The Kroger Co. 10-Q Summary
Reporting period: Second quarter and first two quarters ended August 13, 2022, covering 12 and 28 weeks, respectively. Comparable periods ended August 14, 2021. The request metadata identifies “2021 Q2,” but the filing is for 2022 Q2.
Business context
Kroger is a U.S. food and grocery retailer operating supermarkets, fuel centers, pharmacies, digital commerce, data analytics and alternative profit businesses. Management’s strategy emphasizes fresh products, private-label brands, personalization, digital channels and the seamless integration of stores and delivery.
Financial performance
| Metric | Q2 2022 | Q2 2021 | Change |
|---|---|---|---|
| Sales | $34.638 billion | $31.682 billion | 9.3% |
| Sales excluding fuel | $29.577 billion | $28.105 billion | 5.2% |
| Identical sales excluding fuel | 5.8% | (0.6%) | Increase |
| Operating profit | $954 million | $839 million | 13.7% |
| Operating margin | 2.8% | 2.7% | Up 11 bps |
| Net earnings attributable to Kroger | $731 million | $467 million | 56.5% |
| Diluted EPS | $1.00 | $0.61 | 63.9% |
| Adjusted diluted EPS | $0.90 | $0.80 | 12.5% |
| Adjusted FIFO operating profit | $1.110 billion | $947 million | 17.2% |
For the first two quarters, sales were $79.238 billion, up 8.6%; operating profit was $2.459 billion, up 49.6%; net earnings attributable to Kroger were $1.394 billion, up 129.7%; diluted EPS was $1.89 versus $0.79; and adjusted diluted EPS was $2.36 versus $1.99, up 18.6%.
Q2 gross margin was 20.92%, compared with 21.36% in the prior-year quarter. FIFO gross margin was 21.35% versus 21.51%; excluding fuel, FIFO gross margin increased 2 basis points. The LIFO charge increased to $148 million from $47 million because of higher product-cost inflation, primarily in grocery.
Digital sales increased approximately 8% in Q2 and declined approximately 1% for the first two quarters. Delivery solutions increased 34% in Q2 and 22% year to date, supported by the Boost membership program and expansion of Kroger Delivery.
Cash flow, liquidity and capital structure
- Cash provided by operating activities was $2.427 billion for the first two quarters, compared with $3.123 billion in the prior-year period. The decline primarily reflected increased inventory and other working-capital uses.
- Investing activities used $1.388 billion, including $1.430 billion of property and equipment payments. Capital investments excluding mergers, acquisitions and leased facilities were approximately $1.5 billion year to date.
- Financing activities used $1.758 billion, including $975 million of share repurchases, $307 million of dividends and $486 million of debt and finance-lease payments.
- Cash and temporary cash investments were $1.102 billion at August 13, 2022, compared with $1.821 billion at fiscal year-end.
- Total debt, including finance-lease obligations, declined $87 million from fiscal year-end to approximately $13.4 billion. Kroger repaid $400 million of 2.80% senior notes, partly offset by finance-lease obligations related to new fulfillment centers.
- Kroger had no commercial-paper borrowings and no borrowings under its $2.75 billion revolving credit facility, which can be increased by $1.25 billion. Only $2 million of letters of credit reduced availability.
- The company was in compliance with its financial covenant and stated that it expects available cash, operating cash flow and borrowing capacity to meet liquidity needs.
Material changes versus the prior comparable period
- Sales growth accelerated, driven by higher fuel prices, 5.8% identical sales growth excluding fuel and increased household traffic and basket value.
- Fuel sales increased 41.5% in Q2, primarily from a 47.6% increase in average retail fuel prices, partially offset by a 4.1% decline in gallons sold.
- Adjusted operating results improved despite inflation. Cost savings, sourcing and sales leverage helped offset higher product, transportation, labor and investment costs.
- OG&A expense declined to 15.64% of sales from 16.07%, although underlying expenses excluding fuel and adjusted items increased 36 basis points because of associate investments, incentive accruals and strategic investments.
- The comparison of GAAP earnings was affected by investment-market volatility and unusual prior-year items. Kroger recorded a $103 million investment gain in Q2 2022 versus a $122 million loss in Q2 2021; year-to-date investment losses were $429 million in 2022 versus $601 million in 2021.
- Kroger opened three additional Ocado-powered customer fulfillment centers in Dallas, Pleasant Prairie and Romulus, bringing the total to six. Finance-lease assets of $429 million and liabilities of $391 million were recorded year to date.
- The company repurchased $975 million of shares year to date, compared with $751 million in the prior-year period, and paid $307 million of dividends versus $274 million.
Guidance, outlook and management commentary
Management raised full-year guidance for identical sales excluding fuel, adjusted FIFO operating profit and adjusted diluted EPS, although the filing text provided here does not state the revised numerical ranges.
Kroger targets long-term total shareholder return of 8% to 11%, a net total debt-to-adjusted EBITDA ratio of 2.30 to 2.50 and maintenance of its investment-grade debt rating. Management expects continued free cash flow, dividend growth and share repurchases, while prioritizing investments in organic and inorganic growth.
The company’s value-creation plan includes doubling digital sales and doubling digital passthrough profitability by the end of 2023. On September 9, 2022, the board approved a new $1.0 billion share-repurchase program after the prior program was exhausted.
Risks, contingencies and unusual items
- Key operating risks include inflation or deflation, fuel-cost volatility, supply-chain constraints, labor negotiations and work stoppages, competition, changing consumer spending, interest rates, recession risk, geopolitical events including the war in Ukraine, and future COVID-19 developments.
- Kroger faces potential exposure from cyberattacks, regulatory changes, pharmacy reimbursement and consolidation, multi-employer pension obligations, natural disasters and the execution of its digital and growth initiatives.
- Various litigation matters are pending, including opioid-related litigation. The company cannot currently determine the probability or reasonably possible loss range for the opioid matters.
- Management believes ordinary-course litigation and other contingencies are not expected to have a material effect, but acknowledges that actual outcomes could differ materially from estimates.
- Adjusted results exclude, among other items, the $429 million year-to-date unrealized investment loss, $18 million of Home Chef contingent-consideration expense and prior-year pension withdrawal liabilities and transformation costs.
- The company maintains self-insurance and other insurance arrangements for workers’ compensation, general liability and property risks; actual claims may differ from recorded estimates.
Investor verification points
- Verify the revised full-year guidance ranges, which are referenced but not numerically included in the supplied filing text.
- Assess whether identical sales growth and fuel profitability remain sustainable as inflation, fuel prices and consumer behavior normalize.
- Track LIFO charges, gross-margin trends, transportation costs and underlying OG&A spending excluding fuel and adjusted items.
- Reconcile operating cash flow with inventory growth and capital-investment requirements.
- Monitor leverage, finance-lease additions from Ocado fulfillment centers and progress toward the 2.30-to-2.50 net debt-to-adjusted EBITDA target.
- Evaluate the effect of share repurchases and dividends on liquidity and per-share earnings.
- Review developments in opioid litigation, multi-employer pension obligations, self-insurance claims and other contingencies.
- Confirm the treatment and future volatility of the Ocado investment and other fair-value adjustments in reported earnings.