EUR 850.00 For Business Accounts Only

Morningstar | Kroger's Strong Competitive Standing Should Help It Navigate a Fast-Changing, Competitive Landscape

We are lifting our valuation for narrow-moat Kroger to $31 per share from $29.50, mostly reflecting the time value of money. We believe Kroger's intangible assets (including vendor relationships, strong store banners, industry-leading transaction data and analytics capabilities, and a top-tier private-label lineup) and favorable cost position will help it capitalize on a rapidly shifting grocery environment. However, competition is intensifying, leading us to think that the firm's edge is dulling somewhat.

Unlike its pure-play peers, we believe Kroger can succeed in the new grocery paradigm. With local market scale sufficient to drive the cost leverage needed to hold prices down and fuel omnichannel investments, we suspect Kroger should be able to use its well-located store network to economically meet customers' demands digitally and conventionally. We believe its size and strong management team have enabled the partnerships it has prudently struck with firms such as Microsoft and Walgreens, which we expect to accelerate its omnichannel development and that we contend are enabled by the value it can deliver as America's largest pure-play grocer. Furthermore, Kroger's partnership with European online grocery leader Ocado should allow it to serve digital orders more efficiently while unlocking markets where it does not have a large presence. Additionally, Kroger's stores of transaction data should allow it to optimize promotions and assortment while also selling insights to packaged goods firms.

Considering these factors and the firm's strong private-label assortment, we suspect that rather than Kroger, subscale retailers should bear the brunt of market share pressure from new entrants. We expect 2.6% revenue growth against 2.5% adjusted operating margins on average from fiscal 2019-27. With shares trading near our valuation, we suggest investors wait before building a position in a grocer we see as uniquely able to capitalize on shifting conditions.

We are tempering our moat trend rating to negative from stable, reflecting persistent competitive pressures that should result in ongoing price headwinds and necessitate continued investment to deliver a strong omnichannel experience. Although we contend that Kroger is better positioned than its traditional grocery peers, it is not immune to the price competition that has constrained top-line growth and profitability. While we have a favorable view of management's Restock Kroger optimization initiative, we believe the need to reinvest savings behind low prices as well as the plan's reliance on new alternative revenue streams to achieve the targeted $400 million of incremental operating income by fiscal 2020 suggests a more tempered outlook until results materialize. Still, we anticipate the plan will enable Kroger to hold adjusted operating margins fairly constant despite the challenging environment, with our forecasts calling for less than 5 basis points of deterioration between fiscal 2018 and 2027.