Has Kroger’s Revenue Growth Stalled, and is that bad for Whole Foods?

Kroger’s (NYSE: KR) run of extraordinary revenue growth may have stalled. If it is real such a stall might be very bad news for organic grocers; Whole Foods (NASDAQ: WFM) and Sprouts (NASDAQ: SFM).

Kroger’s TTM revenue grew by $1.55 billion in first quarter 2016; rising from $109.83 billion in January to $111.38 billion in April, ycharts data indicates. The revenue growth is good but not as great I had predicted because Kroger is in the process of absorbing Roundy’s which reported $4.03 billion in revenue on June 30, 2015.

Is Roundy’s a Drag on Kroger’s Revenues?

Roundy’s is the operator of four grocery chains with 151 supermarkets in Wisconsin and Illinois that Kroger bought out in November. I had expected Roundy’s to give Kroger a much larger revenue boost.

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Such a boost might come later this year, as Kroger starts to recover the cost of absorbing Roundy’s. A major problem is that Roundy’s lacks some of the revenue streams available from other Kroger stores; including filling stations and large selections of non-grocery merchandise.

Kroger will have to spend big money to add fuel and a greater selection of merchandise to Roundy’s locations. It may also have to build new stores in Roundy’s markets to get the Roundy’s brands; Mariano’s, Pick n’ Save, Metro Market and Copps, up to the level of existing Kroger brands like King Soopers and Fred Meyer.

Other expenses will include expanding Kroger’s popular loyalty card system to Roundy’s brands, adding the new markets to Kroger’s digital coupon system, and adding Roundy’s networks to Kroger’s inventory and payment ecosystems. All that will take time; and cost a lot of money, but it will pay off in the end. This means Roundy’s might be a drag on Kroger’s revenue for some time.

Are Lower Fuel and Food Costs Hurting Kroger?

Another problem Kroger faces is lower fuel prices, gasoline prices in first quarter 2016 were 45¢ a gallon lower than in the same period in 2015, CFO Mike Schlotman revealed. Statements Schlotman made in this year’s first quarter earnings call indicate that might not be the case.

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Kroger is making less from the fuel it sells but the drop is slight, Schlotman noted. Kroger made 18.4¢ a gallon on fuel in 2015, during the first three months of 2016 it made 18.2¢. If this is true, the lost fuel revenue might not be that great.

Since Kroger uses fuel as a loss leader this makes little difference in the big picture. The company is also saving some money because the profit margin on fuel on fuel rose from 11.6¢ to 14.3¢. Schlotman expects fuel prices to increase, as the effect of lower oil costs hits home.

The company expects fuel sales to grow by 2.5% to 3.5% over the course of 2016, Schlotman added. One problem Kroger may face this year is that customers will have less incentive to buy its cheap gas or participate in its fuel points discount program. That means Kroger may have to drop fuel prices, dramatically to keep sales up.

Whole Foods and Sprouts are in Kroger’s Sights

This revenue slump is a potential threat to both Whole Foods and Sprouts, because Kroger is getting more aggressive in its foray into higher profit organic foods. The idea is to make up falling demand for traditional groceries with ready-made foodd and organics.

This is explains Kroger’s “strategic investment” in Lucky’s Market, a small Colorado based specialty chain that specializes in organics. CEO Randy McMullen admitted as much during the conference call.

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“We invested in Lucky’s because of their great people and unique go-to-market strategy which includes smaller-format stores that resemble an indoor farmer’s market, plus a culinary department that showcases amazingly restaurant-quality prepared foods,” McMullen said.

Lucky’s sounds a great deal like Main & Vine; a Whole Foods clone, that Kroger is testing in Gig Harbor, Washington. It also has strong similarities to Mariano’s; the high-end grocer, Roundy’s operates in Chicago.

It looks as if Kroger is laying the groundwork for a major effort to compete with Whole Foods and its lower competitor Sprouts. It is easy to see why; Kroger reported making $11 billion from natural organic sales in the fiscal year that ended in October 2015.

This bodes ill for Whole Foods and Sprouts, because of Kroger’s greater resources and capacity to deep discount. The amount of natural and organic sales Kroger is approaching Whole Foods’ first quarter revenues of $15.6 billion and it is nearly four times, Sprouts total revenues of $3.739 billion.

Adding to the threat is all the other services Kroger can offer including fuel, prescriptions and a growing variety of general merchandise. Neither Sprouts nor Whole Foods has pharmacies or filling stations.

What’s next for Kroger, Partnership with Uber?

Naturally investors will be wondering what is next for Kroger? My prediction is more acquisitions, and a major push into delivery. Delivery will expand to counter new moves by Amazon (NASDAQ: AMZN) and Walmart (NYSE: WMT).

Kroger has been experimenting with same-day delivery in cities like Denver for some time. Now Walmart has raised the bar in same-day service by partnering with the ride-hailing apps Lyft and Uber.

News reports indicate that Lyft drivers will deliver Walmart orders in Denver and Uber drivers will handle orders in Phoenix. Since both Denver and Phoenix are Kroger markets, it is not hard to imagine these tests as an attack on Kroger. Kroger owns Fry’s in Arizona and King Soopers in the Denver area.

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My prediction is that Kroger will launch a similar service with Lyft or Uber in the near future. The service would take advantage of Kroger’s existing infrastructure with associates pulling orders in the store and handing them off to a driver.

Since Kroger already does that at some King Soopers stores in Denver, it would not be hard to implement. The only difficulty would be union relations; outside New York, Uber drivers are not unionized.

In addition to app-based delivery, I imagine Kroger will make some more acquisitions to expand its footprint. No specific predictions here, but the grocery market is soft; meaning there will be a lot of regional supermarket brands for sale cheap in the near future.

Despite the slowing revenue, Kroger is still a good investment, because of its growth potential. The Cincinnati-based grocery giant is still in a great position to capitalize on the radically changing nature of retail.