Eleven Threats to Kroger

The Kroger Co. (NYSE: KR) is one of the biggest retail success stories around these days averaging a 5% revenue growth rate for the past five years. The supermarket operator has reported market share gains for 12 years straight, not even the economic meltdown of 2007 to 2008 could stop it.

The nation’s largest standalone grocer has been able to go toe to toe with Walmart and often prevail. It’s also proved immune to competitors ranging from Amazon to dollar stores.

It has also been able to grow dramatically in recent years gobbling up regional supermarket operators such as Roundy’s and Harris Teeter and to open dozens of new Marketplace stores. If that was not enough Kroger has introduced new products such as organics and new services including same-day delivery and online grocery ordering.

Despite all that Kroger’s position is far from secure. There are some serious threats to the grocery giant out there that can undermine its business.

Eleven Threats to Kroger’s Business

The biggest threats to Kroger’s business include:

1. Dramatically changing spending habits. Retail sales at restaurants exceeded spending at grocery stores for the first time in 2016, Quartz reported. By 2012, 43.1% of Americans’ food purchases were made outside the home. Younger people the so-called Millennials are more likely to buy prepared foods which is why Kroger is investing heavily in delis and instore restaurants. There are also meal kits boxes that contain everything needed to cook a meal which were a $1.5 billion industry in May 2016 according to Eater. Meal kits are a menace to Kroger because they eliminate the need for grocery shopping.

2. Online retailers like Amazon (NASDAQ: AMZN), Instacart, Google Express and Walmart.com. These are a problem because they enable consumers to order groceries without leaving home. This is why Kroger is investing heavily in online delivery and experimenting with delivery by Uber. A major problem for Kroger is a growing number of Americans who are no longer willing to spend any time pushing a shopping cart around.

 

3. Walmart (NYSE: WMT) and Walmart.com. Walmart is the now nation’s largest grocer and it has long demonstrated a capability to undercut almost anybody’s prices. A major threat is that Walmart.com will be able to deliver groceries at a competitive price to Kroger’s. Another is that Walmart can offer a wide variety of other services.

4. Aldi The German owned discount grocer now has 1,600 stores in 35 states and it has been expanding aggressively into new markets like Southern California in recent years. Aldi has shown an impressive capability to offer high quality products at very low prices. It now operates an Aldi Test Kitchen and has begun offering higher quality including organic fruits and vegetables and USDA Choice Meats.

 

5. Safeway. The privately held grocer now owns Albertsons and as shoppers know has been able to match Kroger’s prices in recent years. It is also experimenting with same day delivery and offering higher quality products. Safeway also operates a loyalty card program that matches and sometimes exceeds the benefits of Kroger’s cards. Like Kroger Safeway aggressively promotes digital coupons and gas points. A resurgent Safeway might be a real threat to Kroger particularly if it starts gobbling up ailing regional grocers such as Winn Dixie and Whole Foods (NASDAQ: WFM).

6. Amazon (NASDAQ: AMZN) – The Everything Store now operates a grocery delivery service and it has opened an experimental grocery store in Seattle. There have also been rumors that Amazon plans to enter the pharmacy business; in direct competition with Kroger, and buy retailers such as BJ’s Wholesale Club. Amazon also competes directly with Kroger in areas such as jewelry, clothing, prepackaged foods, toiletries and household cleaning products. Areas it might enter in the future include frozen food.

 

7. Americans are driving less. Kroger’s basic business model is based on the proposition that most of its customers will own a car and drive. Yet there is evidence that Americans are driving less. The percentage of Americans without a drivers’ license is rising and growing fastest among Millennials. Around 23.3% of persons between 20 and 24 years of age had no driver’s license, a study by the University of Michigan’s Transportation Institute found. As recently 2008 18% of persons in that age group had a license. The same study found that the number of people without a license was rising in all age groups. This provides strong justification for Kroger’s delivery initiatives.

8. Food deflation. This seems counterintuitive but the low price of food these days is a major threat to grocers. Companies like Kroger operate a very low profit margin (1.59% on January 31, 2017) so even modest cuts in food prices can eat into earnings. Food prices fell by 4.9% over summer 2016 and prices of all supermarket items fell by 1.3% during the course of the entire year, the U.S. Agriculture Department’s Economic Research Service reported. This explains why Kroger’s cash supply is limited (it had just $322 million in the bank on January 31, 2017). It also shows why Kroger is going out of its way to expand its pharmacy business, add high priced big ticket items like jewelry to its stores and to offer more premium and precooked. The company needs more cash flow because its core business is less profitable.

 

9. Lower oil prices. Kroger is a major retailer of gasoline and diesel; operating 1,445 supermarket fuel centers and 784 convenience stores. The drop off in driving threatens that business but so do lower oil prices which means lower profits from gas and oil. Lower oil prices threaten Kroger’s business strategy of making up for lower grocery prices with gasoline sales. Kroger was able to offset the losses from food deflation with fuel revenues that may not be possible anymore. Another potential threat is electric cars which require no fuel, if they catch on they might cut into Kroger’s fuel sales or force the grocer to install expensive new infrastructure. A potential revenue source for Kroger would be to retail Tesla cars in its stores.

10. Income inequality and wage stagnation. The income of the average middle class family dropped by nearly $5,000 between 1999 and 2014, Pew Research Center Data indicates. At the turn of the century the average middle class household was making around $77,898 a year, but 2014 had dropped to $72,919. During the same period the average lower class family’s income dropped from $26,373 a year to $23,811 annually. This means Americans have less money to spend on gas and groceries. It explains Kroger’s emphasis on discounting and on adding amenities that appeal to the upper class to its store. One side effect of this is that Kroger is now heavily dependent on government programs like Food Stamps and Medicaid for a significant portion of its revenues.

11. The aging of America. It is no secret that the nation is getting older fast. There are roughly 75 million Baby Boomers who are now in their 50s, 70s and 70s. This hurts Kroger because people buy less as they age. Many of them will also have a lot less disposable income because 46% of Americans have not saved for retirement. The only retirement income many of them will have is Social Security and the average Social Security payment is around $1,350 a month. Boomers will be buying fewer groceries and have less money to spend. At the same time supermarkets’ core customers; middle class suburban boomers, will be dying off and replaced by Millennials – many of whom do not shop for groceries. Kroger will have to redefine its’ business model and redesign its stores to appeal to that demographic which is an expensive proposition.

 

The good news for investors is that Kroger is a highly flexible and creative company that knows how to change with the time. Like Walmart, Kroger is more than capable of reinventing itself for a new American reality; which makes this supermarket operator a really good long-term investment.