehouse designed to bring fresh food to customers faster than ever before. In the cutthroat, rapidly evolving online grocery field, Kroger's Ocado centers may be game-changers.
Consumer trends drive private-label brand extensions
Margins are notoriously slim in the supermarket business. Kroger's net profit margin is akin to skim milk at about 1.5%. But that hasn't stopped management from finding ways to grow by staying ahead of consumer trends with digital investments and new product line extensions.
The company's Simple Truth brand reached $2.3 billion in sales last year, making it the nation's leading brand in the natural and organic category by volume. Sales of private-label brands, which comprise approximately 30% of overall Kroger sales, are growing faster than those of national brands. Kroger expanded its lineup of privately owned goods in the second quarter with the launch of 203 new brands. A "Restock Kroger" initiative geared toward its private-label Own Brands division posted 3.1% sales growth, a record for the second quarter. And in response to beefed-up demand for plant-based meat substitutes, Kroger recently unveiled Simple Truth Plant-Based, which includes 100% plant-based burgers and other non-meat-based foods.
So is Kroger undervalued?
Kroger's share price has moved higher over the past couple of months, but it remains well off its December 2015 all-time high of $42.75. The stock appears cheap at 13 times forward earnings, slightly below its five-year average multiple of 15.
This discounted valuation may be warranted, given Kroger's modest growth profile relative to peers like Walmart and Target, which recently posted same-store sales growth of 2.8% and 3.4% respectively. Nevertheless, the grocery industry veteran is worthy of consideration as a defensive investment for the long-term value investor. A deterioration in the geopolitical or economic landscape could make the stock a recession-friendly pick as consumers potentially shift spending from restaurants to at-home cooking.
While competitive and macroeconomic challenges remain, in building out its e-commerce and private-label capabilities, Kroger appears to be heading down the right aisle. More details regarding the company's progress are expected at its November investor day.
