Traditional grocery stores have put in a surprisingly strong performance during the second half of this year. However, the good times might be coming to an end. Kroger (NYSE:KR) suffered an alarming decline, losing nearly 10% on Thursday. Not only that, the volatility is likely not over for Kroger stock.
On paper and without context, Kroger managed a solid earnings beat for the second quarter. Against a consensus estimate of 38 cents, the company delivered 41 cents, or an 8.5% positive surprise. In the year ago quarter, the grocer merely met expectations with a 39-cent earnings per share.
Unfortunately, what hurt Kroger stock was the underlying company’s sales performance, or lack thereof. In Q2, Kroger rang up $27.87 billion in sales, missing the consensus target calling for $27.95 billion. That part wasn’t a big deal since we’re talking about a less than 0.3% miss. What freaked investors was the decelerating progress.
A Closer Look at Kroger Stock
In Q2 of last year, Kroger delivered just under $27.6 billion. In an extremely-competitive industry, the nation’s largest traditional grocer could only must a 1% year-over-year sales lift. For Q1 2018, Kroger registered a much more palatable 3.4% YOY gain.
Adding to the woes, same-store sales missed expectations. Against a 1.86% target, comparable sales increased 1.6%. Again, the numbers themselves aren’t unsightly. Rather, the revenue misses compound the grocery industry’s razor-thin margins. Essentially, Kroger stock is expensive despite what the paper valuations imply.
More critically, the revenue underperformance demonstrates that Kroger’s brand overhaul isn’t working. Introduced last year, the Restock Kroger Initiative focuses on layout and operational changes. The strategy also dives into incredible granularity, such as offering different barbecue sauce depending on an analysis of regional taste.
It sounds wonderful on surface level. But shareholders in Kroger stock aren’t having any of it. Here’s why:
Kroger Stock Has an Identity Crisis
I’m well familiar with Kroger’s efforts to reinvent itself. The company owns the Ralphs brand that is a fixture in southern California. Recently, I’ve noticed one of my favorite Ralphs location undergoing a serious makeover.
Rejuvenating your brand is a necessary component of long-term success. But when this effort impedes your current customers, the rewards may not be worth the hassle. I can tell you this: with my local Ralphs oftentimes closing entire sections in their stores, management incentivizes customers to shop somewhere else.
And that’s exactly what’s happening. Kroger has spent considerable resources freshening up their stores to compete with higher-end grocers like Amazon’s (NASDAQ:AMZN) Whole Foods Market. But due to the company’s disruptive initiative, shoppers have turned to alternatives. That gives the competition an unnecessary leg up, hurting KR stock.
Moreover, the rebranding itself is unnecessary. People love shopping at Kroger-owned stores because they deliver quality goods conveniently and at reasonable prices. If they revamp the outfit to look more like Whole Foods or Sprouts Farmers Market (NASDAQ:SFM), they’ll need to charge equivalent prices.
But that’s not why investors primarily buy KR stock. Instead, they recognize that Kroger is a high-volume play. If they’re moving into the premium grocer sector, they must abandon the mass-produced food products and focus on high-margin alternatives.
But in a confusing twist, management has pushed their private-label brands. No food snob is going to buy these generic copies of brand-name goods. If Kroger wants to go the premium route, they must align their strategy with ground-floor operations.
As it stands, Kroger has an identity crisis, which is why investors are heading towards the exits. The other reason? Their rebranding is simply unsuccessful.
Kroger Should Play to Its Strengths
In assessing management’s decisions over the past year, I feel as if Amazon intimidated them. This is a shame because you can’t beat Amazon at its own game; you have to play your own.
I appreciate the company’s efforts to integrate technology into its initiative. For instance, Kroger has experimented with home deliveries, curbside pickup, and self-checkout. More tech-based functions are on the way.
But it’s important not to forget your bread and butter. For Kroger, it’s all about the volume. The leadership team can do all the revitalizing it wants. However, if the efforts impede low prices and convenience, customers will flock elsewhere.
Unfortunately, management doesn’t want to listen to its shareholders. That’s why they left, and why they’ll continue to leave unless the attitude changes.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.