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Kroger Grocery Delivery Strategy Called Into Question

U.S. consumers are increasingly demanding quick and cheap grocery delivery, and Kroger has rolled out a partnership strategy to get there. But financial services firm Jefferies has said The Kroger Co. is making a costly mistake by pinning its delivery hopes on its relationship with Ocado Group.

An Ocado robotic grocery distribution center in the UK

Jefferies has downgraded Kroger from buy to hold, as the firm's analysts expressed skepticism that the Kroger partnership with Ocado, which involves developing large warehouses for Kroger, would result in growth for the Ohio-based grocery giant.

The Ocado Smart Platform includes online ordering and home delivery capabilities, but at its heart are fully automated fulfillment centers.

The robots pack groceries for customer orders without human interaction. With its complex logistics system and robotic warehouses, Ocado has built a reputation in Britain for fast deliveries.

Jefferies' analysts aren't sure the system is going to work well in the U.S., asserting that Kroger's investment in the technology is a long-term capital allocation misstep when compared to using micro-fulfillment facilities for delivery, MarketWatch reports.

As opposed to building large, robotic facilities, micro-fulfillment uses more conventional distribution spaces as small as 10K SF that are closer to densely populated areas, the better to deliver groceries more quickly. They can also be built in a few months.

By contrast, the typical Ocado fulfillment center is 300K SF to 400K SF, with each central warehouse for Kroger costing about $55M and taking two or three years to build, CNBC reports

One of Kroger's regional competitors, Meijers, recently inked a deal with logistics specialist Dematic for the development of micro-fulfillment centers to deliver groceries.

Jefferies analysts expressed concern about the time it will take to build the Ocado facilities, and also criticized Kroger for being mum about the details of its agreement with Ocado, including minimum capacity requirements, fee structure and other assumptions that might drive a positive return on investment, Grocery Dive reports.

Kroger stock took a hit on the downgrading, but soon recovered somewhat. At the end of the day on Oct. 11, the company traded at $24.25/share, compared with $24.85/share at the beginning of the week. During 2019, its stock has traded nearly as high as $30/share, and as low as $20/share, but mostly has hovered in the mid-$20s/share.