The Kroger Co. Form 10-Q Summary
Business context and reporting period
This filing covers Kroger’s first quarter of fiscal 2018, the 16-week period ended May 26, 2018, compared with the 16-week period ended May 20, 2017. The request metadata identifies “2017 Q1,” but the filing itself is for 2018 Q1. Kroger operates supermarkets, fuel centers, pharmacies, digital channels, convenience stores and related businesses.
Financial performance and key metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Sales | $37.530 billion | $36.285 billion | +3.4% |
| Operating profit | $1.029 billion | $631 million | +63.1% |
| Operating margin | 2.74% | 1.74% | +100 basis points |
| Net earnings attributable to Kroger | $2.026 billion | $303 million | Material increase |
| Diluted earnings per share | $2.37 | $0.32 | +641.6% |
| Adjusted diluted EPS | $0.73 | $0.58 | +25.9% |
| Cash flow from operations | $2.368 billion | $2.309 billion | Increase |
| Free cash flow | $1.6 billion | $1.6 billion | Flat |
Identical sales excluding fuel increased 1.9%; identical supermarket sales excluding fuel increased 1.4%. Digital revenue increased 66%, driven primarily by ClickList. Supermarket fuel sales increased 19.5%, reflecting higher average fuel prices and increased gallons sold.
Gross margin declined to 21.76% from 22.06%; FIFO gross margin declined to 21.80% from 22.13%. Management attributed the pressure primarily to lower customer prices, transportation and advertising costs, and lower fuel margins. OG&A expense declined to 16.31% of sales from 17.55%, although the comparable result excluding specified adjusted items increased slightly.
Cash and temporary cash investments were $691 million at May 26, 2018, compared with $347 million at fiscal year-end. Total assets were $36.561 billion and total equity was $6.941 billion. Total debt, including current and long-term portions, was approximately $14.301 billion, including $13.477 billion of debt excluding capital leases and financing obligations.
Material changes versus the prior comparable period
- Kroger sold its convenience store business for $2.15 billion on April 20, 2018, recording a $1.771 billion pretax gain and $1.352 billion after-tax gain.
- The sale drove much of the increase in GAAP earnings and supplied proceeds used to repay commercial paper and fund share repurchases. Adjusted net earnings attributable to Kroger increased 14.7% to $626 million.
- Kroger repurchased 74.4 million shares for $1.8 billion at an average price of $24.33 per share, including $1.1 billion settled under an accelerated stock repurchase program.
- Net cash provided by investing activities was $1.349 billion, compared with a $744 million use in the prior-year quarter, primarily because of the business-sale proceeds.
- Financing activities used $3.373 billion, including $2.120 billion of net commercial-paper repayments and $1.809 billion of treasury-stock purchases.
- Kroger issued a $1.0 billion term loan due in 2019 and repaid $200 million of 7% senior notes. It had no outstanding commercial paper or revolving-credit borrowings at quarter-end.
- The effective tax rate declined to 23.4% from 33.3%, primarily because of the lower federal statutory rate under the Tax Cuts and Jobs Act.
- Kroger adopted revenue-recognition, pension-cost presentation and financial-instrument accounting changes. Management stated that the revenue standard had no material financial-statement effect.
Guidance, outlook, risks and unusual items
- 2018 identical sales growth excluding fuel is expected to range from 2.0% to 2.5% under the company’s updated definition.
- 2018 GAAP diluted EPS guidance was raised to $3.64–$3.79, and adjusted diluted EPS guidance was raised to $2.00–$2.15.
- Capital investments excluding mergers, acquisitions and leased facilities are expected to be approximately $3.0 billion for 2018; the first-quarter amount was approximately $848 million.
- The expected 2018 effective tax rate is approximately 22%.
- Kroger expects approximately $5.2 billion of liquidity needs over the next twelve months, including working capital, capital investments, interest and scheduled debt maturities. Management expects operating cash flow and available borrowing capacity to be sufficient.
- The company maintained a $2.75 billion unsecured revolving credit facility, expandable by $1 billion, and was in compliance with debt covenants.
- Kroger announced an exclusive U.S. partnership with Ocado to enhance digital and robotics capabilities and agreed to purchase approximately $243 million of Ocado shares. The Home Chef merger was completed on June 22, 2018 for an initial transaction price of $200 million, with potential earnouts of up to $500 million.
- Key risks include competitive pricing, labor negotiations, fuel-price and fuel-margin volatility, pharmacy reimbursement and payer changes, commodity and operating-cost inflation, cyberattacks, execution of the Restock Kroger strategy, integration of acquisitions and partnerships, refinancing conditions, litigation and multi-employer pension obligations.
- Pending litigation includes antitrust, wage-and-hour, civil-rights and product-liability claims. Management believes the aggregate exposure is not material, but acknowledges that outcomes could differ materially from current estimates.
- The future lease-accounting standard is expected to materially increase reported lease assets and liabilities when adopted; the filing states that Kroger is still evaluating the broader effects.
Important facts for investors to verify
- Separate recurring operating performance from the $1.352 billion after-tax convenience-store-sale gain and the $27 million after-tax Ocado mark-to-market gain.
- Reconcile adjusted diluted EPS of $0.73 with GAAP diluted EPS of $2.37 and review all management-defined adjustments.
- Assess whether lower gross margins and increased underlying OG&A costs, excluding unusual items, could constrain future earnings growth.
- Verify the completion and final economics of the $1.2 billion accelerated stock repurchase program, including remaining repurchases due by July 6, 2018.
- Monitor the $1.0 billion term loan and approximately $1.1 billion of senior notes maturing within the next twelve months, as well as refinancing conditions.
- Evaluate the sustainability of identical-sales growth, digital revenue growth and fuel-driven sales increases.
- Review the financial impact and execution requirements of the Ocado partnership and Home Chef acquisition, including potential earnout payments.
- Confirm the eventual balance-sheet effects of the forthcoming lease-accounting standard and the resolution of pending legal and pension matters.