Kroger Execs Highlight 'Competitive Moats' in Q3 Review

Having been cautious on projections due to uncertainty in the COVID economy—and having delivered an update on its strategies and financial health just over a month ago—there was an understandable lack of surprises revealed during The Kroger Cos.’s third-quarter financial update this week.

So while overall revenue came in a little lighter than some projections, comps and earnings were better than expected, giving CEO Rodney McMullen and Gary Millerchip, Kroger’s chief financial officer, further confidence in delivering an ongoing message they were doing right by the business for the long term and that their strategies were paying off, even as the windfall of sales that came with the pandemic onset nine months ago continued to slowly recede.

Non-fuel same-store sales of 10.9%—nearly half of that accomplished through a digital sales boost of 107% in the period that ended Nov. 7—indicated the company was gaining market share and widening what McMullen calls Kroger’s “competitive moats” in fresh foods, private brands, data and personalization, and “seamless” omnichannel options.

“We are more certain than ever that the strategic choices and investments made over the last three years have positioned us to meet the moment,” McMullen said, according to a Sentieo transcript. Guidance for the fourth quarter was raised slightly, but a comprehensive 2021 fiscal outlook may wait until March when Kroger plans its next investor conference. That could shape up to be a newsworthy event, with updates also anticipated around the openings of its first e-commerce fulfillment centers with Ocado.

Incrementally Profitable Online

As they had while reviewing second quarter earnings in September, officials described an “incrementally profitable” online business, or profitable beyond the considerable ongoing investments behind it. This is supported by higher digital sales volumes, a rapidly growing digital media business and improvements in operational efficiency, executives explained.

“We see a clear path to further improve digital profitability by leveraging our personalization tools to increase basket size and improve sales mix, further reduced the cost to fulfill order via process improvements and automation, and continue to grow digital media revenue,” Millerchip added, noting, for example, that Kroger reduced its cost for pickup orders in-store by double digits compared to the same period last year.

Accomplishing these objectives now is a good signal for the future, he added, because “if we achieve them in Q3 this year, we’ll get the full benefit on the whole volume next year. So actually on the same level of business, digital would be a tailwind in next year’s financial model,” Millerchip added, noting, however, that as volumes grow and Ocado centers get up and running, they too will bring new costs.

Critical Investments

A looming concern for analysts following Kroger is the prospect of a more competitive sales environment as its heads toward a 2021 fiscal year that will include impossible year-on-year sales comparisons. In the current fourth quarter, Kroger has a relatively easy 1.9% comp hurdle to clear before encountering year-on-year comps of 19%, 14.6% and 10.9%, respectively in the three quarters of 2021.

Barclays analyst Karen Short, for one, notes the negative comps are especially ornery for union organized operators like Kroger that have a higher cost structure than many competitors.

Kroger for its part invested in pricing during the quarter with an eye toward the longer term to the extent that margins dipped slightly, executives said.

Again deferring more detail to its March update, Millerchip described Kroger as positioning itself to come out of COVID next year in a stronger position with consumers, with pricing and brand trust being key elements.

“I think it’s important to remember that as we talk about the investments that we’re making in gross margin today, many of those are in areas that matter most to the customer around personalized promotions and value offers that really resonate with the customer in the areas that we believe will drive loyalty long term [and] are in the most important categories for the customer around fresh, because that’s what primarily drives their decision to shop with a food retailer,” Millerchip said. Kroger is also investing in advertising “to grow our marketing effectiveness and share of voice,” he added.

“These are the kind of investments that we’ve been making this year because everything we see in our data and insights says that [will] ensure that we come out at the end of the COVID environment in a stronger position than we went in, and winning market share,” he added. “We believe those investments that we’re making are critical to that, and they’re creating increased separation from some of our traditional peers as we come towards that lapsing that time period with COVID.”

Still Digging Moats

Pandemic trends of fewer store visits and more stock-up trips continued during the third quarter, McMullen said, providing Kroger with an opportunity to win even after the pandemic recedes, McMullen said. In the meantime, Kroger is merchandising to encourage shoppers to “trade up” to items such as premium jumbo blueberries (“they’re delicious,” he noted) and larger size packages of fresh foods.

“Customers across the country are still staying home, and cooking at home is now part of the new routine. We are fulfilling our customers’ growing demand for premium products as they seek joy and elevated experiences,” he said.

The meal kit subsidiary Home Chef, which Kroger acquired two years ago, was called out for continued strong execution and bringing increased innovation as a convenient brand offering in stores in the form of oven-ready entrees and sides, flatbread pizzas, salads, sandwiches and soups.

Private brands grew by 8.6% in the quarter led by Kroger’s premium Private Selection line (up 17%) and Simple Truth (up 15%). In all, 250 new private-brand items were introduced in the quarter, the most ever. “These are incredible numbers and demonstrate that while many competitors offer private label products, Kroger’s unique approach to Our Brands is a differentiator and a competitive moat,” McMullen said.

Kroger also noted progress in further separating itself from competitors by leveraging leadership in customer data and personalization capabilities. “Many retailers have transactional data, but no one has the customer data and the insights that Kroger has,” McMullen said. “The quality of our data is a massive advantage because it allows us to develop a significant alternative profit business that generates income from the traffic while benefiting our customers.”