Kroger made a multiyear mistake in how it delivers its groceries, Jefferies says

Key Points
  • Jefferies downgrades Kroger stock to hold from buy after decisions to invest in centralized fulfillment instead of micro-fulfillment centers.
  • Centralized centers require more up-front investment and have higher delivery costs because they're located far from consumers.
  • Micro-fulfillment centers utilize the space in or next to an existing store and are closer to urban areas.
An employee pushes grocery carts outside a Kroger Co. grocery store in Louisville, Kentucky.
Luke Sharrett | Bloomberg | Getty Images

Kroger was downgraded by Jefferies to hold from buy due to what it believes was a key mistake: investing in centralized fulfillment centers instead of micro-fulfillment.

Kroger should be following Walmart's lead, Jefferies analyst Christopher Mandeville added in a note Thursday.

For a grocery store chain, capturing online shoppers and catching up to Amazon-owned Whole Foods is a tricky business. Companies are grappling with how to fulfill and deliver customers' orders of fresh produce and groceries quickly and cheaply.

Mandeville said a grocery chain's fulfillment method is a make-or-break investment. It could opt for large, central warehouses, also known as centralized fulfillment, or it could go with so-called micro-fulfillment, in-store or store-adjacent spaces that are close to urban centers.

Kroger's decision to invest in centralized fulfillment centers could be a multiyear mistake, Mandeville wrote. A year after Amazon's 2017 merger with Whole Foods, Kroger signed an agreement to build 20 centralized fulfillment centers with British online grocery Ocado's robot technology.

Centralized fulfillment centers require high up-front costs. The average fulfillment center size for Ocado is 300,000 to 400,000 square feet. Each central warehouse for Kroger will cost about $55 million and take two to three years to build. A micro-fulfillment center identifies 5,000 to 20,000 square feet of underutilized space inside an existing grocery store or in a space adjacent to the current store. At both types of centers, robots perform the grocery picking.

Why Walmart is going out of its way to hire more teenagers
Why Walmart is hiring more teenagers

Because micro-fulfillment also naturally puts the grocery picking closer to urban centers, delivery is much cheaper. In particular, the notoriously difficult "last mile," or the final delivery step to a shopper's home, is more efficient from a nearby micro-fulfillment center.

"We view Kroger's centralized fulfillment center platform as a considerably more expensive, time-consuming model that carries higher risk in what is still a nascent market," Mandeville wrote.

Walmart, on the other hand, started testing micro-fulfillments in August 2018, after a partnership with Alert Innovation that uses its robot technology at its warehouses to speed up the picking process.

"We view Walmart as best-positioned for long-term share gains given its early adoption of micro-fulfillment centers to pair with an already robust omni-channel platform and strong feedback from our proprietary shopper survey," Mandeville wrote.

Kroger's stock traded 2% lower Thursday morning and has fallen 11% since January. It has a market cap of $19.7 billion. Walmart, which has a market cap of $338.3 billion, has seen its stock rise almost 28% year to date.

Fmr. Walmart US CEO on company's expansion of unlimited grocery delivery service
Fmr. Walmart US CEO on company's expansion of unlimited grocery delivery service