Consumer Staples

Supermarket sweep: What could lift Kroger shares

Kroger's $3 billion investment in pricing

It's not easy to find a sexy supermarket story. In fact, it's not easy to find many sexy retail stories at all these days.

But Kroger is defying the odds.

After going nowhere for a decade, shares of the stock started to march higher at the end of 2012, and they haven't looked back since. Now the stock is sitting at an all-time high, shooting up another 40 percent so far this year.

Despite a highly competitive environment and a consumer who is still reluctant to spend, the company is growing market share and with it, steadily boosting sales. Kroger has delivered 43 straight quarters of rising sales at stores open at least a year, in large part because of its pricing strategy. Management decided to forfeit higher margins for lower, more affordable prices to compete with Wal-Mart and keep its core customer loyal.

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"We've invested over $3 billion in pricing when you look at the last seven or eight years. There are a lot of customers whose budgets are tight, and that allows the customer's budget to go a little farther," CEO Rodney McMullen told CNBC.

"So price is just one element of it and our customer-first strategy."

Shopper loads purchases at a Kroger store.
Daniel Acker | Bloomberg | Getty Images

The grocer was also early to spot the consumer taste shift to natural and organic foods—a category Wal-Mart has taken aim at over the past few months as it aims to improve its grocery sales.

Although Kroger's shares have seen significant gains over the past year, analysts said the stock could continue to climb for a few key reasons.

Expanding the store count

Kroger has 2,638 stores in 34 states that operate under various names, including Ralphs, Fred Meyer and of course, Kroger. After years of growing through acquisitions, such as the $2.5 billion purchase of Harris Teeter in January, Kroger management has indicated it has plans to open new stores.

Following the company's investor conference at the end of October, JP Morgan analyst Ken Goldman said he expects Kroger to "venture more aggressively into new markets within a year or two. Based on our conversations with management, we think Kroger wants to build maybe five to eight stores per year, per new region, for perhaps a decade."

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When asked about expansion plans, McMullen said Kroger is eyeing markets where the company already has a presence, but sees potential for growth.

"There are still a lot of markets where our market share is 10 or 15 percent. We find that by getting market share higher than that, it really creates a good return," he said.

Experimenting with buy online, pick up in store

The company is testing Harris Teeter's "Click and Collect" program at Kroger stores in Cincinnati, Ohio, hoping to learn and develop the system whereby customers can order groceries online and pick them up in stores.

"We believe this positions Kroger well to be at the forefront of identifying ways to offer convenient grocery shopping options for its customers, beyond traditional emerging delivery programs," said Kelly Bania, an analyst at BMO Capital Markets, after meeting with management.

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"Kroger also revealed that the average transaction size for a 'Click and Collect' transaction tends to be much larger" than typical in-store purchases, Bania said.

Analysts are also optimistic that the recent $280 million purchase of, an online seller of supplements and groceries, will give Kroger useful infrastructure to build out its broader e-commerce and digital business.

Cheap gas prices

Since oil prices have fallen nearly 25 percent since June, the national price of gas has plummeted to around $3 per gallon. Traditionally, cheaper gas prices boost consumer spending on basics such as food and groceries, as well as discretionary items.

Kroger is expecting a lift.

"Usually when fuel prices are going down, it helps earnings some," McMullen said.

Still, the company does face risks. Among them, analysts pointed to heightened promotional activity; competition from dollar stores, club stores and Wal-Mart; and a deceleration in its same-store sales trends.

But the bottom line, analysts agreed, is that Kroger's management team is executing well during a challenging retail and economic environment. Along with recovering consumer confidence and spending, that should continue boosting sales—and the stock.