A Single Tea Leaf in Kroger’s Upcoming Earnings

Kroger Co. (NYSE: KR) reports on the first quarter of its fiscal year on Thursday. Investors are likely to focus on gross margin, which has been under some pressure as the company has attempted to remain price-competitive to protect its market share. I’m the first to caution against extracting larger patterns from isolated actions. But in the context of margins, and ahead of earnings, it’s worth mulling over Kroger’s recent decision to pull out of an important east coast market.

Last week, Kroger announced that it will exit the Raleigh-Durham, North Carolina market, closing 14 locations. It’s a hasty withdrawal, slated to be completed by August 14. The company also announced that wholly owned, North Carolina-headquartered subsidiary Harris Teeter has agreed to take over eight of the 14 Kroger-branded store locations.

Kroger is retreating from a vibrant area. With a highly educated workforce based around three major universities, and flourishing tech, pharmaceutical, and biotech industries, the cities of Raleigh and Durham, along with Chapel Hill, NC, comprise a fast-growing and lucrative market for retailers. The Raleigh metro area has ranked in the top three metros for business and careers in each of the last 15 years, according to Forbes.

It’s also crammed with grocery stores chains. Central North Carolina sits at the heart of the important mid-Atlantic testing ground for grocery expansion. A Bloomberg article last year stated that the “frontline of the new war for the American supermarket runs through the aisles of [nearby] Winston-Salem, North Carolina.”

Established local brands like Lowes Foods, Harris Teeter, and Food Lion (now owned by Dutch grocery giant Ahold Delhaize) have watched the region transform into an expansion beachhead over the last two years. Recent grocery aspirants include Publix from the south, Wegman’s via the northeast, Sprouts Farmers’ Market from the west, and German discount chains Aldi and Lidl from across the Atlantic. Amazon.com’s Whole Foods, which has been in town since it acquired local natural foods chain Wellspring Grocery in 1991, continues to add stores in the metro area.

I live in Raleigh and can attest to the muscular competition, often characterized by ill-conceived bravado. Lidl opened its first Raleigh location last year opposite a Wal-Mart, in such a manner that outgoing traffic from the Wal-Mart nearly feeds into Lidl’s entrance. Both sit three-tenths of a mile from an Aldi shoehorned into a strip mall. A mile away, Wegmans is building its first massive Raleigh location literally on the south property line of a successful Trader Joe’s. A now-forlorn Kroger rests but two blocks away, across the street from a perennially crowded Costco. Harris Teeter astutely passed on taking over this Kroger location.

Image source: Getty Images.

It was inevitable that this game of market share “chicken” would force at least one chain to rethink its investment, but personally, I’m surprised to see an incumbent, not a recent challenger, give in, and so completely at that. In a press release, the president of Kroger’s Mid-Atlantic division, Jerry Clontz, noted that the company had enjoyed some success in the area, but had not grown as it would have liked. “The retail environment is challenging and changing in Raleigh-Durham,” Clontz observed. “Many retail analysts say the Raleigh-Durham market is over-stored.”

There is at least one alternate way to view Kroger’s decision, and that is as a transfer of costs: Kroger’s workforce is unionized, while Harris Teeter’s workforce is not. Conceivably, the parent company gains some profitability by brand-swapping eight stores. Yet even when viewed from this perspective, the corporation is nonetheless shrinking its footprint in an expanding market.

Might this retreat be indicative of competitive pressure Kroger is experiencing in other markets? I tend to believe that it is, and while this is but one of many tea leaves to read, it may portend margin pressure in the company’s upcoming earnings report and beyond. The closures will have an immaterial impact on Kroger’s financials given its nearly 2,800 store footprint, still, shareholders should be concerned if Kroger announces additional market exits in the coming quarters. On the surface, such exercises make sense from a cost-savings and earnings perspective, but they also often cede vital long-term revenue opportunities.

This thought returns me to Kroger’s decision to tear down aisles in the Raleigh-Durham area, which is poised for sustained economic growth and will reward the grocery chains that fight hardest. If management found it costly to uphold the Kroger banner in current conditions, they may find it near-impossible to hoist it again after an indefinite hiatus.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Asit Sharma has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.

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