What Does Kroger Know About Fashion?

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Kroger (NYSE: KR) is the country's largest traditional supermarket chain with around 2,800 stores in 35 states, but under intense pressure from rivals both off and online, it now thinks adding clothing racks to its stores will help boost sales and profits.

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Although other retailers have moved beyond their core offerings in a misguided attempt to draw customers into their stores, Kroger's decision to become a fashion retailer is particularly wrongheaded as it diminishes and devalues its brand.

Penny pinching profits

Kroger's second-quarter earnings report in September was hurt by price cuts it instituted to meet the threat posed by its primary rival Wal-Mart (NYSE: WMT), but also the expanding presence of discount chains like Aldi and Lidl, not to mention the dollar stores that continue to expand the amount of perishables they offer consumers.

The supermarket giant has also been punished severely from Amazon.com (NASDAQ: AMZN) purchasing Whole Foods Market. After an initial round of price cuts immediately after the acquisition was made, Amazon has recently announced it was cutting more prices at the organic grocer and doing so more steeply.

Kroger's revenues of $27.6 billion were up 3% from the year-ago period, but profits slid 8% to $353 million amid the price war.

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Made up out of whole cloth

The grocery business has always carried slim margins of around 2% or so, and year to date Kroger is running about half that. Apparel, however, runs much higher, currently offering net margins of approximately 8%. It's easy to see why Kroger is tempted to make the jump to become a fashion plate to boost profitability, but there is also tremendous risk.

The clothing industry is reeling at the moment as bricks and mortar retailers grapple with changing consumer preferences for how they shop. Most retailers are closing stores, reducing their footprint, and firing workers to remain viable. They're also exploring new ways to bring customers to their stores.

A rush toward "experiential shopping" opportunities has resulted in retailers like footwear outlet DSW opening up manicure and pedicure shops in its stores, American Eagle Outfitters installing a laundromat in one of its locations, and Nordstrom opening a store that offers just about everything but clothing. Maybe they'll go to Kroger to get their threads.

Kroger's new clothing line is part of the Restock Kroger initiative it unveiled last month to boost sales and profitability that it said would generate $400 million in incremental operating margin by 2020. With investments in new technology and store resets part of the plan, it also includes the sale of its 784 convenience stores in 18 states.

The clothing business is part of it as well, and Kroger plans to introduce for the fall 2018 seasonal apparel for kids, juniors, men, and women that it describes as "playful, simple, and uplifting." But the Kroger brand is centered on groceries and by stretching it to include clothes, it could cause its business to unravel.

Threadbare reasoning

Wal-Mart and Target already offer a differentiated experience when it comes to multi-line shopping and Amazon is set to become the largest apparel retailer this year. The last thing the market needs really is another clothing outlet.

Operationally, the only way Kroger will be able to introduce clothing into its stores -- the first clothes will appear in Kroger's Fred Meyer and Kroger Marketplace stores -- is by taking away space from food. Not only does it risk confusing customers about what the Kroger brand is, but it may also undercut the one thing that does make it money. That the grocery store chain thinks this is some low-hanging fruit shows a level of desperation on the part of management and that it has few workable ideas to reverse the direction its primary business is heading.

With shares of Kroger down 35% in 2017, it looks like this supermarket giant is going to see its stock discounted even further as it pursues this misguided venture.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Rich Duprey has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends DSW and Nordstrom. The Motley Fool has a disclosure policy.