Kroger’s Earnings Hit by Food Deflation

Retailer’s total sales grew 5.9% to $26.6 billion in Q3 FY16

k1The Kroger Co. (NYSE: KR), the second-largest food retailer in the U.S. after Wal-Mart Stores Inc. (NYSE: WMT), announced its Q3 FY16 financial results on December 01st, 2016.

The Cincinnati, Ohio-based Company operates stores that comprise full-service grocery, pharmacy, health and beauty departments, and perishable goods, as well as general merchandise and fuel. It operates under brands such as Kroger, Ralphs, Fred Meyer, King Soopers as well as the Simple Truth and Simple Truth Organic brands. Read more about Kroger’s financial results below.

Q3 FY16 financial highlights

During Q3 FY16, Kroger’s total sales grew 5.9% to $26.6 billion compared to $25.1 billion for the same period last year. Total sales, excluding fuel, jumped 7.1% when compared to the year-ago same period. Total supermarket sales, excluding fuel and Roundy’s, rose 1.6% in Q3 FY16 versus the year-ago comparable period. The Company’s top-line growth has been under constant pressure from continued weakness in fuel prices and fuel price volatility.

Kroger, which also operates under the Food 4 Less, Fry’s, Smith’s, and Dillon’s brands, reported that same store sales, excluding fuel centers, grew marginally by 0.1% to $20.9 billion, whereas including fuel center sales, identical supermarket sales edged down 0.2% to $23.5 billion. It is worth noting that the Company achieved the 52nd consecutive quarter of positive identical supermarket sales growth, excluding fuel. During Q3 FY16, Kroger’s comps were negatively impacted by deflation, which affected most of its product categories.

k2During Q3 FY16, Kroger’s gross margin accounted for 22.2% of sales. Excluding fuel, Roundy’s, and LIFO, gross margin decreased 5 basis points from the same period last year. Kroger recorded an $8 million LIFO credit during Q3 FY16, compared to a $9 million LIFO charge in the same quarter last year.

Total operating expenses, excluding fuel, Roundy’s and an $80 million contribution to the UFCW Consolidated Pension Plan in Q3 FY15, increased 19 basis points as a percentage of sales compared to the prior year; of which 15 basis points were related to depreciation due to increases in the capital program. FIFO operating margin on a rolling four quarters basis decreased 12 basis points compared to the prior year, with the following exclusions: fuel, Roundy’s, Q2 FY16 restructuring of certain multi-employer pension obligations, the 2015 and 2014 contributions to the UFCW Consolidated Pension Plan, and Q4 FY14 contribution to The Kroger Co. Foundation.

As a result, operating income fell 7.6% to $713 million, whereas operating margin contracted 40 basis points to 2.7%. In all, Kroger’s Q3 FY16 net earnings fell to $391 million, or $0.41 per diluted share, compared to $428 million, or $0.43 per diluted share, in the year-ago same period.

As with other big-box retailers such as Dollar General Corporation (NYSE: DG), Dollar Tree Inc. (NASDAQ: DLTR), and Wal-Mart Stores Inc. (NYSE: WMT), Kroger faced headwinds in the form of declining food prices, lower store traffic, and lower average ticket. On the other hand, Kroger has been investing heavily in online grocery and offers online grocery pickup at more than 500 stores. At Kroger, the company’s ClickList online grocery service is growing and allows consumers at more than 500 locations to select from more than 40,000 items and pick up orders at stores.

Other highlights: At the end of Q3 FY16, Kroger operated 2,253 pharmacies, 787 convenience stores, 324 fine jewelry stores, 1,439 supermarket fuel centers and 38 food production plants in the U.S.

Financial strategy: Kroger, as part of its long-term plans to drive growth while also giving back to shareholders, has maintained its current investment grade debt rating. This allows the Company to use free cash flow to pursue strategic opportunities, repurchase shares, and fund dividends.

Over the past year, Kroger has used free cash to repurchase $1.4 billion in common shares, pay $418 million in dividends, invest $3.8 billion in capital, merge with Roundy’s Inc. for $866 million, and merge with ModernHEALTH for $390 million.

Kroger’s net total debt to adjusted EBITDA ratio increased to 2.35 in Q3 FY16 compared to 1.99 during the same period last year. At year end, Kroger expects net total debt to adjusted EBITDA to be near the high-end of the company’s targeted range of 2.00 to 2.20 per share.

Guidance for Q4 FY16 and full year FY16

For the full year FY16, Kroger lowered its earnings guidance as a result of continued deflation, and now expects diluted EPS to range between $2.03 and $2.08. The previous guidance range was $2.03 to $2.13 per share. Kroger’s adjusted net earnings guidance range per diluted share for 2016 is $2.10 to $2.15, which excludes the $0.07 per share charge from the company’s commitment to restructure certain multi-employer pension obligations in the second quarter. The previous adjusted guidance range was $2.10 to $2.20 per share.

For Q4 FY16, Kroger expects slightly positive identical supermarket sales growth, excluding fuel. The company’s expected capital investments, excluding mergers, acquisitions and purchases of leased facilities, is forecasted at $3.6 billion to $3.9 billion for FY16.

Kroger stated that it would provide guidance for FY17 in March 2017. However, it expects net earnings growth to be below its previous 8% to 11% forecast. It also sees the second half of 2017 performing better than the first half.

Stock Performance

k3Kroger’s stock ended the day at $32.93, slipping 1.11%, at the close on Monday, December 05th, 2016, having vacillated between an intraday high of $33.22 and a low of $32.70 during the session. The stock’s trading volume was at 10,519,996 for the day. The Company’s market cap was at $31.15 billion as of Monday’s close.

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