In early March, Kroger (KR 2.57%) gave investors some good reasons to feel optimistic about its business. The supermarket chain got help in 2020 from a huge demand surge for many of its staple products. But Kroger also gained market share in a competitive industry.
In a conference call with Wall Street analysts, CEO Rodney McMullen and his team discussed why they think that success points to faster growth and improving investor returns over the next few years.
Let's look at a few highlights from that presentation.
Keeping customers engaged
"When customers engage in both our in-store and online [shopping channels], we see a 98% retention rate within our ecosystem, highlighting how sticky our customer engagement is," McMullen stated.
The requirement for winning market share in the booming consumer staples industry today is delivering a convenient experience that connects online and in-person shopping. Kroger credits its success here as a core competitive advantage against local chains and national peers like Walmart (WMT 1.25%) and Target.
The chain's other standout assets are in-store brands like Simple Truth, its fresh produce section, and its data-crunching abilities based on weekly purchasing data from 60 million loyal shoppers. "Our significant reach allows us to meaningfully personalize the customer experience," McMullen said while citing the billions of personal product recommendations made to individual shoppers each week.
CFO Gary Millerchip said, "We were disciplined in balancing investments in our customers and associates with cost savings. For the third year in a row, our operations and sourcing teams delivered over $1 billion in ... cost savings."
Margins are rising even though Kroger is spending more on labor and on COVID-19-related safety and cleaning measures. The biggest factor behind this spike has been the digital sales channel, which saw profitability increase by 20% in the fourth quarter. Sure, Kroger is unlikely to see another year of triple-digit growth in its e-commerce segment. But that division is sure to keep expanding steadily and lifting gross profit margin in the process.
Creating strong returns
"These two-year expectations are ahead of our [projected] growth [targets], and we believe the momentum in our business places us in an even better position to grow profitably in the future," Millerchip said.
Kroger predicted that sales will turn negative in 2021, falling between 3% and 5% after last year's 14% surge. Earnings should take a similarly modest step backwards following the record growth year.
Zoom out to a two-year basis, which smooths out the disruption caused by the pandemic, and sales should rise by between 9% and 11% annually for 2020 and 2021. Free cash flow will average about $3 billion for the period, too, which has allowed Kroger to boost savings while paying down debt.
That means management has lots of resources it could use to make major acquisitions or increase direct cash returns to shareholders through dividends and stock buybacks.
In any case, investors should achieve significantly higher total returns than the 8% to 11% range that Kroger has targeted over the long term. The growth rate from there will depend on how well the supermarket chain has done at strengthening its competitive moats while Walmart and other rivals direct billions of dollars toward the same goal.