The Kroger Co. 10-Q Summary
Reporting period: The supplied filing is for the 16-week first quarter ended May 21, 2022, compared with the 16-week first quarter ended May 22, 2021. Although the request metadata states “2021 Q1,” the filing itself reports first-quarter 2022 results.
Business Context
Kroger operates food retail, fuel, pharmacy, digital and alternative-profit businesses. Management emphasized its omnichannel strategy, fresh food, personalization, digital capabilities, cost savings and expansion of Kroger Delivery customer fulfillment centers powered by Ocado. Two additional fulfillment centers opened during the quarter, bringing the total to five.
Key Financial Metrics
| Metric | Q1 2022 | Q1 2021 | Change |
|---|---|---|---|
| Sales | $44.600 billion | $41.298 billion | 8.0% |
| Sales excluding fuel | $38.711 billion | $37.308 billion | 3.8% |
| Identical sales excluding fuel | 4.1% | (4.1)% | Improved |
| Operating profit | $1.505 billion | $805 million | 87.0% |
| Operating margin | 3.4% | 1.9% | Up 142 basis points |
| Adjusted FIFO operating profit | $1.601 billion | $1.375 billion | 16.4% |
| Net earnings attributable to Kroger | $664 million | $140 million | 374.3% |
| Diluted earnings per share | $0.90 | $0.18 | 400.0% |
| Adjusted diluted earnings per share | $1.45 | $1.19 | 21.8% |
| Cash flow from operations | $1.102 billion | $2.256 billion | Down $1.154 billion |
| Capital investments excluding mergers, acquisitions and leased facilities | $971 million | $666 million | Up $305 million |
Margins, Costs and Unusual Items
- Gross margin was 21.63%, compared with 22.64% in the prior-year quarter. FIFO gross margin was 21.84%, compared with 22.73%.
- The LIFO charge increased to $93 million from $37 million, reflecting higher product-cost inflation.
- Excluding fuel, FIFO gross margin declined 26 basis points, primarily because of price investments and higher transportation and warehousing costs.
- OG&A expense decreased to 15.69% of sales from 17.98%, benefiting from sales leverage, lower multi-employer pension contributions, lower incentive costs and cost savings initiatives.
- Reported earnings included a $532 million unrealized loss on the Ocado investment, compared with $479 million in the prior-year quarter. The after-tax adjustment was $404 million in 2022 and $367 million in 2021.
- Other 2022 adjusted items included a $7 million pre-tax charge related to Home Chef contingent consideration. Prior-year adjusted items included $449 million of pension withdrawal liabilities, $43 million of Home Chef revaluation costs and $44 million of transformation costs.
- The effective tax rate declined to 18.0% from 20.2%, primarily because of increased deductions from share-based payments.
Cash Flow, Liquidity and Debt
- Operating cash flow was $1.102 billion, down from $2.256 billion, primarily because working-capital changes used approximately $1.3 billion, including a $676 million increase in inventories.
- Investing activities used $723 million, including $745 million of property and equipment payments.
- Financing activities used $818 million, including $665 million of treasury-stock purchases and $154 million of dividends paid.
- Cash and temporary cash investments were $1.382 billion at May 21, 2022, down from $1.821 billion at fiscal year-end.
- Total debt, including finance-lease obligations, increased $275 million from fiscal year-end to approximately $13.7 billion, primarily because of new Ocado-related finance leases.
- Long-term debt excluding finance-lease obligations was $11.731 billion before the current portion, with reported total debt fair value of $11.366 billion.
- Kroger had a $2.75 billion unsecured revolving credit facility, expandable by $1.25 billion, with no outstanding commercial paper or revolver borrowings and only $2 million of outstanding letters of credit reducing availability.
- The company stated that it was in compliance with its financial covenant and expects available cash, operating cash flow and financing sources to meet liquidity needs.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven by higher fuel prices and volumes, higher non-fuel retail sales and a 4.1% increase in identical sales excluding fuel.
- Digital sales declined approximately 6% as customers shifted toward in-store shopping, although digital-platform households increased and most reduced online spending remained within Kroger’s store ecosystem.
- Fuel sales increased 47.6%, primarily from a 43.3% increase in average retail fuel prices and a 3.0% increase in gallons sold.
- Reported profitability rose sharply, but the comparison was affected by nonrecurring or non-operating items. Adjusted diluted EPS increased 21.8%, providing a more comparable measure.
- Operating cash flow declined substantially because of inventory investment and unfavorable working-capital movements.
- Share repurchases increased to $665 million from $402 million. Kroger repurchased 12.8 million shares under its programs during the quarter; $301 million remained under the December 2021 $1.0 billion program at quarter-end.
- Capital investments increased to $971 million from $666 million, while two additional Ocado fulfillment centers were opened.
Guidance, Outlook and Risks
Management raised full-year guidance for identical sales excluding fuel, adjusted FIFO operating profit and adjusted net earnings per diluted share. The supplied filing text does not provide the specific revised full-year numerical guidance ranges.
Management expects continued momentum, ongoing investment in associates and the business, continued dividend growth and share repurchases. Kroger targets net total debt to adjusted EBITDA of 2.30 to 2.50, maintenance of its investment-grade debt rating and long-term total shareholder return of 8% to 11%.
- Principal operating risks include inflation, fuel and commodity costs, supply-chain constraints, labor-market pressures, labor negotiations and potential work stoppages.
- Other risks include changing consumer spending, competition, interest rates, the war in Ukraine, tariffs, public-health events, cyberattacks, data breaches, regulatory changes and execution of digital, technology and growth initiatives.
- Kroger faces numerous opioid-related lawsuits, including five bellwether cases proceeding in federal multidistrict litigation. The company stated that it cannot currently determine the probability or reasonably possible loss.
- Routine litigation, self-insurance claims and contingent lease assignments remain outstanding. Management believes aggregate expected litigation exposure is not material, but adverse outcomes could differ from current estimates.
- The company recorded $339 million of finance-lease assets and $313 million of finance-lease liabilities related to Ocado arrangements during the quarter.
Investor Verification Items
- Verify the revised full-year guidance figures, which are referenced but not numerically stated in the supplied filing text.
- Assess the sustainability of the 4.1% identical-sales increase excluding fuel amid inflation, lower digital sales and changing consumer behavior.
- Separate recurring operating performance from the $532 million unrealized Ocado investment loss and other adjusted items.
- Monitor inventory growth, working-capital consumption and the resulting decline in operating cash flow.
- Track fuel-price normalization and its effect on sales, margins and operating profit.
- Review debt, lease obligations and the company’s 2.30–2.50 net total debt-to-adjusted-EBITDA target as Ocado fulfillment capacity expands.
- Follow opioid litigation and other contingencies because the filing states that potential losses cannot currently be estimated for certain matters.