Earnings   //   June 20, 2019

Kroger’s digital investments are driving sales growth but eating profits

Kroger’s digital sales are increasing as the company invests more in services like delivery and in-store pickup, but the costly logistics continue to eat into the company’s profits.

During its first-quarter earnings on Thursday, Kroger reported that digital sales were up 42% compared to the same period last year, but same-store sales excluding fuel were up just 1.5%. Meanwhile, operating profit declined to $957 million, compared to $1 billion a year ago.

During the company’s earnings call, CEO Rodney McMullen focused in on how much potential the new revenue streams have for the company. “While we’re only in the middle of our transformation, it’s important to frame up the magnitude of the progress we’ve made,” he said, citing the fact that the company did zero digital sales in 2014, but reached a $5 billion run rate for its digital business in 2018. Kroger also announced today that it expects its alternative profit streams — which mostly consists of sales generated by its Kroger Personal Finance business, its media business, and its customer data insights division — to contribute $100 million in net operating profit by the end of 2019.

In 2017, Kroger introduced its Restock Kroger initiative, a restructuring strategy put in place to drive such revenue streams and create an Amazon-style flywheel to protect its business. It’s a playbook that’s also being followed by Target and Walmart, who are aggressively courting advertisers and building their own media businesses.

McMullen said that the Restock Kroger initiative would generate $400 million in incremental operating margin by 2020 — but that it would require a $1.3 billion investment. And Kroger is in the middle of making many of those investments right now, especially to build out its delivery and pick up business. For example, the company broke ground this quarter on the first of 20 automated warehouses it plans to build over the next two years in partnership with British online grocer Ocado to fulfill online grocery orders. As competitors like Target, Walmart and Instacart continue to roll out delivery and in-store pickup to more locations, or add more membership options like an unlimited subscription service, grocery delivery will remain a competitive market, and one that will require continued investment to stay ahead of other retailers.

McMullen was also asked during the call about how the company is reacting to its competitors’ willingness to acquire other companies to help grow their media businesses. Walmart recently acquired ad tech startup Polymorph Labs, while it was rumored last month that Target was looking to acquire Triad Retail Media from WPP. He didn’t rule out acquiring companies in the future, but said that for now, Kroger was happy with its existing partnerships.

One bright spot for the company is that sales from its private label brands continue to grow, which should help the company improve its margins. Sales from private label brands were up 3.3%, mostly from its Simple Truth private label brand, which sells organic and natural food products.

“We continue to expect 2019 to be a transition year for Kroger with returns on its investments in the Restock Kroger plan starting to accelerate in 2020,” said Mickey Chada, vp of financial services company Moody’s.

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