Few investors will be surprised to learn the war Kroger (NYSE:KR) is fighting against Walmart (NYSE:WMT), Amazon.com (NASDAQ:AMZN) and others has been neither cheap nor easy. Yet, the 10% tumble KR stock took on Thursday following its disappointing fourth quarter suggests shareholders weren’t quite ready to see that reality in print.
The matter leaves current and would-be owners of KR stock in a conundrum. The grocery giant remains a work in progress, and though it might reshape itself into what it needs to be, there’s little evidence just this year that the effort will yield results.
Whatever’s in store, nobody disagrees that Kroger can’t continue to do business as it has in the past.
Kroger Earnings in a Nutshell
Online ordering, curbside pickup and even home-deliveries are just some of the innovations that have proven disruptive to the grocery business.
Kroger was slow to make the competitive shift, but is playing catch-up now. With more than 2,000 locations now providing delivery and 1,600 offering curbside pickup, some 90% of the grocer’s reachable customers don’t need to enter a store to get their purchases. Last quarter’s digital sales were up 58% year-over-year, and on pace to account for $9 billion worth of annualized revenue before the end of the year.
It’s certainly a step in the right direction. It’s been an expensive step though. Also in its recently completed Q4, adjusted net operating income of $391 million fell from the year-ago figure of $483 million. Per share operating income of 48 cents was down from 54 cents, and fell short of the 53 cents per share that Kroger stock analysts had been modeling.
But the GAAP earnings decline was worse, as the company spent $3 billion on company-wide remodels and digital initiatives that were part of the grocer’s “Restock Kroger” revitalization program. The Cincinnati-based company expects to spend $3.2 billion on the initiative this year, which to its credit, drove same-store sales growth (ex-fuel) of 1.9% for the quarter ending in early February.
Still, that rate fell short of Walmart’s same-store sales growth of 4.2%.
No Choice But to Spend
The heavy spending — past and projected — is anything but a hit with investors. But, it’s not optional at this point.
“They have no choice at all but to make these investments,” says the Wall Street Journal’s Aaron Back. The Heard on the Street columnist went on to explain: “They’re saying, look, however you want to get your groceries, we’ll find a way to get them to you. Basically, whatever you want, but that costs money.”
Wolfe Research’s Scott Mushkin also points out that while the “Restock Kroger” program is a must-do if the grocer hopes to retain market share, nobody makes any money with Kroger’s omnichannel development.
That’s not holding Kroger back, though, as it did see some bright spots last quarter. Aside from at least luring customers to its stores, sales of its private label products — which drive higher-margin revenue — now account for more than 30% of all goods sold.
Guggenheim analysts conceded “This print was far from perfect,” but added to its post-earnings note “the selloff looks overdone, in our view, implying a ~6x multiple on our 2019 EBITDA estimate at $25.”
Looking Ahead at Kroger Stock
Even as the grocery giant undergoes an overhaul, the industry landscape continues to change. Amazon.com, which already owns Whole Foods Market, recently announced it was planning to open dozens of more conventional grocery stores in the foreseeable future. While the e-commerce company has struggled to make Whole Foods more viable and would certainly find a formidable opponent in the new-and-improved Kroger, it’s competition Kroger doesn’t need right now.
Walmart has also stepped up its game, offering curbside pickup and deliveries from thousands of its U.S. stores.
“We understand that we have our work cut out for us,” said Kroger CEO Rodney McMullen during the earnings call, who went on to say “We realize business transformations are hard but I want to emphasize we are on track to deliver on our ‘Restock Kroger’ commitments.”
That program won’t be bearing as much fruit as hoped as soon as expected though, given the company’s 2019 earnings guidance. The grocer is calling for a profit of between $2.15 and $2.25 per share of Kroger stock, falling short of the $2.30 analysts, on average, were expecting.
Still, the steep selloff makes KR stock look like it’s priced at a tempting discount.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can learn more about James at his site, jamesbrumley.com, or follow him on Twitter, at @jbrumley.
