Kroger stuns with 92% e-commerce gain, but it has to prove it's not a coronavirus blip

Key Points
  • Kroger is one of the companies that's seen increased demand as more Americans stay in and cook at home during the coronavirus pandemic.
  • During the fiscal first quarter, it saw a 92% jump in online grocery sales.
  • Kroger is the largest supermarket chain in the U.S., but it's lagged behind competitors like Walmart, Amazon and Target with e-commerce.
  • The grocer has tried to accelerate its efforts by partnering with British robotics company Ocado to build a network of fulfillment centers.
Kroger grocery store bags are removed from a shopping basket in Flowood, Miss.
Rogelio V. Solis | AP

Kroger is trying to turbocharge its online grocery business and catch up to competitors. Customers' changing habits during the pandemic have added new urgency to that effort. 

Many Americans have looked for safer and faster ways to fill up their fridges during the coronavirus pandemic. They shopped online and in some cases, were willing to wait many days for curbside pickup and delivery slots. They began cooking more meals at home because of stay-at-home orders, closed restaurants and heightened health concerns.

That's given Kroger a boost. Its digital sales grew by 92% in the fiscal first quarter, which ended May 23. 

In recent weeks, that pattern has continued, Kroger's Chief Financial Officer Gary Millerchip said in an earnings call Thursday.

Same-store sales growth in the fiscal second quarter so far have been in the mid-teens. Digital sales were up triple digits in the first three weeks of the second quarter. Pickup and delivery of online orders have attracted new customers and inspired repeat visits, he said.

Investors and analysts will now watch to see if the grocer can turn that bounce into sustained momentum, and whether it can make those online sales more profitable. Despite topping analyst expectations for the first quarter, Kroger shares were down nearly 6% in trading Thursday. 

The company's revenue rose to $41.55 billion from $37 billion a year ago. Net income climbed to $1.21 billion, or $1.52 per share, from $722 million, or 95 cents per share, last year. Its adjusted earnings per share were $1.22. 

The scramble to build online sales

Kroger has grown into the nation's largest supermarket chain since it began in Cincinnati in 1883. It owns nearly 2,800 stores across 35 states and Washington, D.C. under its own name and other banners, such as Fred Meyer and Fry's. Yet despite its size and scale, Kroger has struggled to keep up as the world of grocery shopping has transformed and Walmart, Amazon and others have raised consumers' expectations.

"Their risk is that if they don't optimize their business for the incredibly digital customer-centric world we all live in they will get passed and won't be relevant," said David Bernstein, head of retail for North America at digital consultancy Publicis Sapient.

In recent years, Kroger has tried to play catch up. It launched a multiyear initiative to rev up the business in 2017, dubbed "Restock Kroger." It bought a meal kit company, Home Chef, and it struck a deal with British robotics company, Ocado, to help speed up and lower the cost of fulfilling online grocery orders.

Kroger and Ocado are building high-tech facilities across the U.S. They announced plans earlier this month for three more facilities in the Great Lakes, Pacific Northwest and West regions. Its first facility is expected to open in 2021 in a suburb of Cincinnati.

During the pandemic, Kroger CEO Rodney McMullen said the company expanded its e-commerce offerings. It began testing a grocery pickup-only model at one of its stores in the Cincinnati area. It started no contact delivery and low-contact pickup services. It hired more employees for e-commerce and added more pickup slots for online orders.

He said the customer now has over 2,000 pickup locations and 2,400 delivery locations that reach 97% of its customers.

McMullen said the grocer is confident that the trends that boosted its business in the first quarter will continue, though not at the same intensity. For example, he said, customers have told the grocer they intend to keep cooking, even as restrictions ease. He said he expects e-commerce to remain at a higher level than it was before Covid-19.

The company said it expected to exceed its financial outlook for the year — though it didn't say by how much. Kroger withdrew its previous guidance for fiscal 2020 and didn't give a new one, saying the pandemic makes it difficult to predict consumer behavior. 

Sales at stores open at least 15 months, excluding fuel, were up 19% in the fiscal first quarter. That's a significant increase from a year ago, when they grew by 1.5%. It is nearly 10 times its average quarterly gains. 

Other grocers have also had strong sales and gains in online shopping during the pandemic. Walmart's same-store sales grew by 10% and its digital sales rose by 74% in its fiscal first quarter. Stop & Shop parent company Ahold Delhaize's U.S. same-store sales, excluding gas, grew by 13.8% and the company said it was accelerating its digital investments, even as it pulled back on other capital spending. 

Building loyalty and profits

With its online business, Kroger has several challenges, Bernstein said. It's relied on Instacart for many of its grocery deliveries, which makes it harder to build customer loyalty and gain insights that help it personalize offers and manage inventory, he said. According to the firm's preliminary research, it has a higher rate of substitutions and unfulfilled line items than rivals Walmart, Amazon and Target. That hurts the customer experience and lowers total sales.

Still, he said, the company's increased investments could pay off as it competes with those companies. 

"While they're behind the other three, they're ahead of everyone else," he said.

By working with Ocado, Kroger can bring more of those doorstep deliveries in house and collect data so it can personalize more coupons and ads for customers, he said. The large warehouses will help restock store shelves, too, so they're "filled with the right things for the right customers."

McMullen acknowledged another challenge that Kroger faces with e-commerce on the earnings call: Making it more profitable. When a customer switches to online grocery shopping, he said, it typically takes three to four years before that customer's profitability is the same as if they had shopped in the store.

Once they become an online grocery shopper at Kroger, however, the company gets "a significantly higher share of that customers' total household spend," he said.

He said its partnership and new facilities with Ocado are a big part of the solution.

Along with sales, Kroger's workforce and labor costs grew during the pandemic. It has hired more than 100,000 workers, including many from hard-hit sectors like restaurants and hotels, to help keep shelves stocked and stores sanitized.

Kroger said it spent more than $830 million on employee pay and health-related services, such as free Covid-19 testing, in the quarter. That included bonuses to recognize employees for their help stocking shelves, sanitizing and serving a flurry of customers.

Watch CNBC's full interview with Kroger CEO Rodney McMullen on food supply amid coronavirus pandemic
Watch CNBC's full interview with Kroger CEO Rodney McMullen on food supply amid coronavirus pandemic