The Next Digital Helix Windfall

U.S. Dividend Stock Investing for Canadian Investors The Next Digital Helix Windfall

THE NEXT DIGITAL HELIX WINDFALL

The U.S. grocery industry is undergoing the most significant revolution ever in its history – thanks to technology – in how it operates.

It is not an exaggeration to say that companies that do not participate in the industry's biggest transformation in its history will be consigned to the dustbin of economic history.

My recommendation is a grocer that is quickly adapting to the new environment and will emerge as a big winner in the years ahead. But more on that later… first, let's look at the many changes happening in the once staid grocery business.

For the companies that do not adapt to the new realities of the grocery industry – that were accelerated by the 2017 purchase of Whole Foods by Amazon, their disappearance will likely happen very quickly. One needs only to look at the fact that 18 major grocery firms have gone bankrupt here in the U.S. just since 2014.

And before you think that groceries are not a growth business, consider that food and beverage is Amazon's fastest growing category in 2018 as measured by sales growth in the U.S. And with the changes occurring in the sector, that growth is likely to continue for the foreseeable future.

So, what will the vastly changed grocery industry landscape look like at the start of the next decade? Here's a quick look ahead at some of the changes I expect…

The Grocery Industry Landscape in 2020

Online Shopping - Increased consumer demand for more convenient shopping options will continue to boost online food and grocery sales in the years ahead. Consumer adoption of online grocery shopping is skyrocketing, with the number of customers who have shopped online for food growing from just 14.3% in 2012 to 23.4% in 2017.

And even though the U.S. trails other countries in this category, the research firm GlobalData expects that pure online will account for 7.4% of grocery sales by 2020, up from 4.1% in 2016, with continued growth in the years to follow. 1 The Next Digital Helix Windfall

Online grocery shopping is just the tip of the proverbial iceberg when it comes to how technology is changing the grocery business.

Smart Shopping – Digital assistants such as Amazon's Alexa will likely have a profound impact on both the grocery industry and consumer products brands. There are already about 500 million of these type of devices in the United States, with forecasts of that number reaching 870 million by 2022.

Adding to that likely event is the forecast from research firm Profitero that, by 2020, half of all searches could be made by voice.

The goal, of course, for grocers and consumer product firms will be to forge more personalized relationships with each individual customer. Even drinks giant Coca-Cola, with more sales revenue moving online, has made digitalization its “top priority”.

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So-called smart shopping then leads directly to the next major change in the industry – innovative delivery options that extend beyond picking up your groceries at the store after ordering them online.

Grocery Home Delivery – In an effort to beat Amazon at its own game, grocery retailers are beginning to offer all sorts of delivery options for consumers. For example, Walmart is expanding its grocery delivery service, with plans to serve more than 40% of U.S. households by the end of 2018.

Speaking of Amazon, it has started expanding its Prime Now one-hour and two-hour grocery delivery services across the country by opening warehouses in key locations. For example, the retailer recently opened a new warehouse that will allow customers in Miami to access one-hour delivery services.

And Walmart has partnered with Deliv, a same-day delivery startup, and August Home, one of the leading providers of smart locks and smart home accessories, to test the concept of direct-to-fridge online grocery delivery. This service sends customers a notification when the delivery person reaches their door.

After entering a one-time password, the employee enters the house and places the groceries directly in the customer’s refrigerator. Customers can monitor all activity through their home surveillance cameras.

That's a little too creepy for me – I think I'll settle for deliveries to the door and then I'll take it from there.

The investing angle here is that the long-dormant grocery industry is finally undergoing a very necessary period of change. By 2020, this industry will be firmly entrenched in a new reality with a complete focus on the customer.

Consumers will be able to purchase more exciting products, more conveniently, and at lower price points.

Brick-and-mortar stores will still exist, and customers who want a traditional experience (like me) will still be able to find it. But the choices I've described, and others will only multiply in the future.

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A future where only grocers that understand the changes and adapt to them by embracing technology will be the ones that succeed. One such company is Kroger (NYSE: KR) and here's why…

KROGER IS DOING ALL THE RIGHT THINGS

As I've described to you, the future of grocery shopping depends on all sorts of things that did not exist just a few short years ago. Think automated warehouses, driverless cars, meal kits, etc.

Our country's largest grocery store chain (nearly 2,800 stores), Kroger (NYSE: KR), is not only aware of these changes, but it is betting on all the above and more, such as Big Data. The company delivers more than three billion personalized recommendation (based on the data it has) to its customers annually to create unique shopping experiences.

Since May, it has really hit the innovation accelerator, unveiling a series of initiatives to strengthen its hand in e-commerce, the grocery industry’s next battleground.

These initiatives include testing self-driving delivery vehicles, buying meal-kit maker Home Chef for $700 million, and taking a stake in Ocado that will see the U.K. company provide logistics technology for online orders.

In August, Kroger launched a delivery service in four cities, with plans to expand across the U.S. It is also making its first international foray through a partnership with e- commerce site Alibaba (NYSE: BABA) to sell its private label products in China.

As Kroger CEO, Rodney McMullen, said on the company's latest earnings call, “What we’re really focused on is when somebody decides to eat something, they can get it from us.”

