Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche


Kroger and the Future of Grocery

Strangely, the traditional supermarket operator Kroger (NYSE: KR) is giving us a glimpse of the future of grocery.

To explain, Kroger is partnering with Britain’s Ocado Group plc (LSE: OCDO) to build 20 robotic fulfillment centers across the United States. In fact, Kroger has plans for three customer fulfillment centers (CFCs) where robots will pick and pack groceries.

The first CFC is being built in Monroe, Ohio; outside Cincinatti, Supermarket News reports. Kroger will spend $55 million that facility. Plus, they will build a second CFC in Groveland, Florida, outside Orlando, The Orlando Sentinel reveals.

Intriguingly, Kroger owns no stores in the Orlando market. In fact, Kroger operates just one Harris Teeter store in Florida. Hence, Ocado could help Kroger tap new markets.

Can Kroger and Ocado Revolutionize On-Line Grocery?

Instead, Kroger could enter new markets with grocery delivery with Ocado’s help. To elaborate, Ocado’s online delivery service controls 1.3% of the British grocery market, Reuters estimates.

Kroger owns 6% of Ocado; but its that company’s technology not the British customers Kroger wants. Specifically, Ocado claims its robots can pick and pull 50 grocery items in five minutes.

Additionally, the Ocado Smart Platform could operate up to 1,000 robots at once in a “swarm” or “hive” using artificial intelligence (AI). In detail, the Ocado Smart Platform is an operating system for fulfillment center robots.

Kroger management believes the Smart Platform will give their CFCs the capability to rival Amazon. Notably, Kroger claims an Ocado-powered CFC can fulfill “anything, anytime and anywhere,” Supermarket News notes.

To clarify, Kroger plans to use the Ocado Smart Platform to pick and pull grocery orders. Kroger’s delivery service and contractors like Instacart will deliver the grocery orders.

Why Kroger wants Ocado

Kroger wants Ocado’s help because its revenues are shrinking. Specifically, Kroger reports revenues of $121.162 billion for 2018. That number is down from $122.662 billion in 2017.

In addition, Stockrow gives Kroger a negative revenue growth rate of -1.22% for 2018. Tellingly, this is the first negative annual revenue growth rate for Kroger in several years.

Moreover, Macrotrends estimates Kroger’s year-to-year revenues fell by 9.47% between 31 January 2018 and 31 January 2019. Therefore, Kroger’s business could be shrinking.

Consequently, Kroger’s annual gross profit fell from $27 billion in 2017 to $26.258 billion in 2018. However Kroger’s annual net income jumped from $1.907 billion in 2017 to $3.11 billion in 2018.

Why Ocado is Partnering with Kroger

Thus, it is easy to see why Ocaodo is partnering with Kroger. The financial numbers show Kroger could make more money from less revenue without Ocado’s technology.  

In fact, Kroger’s earnings before tax grew from $1.502 billion in 2017 to $4.01 in 2018. Moreover, Kroger’s operating income grew slightly from $2.612 billion in 2017 to $2.614 billion in 2018.

Tellingly, Kroger is generating more cash. For instance, Kroger’s cash from operations grew from $3.413 billion in 2017 to $4.164 billion in 2018. Additionally, Kroger’s annual free cash flow grew from $604 million in 2017 to $1.197 billion in 2018. Therefore, Kroger is increasing its cash flow despite falling revenues.

Hence, Ocado is partnering with Kroger, because Kroger can make money from the US grocery business. Furthermore, Kroger offers many impressive resources in the United States.

Kroger’s Impressive Resources

Kroger is making more money because of its huge footprint. For instance, Statista estimates Kroger owned 2,764 supermarkets in the United States on 2 February 2019.

