In the grocery industry, investors have gotten used to Whole Foods Market (NASDAQ:WFM) dominating the pack with its emphasis on higher-margin organic and natural foods that cater to a premium customer base. Yet when you look at some of the best-performing stocks in 2014, Whole Foods is nowhere to be seen.
But traditional grocery giant Kroger (NYSE:KR) has lit up the charts with a 65% gain this year. Effectively, Kroger has taken the best bits of Whole Foods' strategy and integrated them into its own business model, and so far, the results have been extremely successful. Let's take a closer look at Kroger and how it can turn a rewarding 2014 into even further gains in 2015 and future years.
How Kroger crushed Whole Foods in 2014
As in most industries, the name of the game in the grocery business is growth, and lately, Kroger has been one of the most successful grocery companies in producing the growth that investors want to see. Kroger managed to produce 11% higher revenue in its fiscal third quarter earlier this month, with same-store sales growth of 5.6% coming in well ahead of Whole Foods and its slower 3.1% rise in comps.
More importantly, Kroger is getting even more of its revenue to the bottom line in the form of profits. Third-quarter earnings per share jumped 21% from year-ago levels, showing the rise in margins the company has managed to achieve. Kroger also pushed its expectations for full fiscal-year earnings higher, with hopes that a better winter-weather picture than last year could help drive gains above its previous targets.
Kroger has achieved this success using a wide variety of different strategies. First, it has challenged Whole Foods on its own turf, promoting greater sales of organic and natural foods in an attempt to capture the higher margins that those products command compared to traditional grocery offerings. With natural foods boasting double-digit percentage growth, Kroger still has plenty of room to expand and become even more of a powerhouse in the space, even as it already has reached the No. 2 spot behind Whole Foods in terms of sales of organic food.
Kroger hasn't just counted on organics, though. Kroger's private-label store brands have taken off, making up more than a quarter of the grocer's overall revenue and having seen growth accelerate recently. With many shoppers looking for ways to save money, private-label sales are essential, yet paradoxically, they often mean more profits in Kroger's pocket because the grocery chain doesn't have to share margin-enhancing profits with a brand-name food producer. In addition, Kroger has looked at vertically integrating its business even further, with the company owning its own food production facilities to make milk, juice, and other beverages for which freshness carries a greater price premium.
Can Kroger keep up the pace?
Of course, one big challenge Kroger will have now that it has become a major threat to Whole Foods is whether it can sustain the competitive advantages it has earned. In response to its recent slump, Whole Foods has made several efforts to bolster its brand, with a new marketing campaign touting its status as America's Healthiest Grocery Store and seeking to cement its place in American households. If Whole Foods can demonstrate to Kroger shoppers that they'll find better products by switching, then Kroger could see its recent comparable-store sales gains start to slow.
Another concern that many investors have is that Kroger has turned to the credit markets in a big way to help finance its acquisition-led growth spurt. With $11.5 billion in debt outstanding, Kroger has identified the need to get the liability side of its balance sheet under control, but it could nevertheless take a year or more to get Kroger's debt levels down to where management feels comfortable in the long run.
Kroger has made the most of the opportunities it has to grow its business, making good use both of acquisitions and of boosting its own business from within. Investors shouldn't expect to see 65% returns year in and year out, but going forward, Kroger has several promising strategies that could generate more positive gains for long-term shareholders for years to come.
John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Dan Caplinger owns shares of Whole Foods Market. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.