Grocery store chain Kroger (KR -0.43%) knocked it out of the park last quarter ... relatively speaking. While same-store sales growth of 6.2% year over year isn't exactly earth-shattering, it's huge by the grocery industry's standards. Q4's adjusted per-share earnings of $0.99 also easily topped the consensus estimate of $0.90 per share, as did Kroger's profit guidance for the fiscal year now underway.
The real shining star of this company's fourth quarter, however, is hiding in plain sight. During the three-month stretch ending in January, Kroger's private label brands led the charge with 10.1% year-over-year revenue growth.
That's a big deal, even if nobody's talking about it.
What's private label?
If you're not familiar with the term "private label," it's a nicer-sounding alternative to "generic" -- a word that once largely applied to lower-cost and notably lower-quality consumer goods. Sometimes you'll hear them called house brands, although Kroger lovingly refers to these types of products as "Our Brands."
Whatever you want to call them, the days of their plain packaging and subpar quality are largely in the past. These products look and feel and taste much like the more familiar national brands' products. Simple Truth, Private Selection, Smart Way, and Heritage Farm are some of Kroger's brands you may have been buying without even realizing you're only buying them from a Kroger-owned grocery store.
That's the point. These items are competing with national brands -- they have to look and taste as good as the national brands' products.
And they do, if the Private Label Manufacturers Association's most recent numbers are any indication. The PLMA reports that U.S. consumers spent a record-breaking $228.6 billion on private label goods last year, up 11.2% from 2021's tally. The data further indicates that these house brands now account for 18.9% of all consumer retailing revenue, up from the prior year's comparison of 18.2%. Store brand sales are up 40% for the past five years, easily outpacing the growth of national brands.
The quest for value against a backdrop of inflation is a key driver of this recent growth, although not the only one. Consumers just like these products too. The Food Industry Association says more than 40% of consumers choose these lower-cost food options because of their taste and quality.
Kroger knows all of this, and it is taking advantage of the dynamic in brilliant fashion.
Kroger's Our Brands is crushing it
Aside from noting the 10.1% sales growth of its Our Brands goods, Kroger's Q4 press release didn't offer investors much information on this front. The quarterly conference call didn't add much more, other than to say the grocer will continue developing these brands' assortments; the company doesn't even disclose how much of its revenue regularly comes from its private label goods.
It is possible to ferret out a rough idea of this lineup's impact, though, and it isn't small.
The figure's a bit stale now, reported in early 2021, but Kroger did indicate that its annual private label business exceeded $26.2 billion in 2020. That was right around one-fifth of the company's annual top line at the time. Given the usual low-double-digit growth of Our Brands since then, it's not a stretch to suggest Kroger's private labels now make up roughly one-fourth of its business.
But the upside of Our Brands' growing reach is even better for the bottom line. That's because these goods are typically more profitable for the retailer than selling national brands is.
While the profit margin profile can change from one product category to the next and from one retailer to the next, numbers from Mercator Advisory group indicate that private label groceries boast profit margins on the order of 35%, versus a markedly more modest 26% for national brands. When net profit margins are as paper-thin as they are for the grocery business, those pennies can make a massive difference.
Time to buy
Don't jump to sweeping conclusions. While the growth of Kroger's private label business is improving the overall profit profile of its product assortment, costs are headed higher. The grocery store chain intends to spend $770 million more on its associates this year than it did last year, for instance. In the meantime, its own freight costs remain uncomfortably high, and its planned acquisition of Albertsons is tenuous and complicated at best.
Think bigger picture, though. Not only is Kroger shifting toward a more profitable revenue mix, it's able to do so because much of its private label growth is the result of cost-cutting vertical integration. It's bringing its supply sources closer to home, allowing it to place even more higher-margin Our Brands items in its stores in the future. That's even more so the case if it can scale up by merging its operations with Albertsons.
Bottom line? It may seem small on the surface, but the private label strategy is actually proving to be a pretty big deal, and one of the key reasons Kroger's 2023 profit outlook of between $4.45 and $4.60 per share was such a pleasant surprise (analysts were only calling for an average profit of $4.20 per share).
Take the hint and step into this stock following its multi-month soft patch. Its private label edge makes Kroger a compelling investment regardless of how the Albertsons deal shakes out.