However, those supermarkets are just the tip of the iceberg at Kroger. Kroger’s other resources include:

  • 319 Fred Meyer Jewelry Stores.
  • Supermarket chains in 35 of America’s 50 states
  • 37 food manufacturing facilities.
  • 17 dairies.
  • The Simple Truth private label natural and organic brand. Kroger claims to have sold $2 billion worth of Simple Truth products, Grocery Dive reports. Plus, there are over 1,400 Simple Truth products.
  • A variety of Private Label brands like Simple Truth that account for 28.2% of Kroger’s sales, Food Dive estimates. I estimate Kroger made $34. 18 billion from private label brands in 2018. To clarify, Kroger reports 2018 sales of $121.2 billion.
  •  Grocery deliveries from up to 1,372 supermarkets in 45 markets, Progressive Grocer reports. Notably, Progressive Grocer estimates that Kroger’s delivery footprint grew by 500 stores in the second half of 2019.
  • Curbside grocery pickup at 1,091 stores in August 2018, Progressive Grocer estimates.
  •  2,270 pharmacies.
  •  1,537 supermarket fuel centers.
  • A stable of historic supermarket brands that includes Ralph’s, Fred Meyer, Smith’s King Soopers’ Fry’s, Copps, Baker’s, Mariano’s, Harris Teeter, City Market, Pick n’ Save, QFC, and Metro Market.
  •  The Vitacost discount vitamin and supplements online retailer.

Kroger’s Private Label Brands Rival Costco

Private label brands are among the most profitable segment of the grocery business. Moreover Kroger’s private label brand sales rival those of membership club giant Costco Wholesale (NASDAQ: COST).

To elaborate, Costco sold $39 billion worth of its Kirkland Signature products in 2018, CNBC estimates. Thus, Kroger’s private label sales are closing in on Costco’s.

Moreover, Warren Buffett estimates Costco’s Kirkland Signature sales exceed those of the historic food brand Kraft-Heinz, Grocery Dive reports. To explain, Buffett estimates Berkshire Hathaway (NYSE: BRK.H) subsidiary Kraft-Heinz’s 2018 sales at $26 billion.

Therefore, Kroger has a potentially lucrative business model. For example, Costco records 2018 revenues of $141.576 billion and a quarterly gross profit of $4.676 billion on 9 February 2019. Incredibly, Costco operates just 510 worldwide but it is America’s fourth largest retailer by revenue.

How Much Money is Kroger Making?

Unfortunately, Kroger is not making that much money from its supermarket empire.

For instance, Kroger reports an operating cash flow of just $431 million and a negative free cash flow -$279 million on 2 February 2019. Moreover Kroger had just $429 million in cash and short-term investments on 2 February 2019.

Moreover Kroger a share price of $25.57 and a market capitalization of $20.41 billion on 29 April 2019. Consequently, Kroger could have a hard time attracting investment without Ocado’s technology.

I think these low numbers explain Kroger’s partnership with Ocado. For instance, Ocado had a high stock price; £1,389.50 ($1,796.96) and market capitalization; £9.827 billion ($7.59 billion), for its size on 29 April 2019.

In contrast, Kroger had a low stock price; $25.71, and market cap $20.525 billion on 25 April 2019. Thus, Kroger management hopes to increase the market cap and stock price with Ocado’s help.

Why Kroger needs Ocado

Moreover, Ocado is generating more cash in recent years. For instance, Ocado’s cash and equivalents grew from £150 million ($194.16 million) in December 2017 to £410.8 million ($531.74 million) in December 2018.

Consequently, Kroger management hopes Ocado’s tech can help it counter well-capitalized competitors like Amazon (NASDAQ: AMZN). Notably, Amazon had cash and equivalents of $41.25 billion on 31 December 2019. In addition, Amazon had a stock price of $1,98.43 and a market cap of $954.35 billion on 29 April 2019.

Is Kroger a Value Investment?

I think Kroger is a value investment because of its size, private label business, and partnership with Ocado.

Specifically, Kroger’s 29 April 2019; $25.58 share price make it well worth investigating. Compared to Amazon and the £1,389.50 ($1,796.96) a share Ocado, Kroger is a bargain.

Plus, unlike Amazon, Kroger pays a dividend. In fact, Kroger will pay 14₵ a share on 1 June 2019. That number is up from 12.5₵ a share on 1 June 2018. In addition, Kroger paid a 45.5₵ special dividend on 17 October 2019.

That dividend is reliable because credits Kroger with 10 years of dividend growth. Moreover, Kroger shares offer a 2.17% dividend yield, an annualized payout of 56₵, and a payout ratio 26.4%, calculates.

In the final analysis, Kroger is a value investment that could grow into a major player in online retail. Investors and retailers need to watch Kroger because the historic grocer is trying to build a retail platform that could give Amazon a run for its money.

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