Grocery chain enlists U.K. firm to equip and operate warehouses for home delivery
By Heather Haddon and Saabira Chaudhuri
This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (May 18, 2018).
Kroger Co. has struck a deal with a British grocer known for its use of warehouse robots, as the biggest U.S. grocery chain aims to supercharge its online delivery business in the face of competition from Amazon.com Inc. and Walmart Inc.
Kroger has agreed to raise its stake in Ocado Group PLC to more than 6%, and to license technology from the British company to run automated warehouses and process online orders. The companies said they will identify locations for three new warehouses this year and a total of 20 warehouses in three years.
Kroger Chief Executive Rodney McMullen said that the companies began discussing a partnership years ago and that it wasn't a direct response to Amazon's $13.7 billion purchase of rival grocer Whole Foods last year. The talks intensified in recent months after Ocado improved its online grocery-delivery business, he said.
"They've done an incredible job over the years continuing to improve the experience for the customers and the economics as well," Mr. McMullen said in an interview Thursday.
The U.K. firm, which calls itself one of the world's largest online-only grocery retailers, said Kroger's latest investment in Ocado is worth GBP183 million ($247.2 million). The company took its original stake of more than 1% earlier this year.
Kroger finance chief Michael Schlotman said the company will expend further capital to build the warehouses, which Ocado will operate. He said the added capacity should save the company in other areas of operations, while also widening access to markets, including some dense urban areas that Kroger has tended to ignore.
Mr. Schlotman said at an investor conference Thursday that Kroger generally seeks investments that will return at least 11% in earnings after taxes, and the Ocado agreement "didn't have any trouble clearing that hurdle."
Shares of Ocado, which in addition to selling groceries licenses technology and equipment to other grocers, rose 50% to an all-time high in London trading as investors cheered the overseas deal, its fourth this year. Kroger shares, which have slipped this year, rose 1.3% on Thursday. Amazon's push into the grocery business, as well as weak inflation in food for the home, has weighed on supermarket stocks over the past year.
Even as Kroger has invested in technology instead of opening new stores, investors have punished the grocer's stock, which dropped 12% in a single session when its latest quarterly report showed gross margins had declined from a year earlier.
Walmart is focusing on food retail operations, too. The U.S.'s largest retailer said on Thursday that sales rose in its latest quarter thanks in part to its grocery business. Walmart hopes to have its grocery-delivery service capable of reaching 40% of the U.S. population by the end of this year.
Walmart has pursued online-delivery partnerships aggressively. Most recently, it agreed to take a majority stake in Indian e-commerce company Flipkart. Amazon is expanding its Whole Foods delivery sites and said earlier this week that it will give Amazon Prime members additional discounts at the natural-foods chain.
Ocado, meanwhile, has become a world leader in online grocery sales, a tricky business that even Amazon has struggled to master. The company says it has the world's most sophisticated automated grocery warehouses. Thousands of robots at its facilities communicate via advanced network technology to pick groceries out of storage and fill as many as 65,000 orders a week. Artificial intelligence helps to continually optimize those operations.
Ocado's technology has become increasingly attractive to those looking to bulk up their online operations since Amazon bought Whole Foods. Mr. Schlotman said Kroger's deal with the U.K. company is exclusive across the U.S.
"This relationship with Ocado demonstrates that we do evolve our thinking," the finance chief said.
Kroger so far has focused its online grocery efforts on opening hundreds of sites at stores where customers can pick up groceries ordered online. It has also worked with Instacart Inc. and Uber Technologies Inc. to test online grocery delivery, and has invested millions of dollars in data science to predict customer-ordering patterns.
"Kroger has more data than any of our competitors," Mr. McMullen wrote in a letter to shareholders earlier this week.
Analysts said Ocado could help Kroger process deliveries efficiently and give it a jump on competitors. But the stake and other investments for online expansion could further weigh on the grocer's profit, they said.
J.P. Morgan analyst Ken Goldman called the deal "modestly constructive" for Kroger, while cautioning clients that the U.S. food retail industry is "littered with examples of European companies failing to replicate their success here."
Mr. McMullen said that Ocado's experience would translate well to the U.S. market, and that the deal won't prompt Kroger to lower its earnings outlook.
Ocado, which was founded in 2000 by three former Goldman Sachs bankers, has 12,600 employees and about 1.2% of the grocery market in the U.K., according to Kantar.
Some grocers have workers collect items for online orders within retail stores, instead of from dedicated warehouses. Ocado Chief Executive Tim Steiner has described this method, called store picking, as "a really stupid business," saying it piles additional costs onto already low margins while cannibalizing sales.
Ocado's store-free model contains costs through scale, automation and sophisticated algorithms. In fiscal 2017 the company generated GBP1.43 billion in revenue, with active customers up more than 11% to 645,000 and order volumes up 14% to 263,000 a week. The company, however, reported a loss for the year and has warned that heavy investments will drag down profits for its current fiscal year.
At its older warehouses, Ocado sends crates of grocery products and boxes for customers labeled with bar codes to enable sorting by the company's software. The crates whiz around on conveyor belts to picking stations for filling and distribution. From its three warehouses, Ocado trucks its own products as well as those of upmarket U.K. grocer Waitrose, to whom it pays a fee to offer its products to 70% of British households.
The Kroger deal is the latest in a flurry of international deals that Ocado had been promising to investors for years. Earlier this month it said it had struck a deal to help Swedish supermarket ICA build up an online grocery business. Ocado has also reached deals with French supermarket chain Groupe Casino and Canadian grocer Sobeys.
Jefferies analyst James Grzinic called Kroger's investment in Ocado "the strongest endorsement that Ocado could have delivered to investors."
Write to Heather Haddon at email@example.com and Saabira Chaudhuri at firstname.lastname@example.org
(END) Dow Jones Newswires
May 18, 2018 02:47 ET (06:47 GMT)
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