By Neil Saunders
The extent to which the grocery market has shifted from an environment of modest inflation to one of deflation and tough price competition is evident in Kroger’s numbers. The total figure looks healthy; however, this is flattered by the inclusion of Roundy’s: when the benefit of this acquisition is removed, total sales excluding fuel grew by a more lackluster 1.6%.
It is the underlying sales number that is most revealing. This has been in descent for a number of quarters, but the reported growth of just 0.1% this period is particularly somber — especially by Kroger’s usual standards. Unfortunately, the deflationary environment has meant that Kroger has had to invest more in prices which has driven down operating profit by 7.6% over the prior year.
This, in our view, is a necessary evil and we believe that Kroger is right to maintain its competitiveness. On the flip side of reduced margins, Kroger has managed to maintain the loyalty of customers and the consequent volumes that this brings.
If customer focus has been the key to Kroger’s past success, it is also the key to maintaining its leading position.
As much as the near-term outlook is pressured, the longer-term position is more favorable. While Kroger can’t do much about margin pressure it can engineer savings elsewhere in the business. It has already done this by reviewing capital expenditures and we believe that more cost savings will be found over the coming quarters. These should have the effect of easing pressure on the bottom line.
While Kroger will review costs, one area where it will strengthen focus is its efforts around customers. This has already delivered dividends for the company with, for example, a very clear range architecture allowing it to compete across all price segments. Such tiered pricing is arguably more important now than ever with consumers becoming more price conscious but, at the same time, seeking added value across several categories. It also allows Kroger to serve different segments of the market with different needs around quality and price.
If customer focus has been the key to Kroger’s past success, it is also the key to maintaining its leading position. In this regard, we are pleased to see a continued focus on digital developments. Here we see services like ClickList as helping the company drive sales through the nascent online grocery channel: this may only be responsible for a small proportion of sales at present, but we believe it will become a much more sizeable business and driver of growth over the next five or so years.
Despite the fact, Kroger remains a good, and an innovative business there is no doubt that an inflection point in grocery has now been reached. This is a lower, slower growth environment. Despite the short-term pain, the positive for Kroger is that such conditions may create difficulties at smaller companies – which Kroger may wish to acquire. Kroger, unlike many other players, has the financial muscle to weather this storm.
Neil Saunders is CEO of research firm Conlumino.