Kroger Earnings: Maybe It Can Survive Amazon

(Bloomberg Gadfly) -- Ever since Amazon.com Inc. sank its tentacles into the grocery business with its acquisition of Whole Foods Market, it has been hard for Kroger Co. to get much love from investors.

That is, until Thursday, when the supermarket giant's stock shot up more than 11 percent in early trading after it delivered an upbeat third-quarter earnings surprise.

Its earnings per share of 44 cents beat analysts' expectations, while comparable sales excluding fuel rose 1.1 percent from a year earlier, an improvement over the previous quarter. Gross margin gained even as the company lowered prices.

That investors have again found reason to be optimistic about Kroger may tell us something we should have realized all along: The early market reaction to the Amazon-Whole Foods deal may have been somewhat overblown.

It's true that Amazon has a track record of crushing the competition in new businesses. It's grabbing market share in retail categories such as apparel, beauty, and home goods. Grocers undoubtedly should worry and aggressively defend their turf.

But that June selloff of Kroger and other grocery stocks was based on little more than fear of Amazon's bite and not on any specifics of how, precisely, the tie-up would scramble the grocery industry.

In fact, we still don't quite know exactly what Amazon plans to do with Whole Foods -- and thus which grocery sellers are most directly in its path.

On the day the deal closed, Amazon announced it would slash prices on key items at Whole Foods. However, it remains uncertain just how much deeper or wider it plans to take those cuts. A study found there was an initial bump in traffic to Whole Foods after its first price cuts, but it's not clear yet the increase has been sustainable.

And Amazon wants to do more to entwine its Prime membership program with Whole Foods. This was on display in the run-up to Thanksgiving, when it promised special discounts on turkeys for Prime members.

But there are many unanswered questions. Will Amazon expand Whole Foods' physical footprint much, and if so, will that happen in markets dominated by Kroger? What about Publix Super Markets Inc.? Koninklijke Ahold Delhaize NV's Giant or Stop & Shop?

Will it focus on using Whole Foods' supply chain to dominate the wide-open e-commerce grocery market? Will it lower prices in a serious enough way that it threatens value players such as Target Corp.?

These details matter. And Kroger's recent progress shows it has a chance of withstanding the onslaught. 

I'll admit I was not terribly impressed with the turnaround plan Kroger unveiled in October. Executives talked at length about leveraging data science and personalization in ways that didn't sound particularly fresh. I also remain confused about why Kroger is bothering with distractions such as a restaurant and an apparel line.

But Kroger is a business that has plenty going for it -- in particular, its massive scale. It has almost 3,000 supermarkets and nearly 800 convenience stores. Of legacy grocers, only Wal-Mart Stores Inc. is in a better position than Kroger to flex muscle with suppliers on price.

Kroger has said it plans to explore a sale of its convenience-store business. That's a fine idea, in that it could generate cash to invest in the core grocery business. But it could also keep those small-footprint stores and transform them into pickup points for click-and-collect online orders.

Kroger 3Q increase in digital revenue, YOY

109%

And while I still think Kroger doesn't quite understand just how dramatic a step change e-commerce presents for its industry, it is a good sign that its ClickList grocery pickup service is growing robustly. In the latest quarter, executives said digital sales were up 109 percent compared to a year earlier, largely thanks to this offering.

Amazon has key advantages in the grocery wars, including a willingness to plow money into growing the business at the expense of profitability. But we shouldn't underestimate the old-school players' ability to put up a fight. A supply chain for perishable goods is difficult and time-consuming to build, and so is customer loyalty. 

The food fight is just getting started. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Sarah Halzack is a Bloomberg Gadfly columnist covering the consumer and retail industries. She was previously a national retail reporter for the Washington Post.

To contact the author of this story: Sarah Halzack in Washington at shalzack@bloomberg.net.

To contact the editor responsible for this story: Mark Gongloff at mgongloff1@bloomberg.net.

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