Analyst worries that Kroger comment will lead the grocer down the same path as Sears

Digital sales growth topped 60%, but GlobalData is concerned about the stores

Kroger’s digital sales grew, but GlobalData Retail is concerned about stores.

By Tonya Garcia – Reporter, MarketWatch

A comment from Kroger Co. Chief Executive Rodney McMullen has given GlobalData Retail’s Managing Director Neil Saunders a sinking sense of déjà vu, going back to Eddie Lampert and Sears Holding Corp.

On the earnings call, McMullen talked up Kroger’s KR, -1.12%   digital advancements. The grocer reported third-quarter digital sales growth of more than 60%.

“We’re moving from a traditional grocer to a growth company with both a strong customer ecosystem that offers anything, anytime, anywhere, and asset-light, high-margin alternative partnerships and services,” he said, according to a FactSet transcript.

Saunders worries that Kroger will focus too much on digital at the expense of stores, many of which he says “feel run down and dispiriting” and don’t highlight what Kroger has to offer.

“This mantra was also one peddled by Eddie Lampert, who used it to justify the deterioration in stores,” Saunders wrote. “This did not work well for Sears and ultimately, we do not believe it will work out well for Kroger unless the company comes up with a more balanced growth strategy.”

Sears SHLDQ, -4.52%   filed for bankruptcy in October. Eddie Lampert’s ESL Investments made a $4.6 billion bid to purchase what’s left of the company this week.

To be sure, Saunders isn’t against Kroger’s tech investments; he calls the Ocado partnership “appropriate and necessary.” But online grocery has yet to take off.

An October Moody’s report notes that the Inc. AMZN, -0.67%   purchase of Whole Foods in 2017 made e-commerce grocery a bigger focus, but online penetration is still only about 2% of the $1 trillion U.S. food sales. Logistics for perishable items are a major challenge.

“Despite the many compelling reasons for online sales to grow, we think most of the growth in online grocery sales will be limited to certain densely populated metropolitan areas, where income levels and density of delivery routes are more conducive to online grocery purchases,” the report said.

“The trend toward healthier food consumption like fresh, natural, organic and other specialty foods also does not translate well toward home delivery in a box.”

However, Moody’s does see value in some of the tech efforts that Kroger has made.

“Digital growth continued to be impressive at including pickup and delivery with a majority of stores now offering these capabilities,” said Mickey Chadha. “We expect the remainder fiscal 2018 and most of fiscal 2019 to be a transformational period as Kroger continues to make necessary investments for future growth with benefits of these investments starting to come to fruition toward the back end of fiscal 2019.”

UBS analysts note the “top-line challenges” that persisted at Kroger in the most recent quarter. Kroger reported sales of $27.67 billion, down from $27.75 billion last year, but ahead of the $27.65 billion FactSet consensus.

Identical sales excluding fuel were up 1.6%.

“Overall, Kroger’s core identical sales reflected some of the challenges it anticipated as it remodels more stores,” analysts led by Michael Lasser wrote. “When considering its recent price investments and its remodeling projects should collectively transition from being a headwind to a tailwind, we don’t think consistent 2%+ same-store sales growth is that far off.”

However, UBS is uncertain whether Kroger’s initiatives, like Kroger Precision Marketing, which connects Kroger customers with brands, will offset margin headwinds in the long-term.

UBS rates Kroger shares neutral with a $31 price target.

Kroger shares have gained 6.6% in 2018 while the S&P 500 index SPX, -1.54%   has shed 0.1% in the period.

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