2017 was an eventful year for the grocery industry, with Amazon.com's acquisition of Whole Foods marking the e-commerce giant's first major foray into brick-and-mortar retail. Shares of Kroger (NYSE: KR) dropped more than 40% in the first nine months of year, driven in part by fears of competition from Amazon.
Kroger stock rebounded in the past few months, with the company's third-quarter report beating expectations. The stock ended 2017 down 20.5%. That's still a terrible year, especially with the S&P 500 up nearly 20%. But it could have been much worse.
Kroger's efforts to keep pace with a changing industry are partially responsible for the renewed confidence in the stock. The company's ClickList online grocery pickup service has been a success so far, and it plans to continue to invest in digital initiatives in 2018.
Betting on online grocery
The grocery business was largely unaffected by the internet until relatively recently. While sales of other types of products, like electronics and books, began shifting online long ago, grocery stores haven't had too much to worry about. That's now changing, and Amazon's acquisition of Whole Foods has no doubt lit a fire under many traditional grocery chains.
Wal-Mart has been aggressive in its roll-out of its online grocery delivery service, where customers order online and have their items loaded into their car at a store. The megaretailer offers the service at more than 1,000 locations, with no additional fees on top of the cost of the groceries.
While Wal-Mart's online grocery push gets most of the headlines, Kroger has been expanding its own online grocery service. Kroger's ClickList works in the same way as Wal-Mart's service. Customers place their order on the website or app and choose a pick-up window. When they arrive at the store, they park in a special ClickList spot and call a number to let the store know they've arrived. A few minutes later, their order is wheeled out and loaded into their car. Kroger charges a $4.95 fee for this service, unlike Wal-Mart.
Kroger management said during its third-quarter conference call that ClickList would be available at more than one thousand locations by the end of the year. The company also offers delivery at 300 locations via partnerships with companies like Roadie and Uber. Kroger plans to expand its delivery program in 2018, including what it calls "a unique relationship" with Instacart.
Third-quarter digital sales soared 109% year over year for Kroger thanks to ClickList, contributing to the company's 1.1% comparable sales growth. It's not quite as rosy on the cost side, with CEO Rodney McMullen saying in the conference call that it takes three to five years of ClickList operating at a store before there's no negative financial impact from a customer choosing ClickList over shopping themselves.
That's a price that must be paid if Kroger wants to prevent customers from fleeing to more convenient options. Offering low prices is table stakes. To really stand out, Kroger needs to also be the most convenient option for its customers. ClickList puts the company on the right track.
A mixed-bag stock
While Kroger is taking the necessary steps to compete, I don't think the stock is all that attractive. It looks reasonably cheap, trading for about 16 times trailing 12-month earnings and 13.5 times the average analyst estimate for 2018 earnings. But investments in online grocery could knock down margins in an industry where margins are already razor-thin. It's also still not clear what Amazon plans to do with Whole Foods, but I would imagine an aggressive push into online ordering, pickup, and delivery is coming sooner or later.
The grocery business is being disrupted, and I think we're still in the beginning stages of that disruption. Kroger is making the right moves, but so are other grocery chains, most notably Wal-Mart. Earnings growth will be tough in the coming years as investments are made just to keep pace with the competition. The stock isn't expensive, but I don't think it's a good deal either.
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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. Timothy Green has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.