New Organic Growth at Kroger

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Kroger (NYSE: KR) recently rolled out a new organic product line, Simple Truth, with lots of headlines and prominent displays at Kroger stores. Organic food sales could help Kroger improve its margins, reduce its debt load, and avoid losing shoppers to rapidly expanding health food stores. But Kroger will have to compete for shoppers with other traditional supermarkets that offer their own organic private-label brands. And Kroger's current organic food suppliers may also get more competition than they expected.

Kroger's Ralphs store where I live already had a sizable selection of health food, including organic soup, fresh vegetables, baked chips, and gluten-free products. Although Kroger's new organic food line has made a big splash, this actually isn't the first time Kroger's offered its own private-label organic products. Wall Street Journal reporter Annie Gasparro explained that Kroger rolled out organic private-label brands in 2000 and 2006. The Simple Truth line includes both of these earlier brands, since Kroger thinks organizing all of its health food under a single brand will be less confusing.

Kroger might have just launched its organic brands too early for many shoppers. The International Trade Centre estimated that the United States organic grocery market was worth $8 billion total in 2000. The Organic Trade Association estimates the 2011 size of the organic grocery market at $31 billion. The market has grown almost four times larger in nominal figures since Kroger launched its first organic brand, so there may simply be more shoppers who want to buy organic food at Kroger stores now.

Kroger could improve its overall margins with Simple Truth and still undercut other organic brands, which might create downside risks for health food specialists. Annie's (NYSE: BNNY) graham crackers and fruit snacks do show up at my local Ralphs store. With a 6.7% profit margin, Annie's has some room to cut prices, but investors expect rapid earnings growth. Annie's might have to choose between maintaining earnings growth, which was 17.6% last quarter, or sales growth, which was 19.9% last quarter. With a 2.5 PEG, any sign of weakness for Annie's could be disastrous.

Safeway's (NYSE: SWY) 1.2% profit margin isn't great, but it still beats Kroger's 0.7% figure, and Safeway's private-label health brands have provided some help here. Safeway now has several health brands, including its older O organic food line and its newer Open Nature line. Frozen & Refrigerated Buyer reported that Safeway's total sales from its O, Open Nature, and Eating Right brands were over $800 million a year.

Kroger and Safeway might have to discount organic food more than they expected to beat Whole Foods (NASDAQ: WFM) on price. Mark Hamstra, at Supermarket News, reported that a Wells Fargo report stated that Whole Foods charged less than several major supermarket chains, including Safeway, for many items. The article didn't specify which items the surveyor compared, but organic food seems likely, since Safeway and Kroger sell staples cheaply to compete with Wal-Mart and dollar stores.

Simple Truth's effects on Kroger's competitors aren't entirely clear. Safeway's wellness program income might help it compete on price with Kroger, and Whole Foods has its own price-cutting initiatives, as well as the selection advantage. Kroger's decision could pose the biggest risk to organic food suppliers, although traditional supermarkets' organic offerings haven't stopped some prominent suppliers from reporting strong growth recently. However, the Simple Truth brand seems like it will help Kroger itself -- and it might even give the grocer room to raise its dividend again in the future.

Eric Novinson owns shares of Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Motley Fool newsletter services recommend Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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