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The most significant of these moves may well be Kroger's joining up with Britain's Ocado on logistics and warehouse technology. Full disclosure – I own shares in Ocado, so it is not surprising that I consider Ocado's technology superior to even Amazon's.

Let me fill you in on what the deal will mean for Kroger in its battle for grocery supremacy.

Kroger and Ocado

In what was a roughly $250 million deal, Kroger bought a 5% stake in Ocado in order gain exclusive access to the company's technology in the United States.

Ocado already has existing agreements on both sides of the Atlantic to provide high-tech logistics to French supermarket chain Casino, Wm Morrison in the U.K., Sobeys in Canada and ICA in Sweden.

It's a deal Kroger had to do because Americans are finally warming to grocery delivery. Walmart says it is on track for a 40% increase in online sales this year. Kroger's CEO said the partnership would speed up the company’s efforts to “redefine the food and grocery customer experience” and described the automation and route-mapping systems that Ocado had developed as “remarkable”.

I agree with his assessment of Ocado's automated warehouse technology. As anyone that follows Amazon knows, warehouses are being revolutionized by AI and robotics.

And Ocado is at the forefront of this revolution.

In a side note, many traders in the U.K. did not believe in Ocado's technology – it was one of the most shorted stocks on the London Stock Exchange. These shorts were blown out of the water after the deal announcement as the stock soared about 50%.

Even Ocado pessimists conceded the Kroger deal was a game-changer. “This is a real step change in the pace of roll out and makes it much more reasonable to believe that Ocado has the ‘killer app’ for online grocery,” said one analyst to the Financial Times who had been skeptical of Ocado.

Its stock is now up 150% this year.

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After the Kroger deal was announced, one of Britain's top brokerage firms, Peel Hunt, said that Ocado had the potential to become the “Microsoft of Retail” by transforming itself into a core platform for the sector’s logistics. It said the company should adopt the approach deployed by Microsoft to make its Windows operating system available to all PC manufacturers.

By becoming the open industry standard, Ocado would gain “higher penetration, stronger control and greater revenue”, Peel Hunt said.

However, there are risks. The Kroger deal will be its largest in scale. Subject to a final agreement, in the coming three years Ocado will build 20 automated “customer fulfillment centers” across the U.S., to pick, pack and dispatch groceries ordered online.

Preliminary work on the first three sites is already underway.

This tie-up with Ocado is crucial for Kroger's future since delivering groceries is more complex than selling books or video games. That's because food needs to be stored at the right temperature to ensure it doesn’t spoil.

Ocado’s software helps trucks take the best route, so that deliveries arrive at the customer’s door within a one-hour window.

For Kroger, the partnership is all about serving customers who are shifting their grocery- buying habits. “It’s about using our technology and data so that customers can move back and forth,” McMullen said in a Bloomberg interview. “It really accelerates our ability to offer a seamless experience.”

Kroger's Other Deals

Kroger's other recent transactions may also turn out to be significant. Here's a quick look at those…

Kroger is partnering with autonomous vehicle start-up Nuro to test the delivery of groceries in what the companies claim will be an unmanned road vehicle that can steer itself from the grocery store to a customer’s home. The pilot program will begin this autumn at an undisclosed U.S. store.

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For the Kroger test, the cars will be unmanned, but the company will “have the ability to monitor each vehicle.” It will operate kind of like a Lyft or Uber: dispatched to a customer’s address loaded with groceries, with updates on the location of the order provided through a mobile app.

Once the delivery arrives, the customer will go outside and unlock the grocery order, according to Nuro.

The next interesting transaction was Kroger paying an initial transaction price of $200 million to buy Home Chef. Kroger will pay up to $500 million over five years “contingent on achieving certain milestones, including significant growth of in-store and online meal kit sales.”

Home Chef can reach 98% of continental US households within a two-day delivery window. Kroger said the tie-up will “significantly accelerate availability of meal kits”, which will be available both online and in-store.

Finally, there is the tie-up with China's Alibaba, which is its first foray in overseas markets.

Keep in mind that rival Walmart paid $16 billion for a majority stake in the Indian e- commerce leader Flipkart.

Kroger said it will begin by selling select Simple Truth products — a range of natural and organic items including produce, meat and seafood and cleaning and household products — on Alibaba’s Tmall Global platform, targeting more than half a billion Chinese consumers. This is a great move because the intersection of retail and technology is red- hot in China right now.

Simple Truth launched five years ago and is the second largest brand sold in Kroger stores, with annual sales to reach $2 billion this year. Tmall allows foreign companies without operations in China to build virtual storefronts and ship products to the country.

It will enable Kroger to quickly scale to reach new customers and markets where it doesn’t operate physical stores, such as in China.

Add this all up and you have a company – Kroger – pushing all the right buttons.

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That is why I bought the stock after the Ocado deal was announced. And its subsequent actions, such as the deal with Alibaba, make me even more confident despite all the skepticism coming from Wall Street.

Kroger will be a winner as grocery shopping and technology intersect. So, you can feel safe buying the shares anywhere up to $33 a share.

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