Loyalty Cards and Organic Food Will Drive Growth for This Grocer

Ash is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The Kroger Company (NYSE: KR) will continue to invest in pricing discounts with its loyalty cards to improve the price positioning of its products. It has a 50% stake in Dunnhumby USA, which will helps it to move ahead with loyalty cards and other strategic plays. The company also focuses on wellness of customers and one of its fastest growing segments -Natural & Organic food- will drive same store sales growth. Its changed capital allocation process for new store openings and remodeling is expected to generate quick returns and to fuel bottom-line growth. Now, let’s discuss these points in detail.

Loyalty card and its partnership with Dunnhumby will drive sales

In the current scenario, companies are coming up with different loyalty schemes through aggressive digital and social media use. Its joint venture with Dunnhumby provides it with more opportunities through services like customer data analysis and direct mail offers. Dunnhumby sends 8.5-9 million mailings per quarter and 90% of the coupons are unique for the household. It has already produced a Kroger app which enables customers to download coupons and redeem loyalty points directly. Dunnhumby also provides assistance on vendor management, store level management and design promotion. This partnership with Dunnhumby and the loyalty cards scheme are expected to drive sales in the future.

Natural & Organic food with value proposition will be the opportunity to explore

Kroger believes in the wellness of the customer, and it will look for more opportunity in the Natural & Organic foods segment. This is one of the fastest growing segments with improved perishables offerings and a highly evolved pharmacy. Its private label Simple Truth and its rollout have helped this segment to reach 4%-5% of sales. It has also achieved wellness with more value offerings in perishables. Improved freshness with process enhancement in the dairy category has helped it to keep products fresh for nine or more days. These categories provide a good opportunity for future growth.

New store expansion strategy will ensure returns in the long term

Store expansion has been a key growth driver for the company over the years. In the old system, capital was allocated for all geographies for new stores and remodeling. Now onwards, it will keep check on the average age of stores of that particular geography, number of competitor’s stores and maintain newness of the stores with remodeling. Allocation will be done across all geographies and the company is targeting 45-50 new stores this year. The result of this new approach can be seen in quick returns from new stores than the returns it has achieved historically.

Peer Analysis

In traditional grocery stores, the other two players which are competitors of Kroger are Supervalu (NYSE: SVU) and Safeway (NYSE: SWY). Supervalu took a step back to move forward this year, when it made the decision to divest its business. In March 2013, the company closed a $3.3 billion deal with a Cerebus-led investors’ consortium. It sold off five Albertsons banners and related Osco and Sav-on pharmacies to AB Acquisition LLC, an affiliate of the consortium. It has reduced its workforce and will be focusing on its three business units i.e. Independent business, Save-A-Lot retail business and five regional retail banners. The newly appointed president and CEO Sam Duncan indicated that they will achieve growth with decentralized and autonomous leadership in its three business units. Its efforts are expected to increase its sales in the future, but it will take time to get back the investor’s confidence.

Safeway is also making strong moves this year with its successful customer loyalty program “Just for U.” It has been able to attract above 5 million registered users and generate almost 50% of the supermarket revenue. It will launch this program in Canada in the third quarter of this fiscal year. It has expanded its rewards program to company owned fuel stations. It has also expanded this program to fuel stations of Chevron and ExxonMobil. It is expected to have a fuel partner available for 94% of its stores by 2Q13. The company is also targeting at store expansion and has gained market share in the West, where Supervalu sold its store in a deal.

<table> <thead> <tr><th> <p><strong>Company</strong></p> </th><th> <p><strong>P/S ratio</strong></p> </th><th> <p><strong>Op. Margin</strong></p> </th><th> <p><strong>1yr. Fwd. P/E</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p><strong>The Kroger Co.</strong></p> </td> <td> <p>0.18</p> </td> <td> <p>3.39%</p> </td> <td> <p>10.79</p> </td> </tr> <tr> <td> <p><strong>Supervalu </strong></p> </td> <td> <p>0.1</p> </td> <td> <p>-5.58%</p> </td> <td> <p>16.5</p> </td> </tr> <tr> <td> <p><strong>Safeway Inc. </strong></p> </td> <td> <p>0.13</p> </td> <td> <p>1.80%</p> </td> <td> <p>9.32</p> </td> </tr> </tbody> </table>

Source: Google Finance and Yahoo Finance

Kroger is performing best in respect of the operating margin with 3.39% among the three peers and has a modest forward P/E of 10.79. Supervalu is not an obvious choice with its negative operating margin and highest forward P/E. Safeway can be a better option with its modest operating margin of 1.8% and lowest forward P/E among the three peers. 

Conclusion

The Kroger Company has a great loyalty program in place in partnership with Dunnhumby. It is expected to drive the company’s sales with its expertise in the domain. The Natural & Organic food segment will provide opportunity for growth along with its new store growth strategy. So, I will recommend a “buy.” Supervalu is struggling after it sold off five of its banners. Its margins are under pressure and will take some time to improve. So, I would recommend a “sell.” Safeway has a successful “Just for U” loyalty program, and it is expanding it to fuel stations. It is expanding its store base in the West, where Supervalu sold its business. So, I would recommend “hold” for good returns in the long term.

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Ash Sharma has no position in any stocks mentioned. The Motley Fool owns shares of Supervalu. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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