The Kroger Co. — Form 10-Q Summary
Reporting period: The filing covers the second quarter and first two quarters ended August 17, 2019, representing 12-week and 28-week periods, respectively. The requested metadata identifies “2018 Q2,” but the supplied filing is the 2019 second-quarter report, with August 18, 2018 as the comparable prior-year period.
Business Context and Key Financial Metrics
Kroger operates a U.S. supermarket business with fuel, pharmacy, digital commerce, specialty pharmacy, personal finance, data analytics and media activities. The company continued executing its Restock Kroger strategy, investing in digital capabilities, wages, customer pricing and store productivity.
| Metric | Second quarter 2019 | Second quarter 2018 | First two quarters 2019 | First two quarters 2018 |
|---|---|---|---|---|
| Sales | $28.168 billion | $28.014 billion | $65.419 billion | $65.735 billion |
| Operating profit | $559 million | $549 million | $1.460 billion | $1.577 billion |
| Operating margin | 1.98% | 1.96% | 2.23% | 2.40% |
| Net earnings attributable to Kroger | $297 million | $508 million | $1.069 billion | $2.534 billion |
| Diluted EPS | $0.37 | $0.62 | $1.31 | $3.03 |
| Adjusted diluted EPS | $0.44 | $0.41 | $1.16 | $1.15 |
| Cash flow from operations | Not separately provided | Not separately provided | $3.277 billion | $3.260 billion |
- Identical sales excluding fuel increased 2.2% in the second quarter and 1.8% for the first two quarters.
- Digital revenue grew 31% in the second quarter and 37% year to date, primarily from Pickup and Delivery. Growth moderated because of cycling the Home Chef merger.
- FIFO gross margin was 21.98% in the second quarter and 22.13% year to date, compared with 21.59% and 21.86%, respectively, in the prior-year periods.
- FIFO operating profit was $589 million in the second quarter and approximately $1.5 billion year to date.
- The second-quarter LIFO charge was $30 million, compared with $12 million in the prior year; the year-to-date charge was $46 million versus $27 million.
- Cash and temporary cash investments were $629 million at August 17, 2019, compared with $429 million at fiscal year-end.
- Total debt, excluding finance-lease obligations, was $12.605 billion; total debt including finance-lease obligations declined approximately $1.7 billion from fiscal year-end.
- Operating lease liabilities were $7.138 billion on a present-value basis, reflecting adoption of the new lease accounting standard.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales increased 0.5%, while first-half sales declined 0.5%, largely because of lower fuel sales and business dispositions.
- Fuel sales declined 9.9% in the quarter and 6.5% year to date, reflecting lower gallons sold and lower average fuel prices.
- Reported diluted EPS declined sharply because 2018 included significant gains from the sale of the convenience-store business and an Ocado mark-to-market gain. Adjusted diluted EPS increased 7.3% in the quarter and 0.9% year to date.
- First-half operating margin declined to 2.23% from 2.40%, primarily from higher OG&A and depreciation and amortization expense as a percentage of sales.
- Net cash from operations was broadly stable, while investing cash flow changed from $128 million provided in 2018 to $1.039 billion used in 2019, principally because prior-year business-sale proceeds were larger.
- Financing cash use declined to $2.038 billion from $3.374 billion, reflecting lower commercial-paper repayments and share repurchases, partly offset by greater long-term debt repayment.
- Kroger sold You Technology for total consideration of $565 million, including $396 million of cash and $64 million of preferred equity, and sold Turkey Hill Dairy for $225 million. The transactions produced aggregate pretax gains of $176 million.
- The company recorded $86 million of pretax charges for multi-employer pension withdrawal liabilities during the first two quarters.
- Kroger adopted lease accounting guidance, recognizing approximately $6.8 billion of operating lease assets and $7.0 billion of operating lease liabilities at adoption. The adoption did not materially affect earnings or cash flow.
Guidance, Outlook, Risks and Unusual Items
- 2019 identical sales growth excluding fuel is targeted at 2.0% to 2.25%.
- 2019 GAAP diluted EPS guidance is $2.30 to $2.40; adjusted diluted EPS guidance is $2.15 to $2.25.
- Expected 2019 FIFO operating profit is $2.8 billion to $2.9 billion, or $2.9 billion to $3.0 billion on an adjusted basis.
- Alternative profit streams are expected to contribute an incremental $100 million of operating profit in 2019.
- Expected 2019 tax rate is 22.9% to 23.4%, or 22.3% to 22.8% excluding adjusted items.
- Capital investments excluding mergers, acquisitions and leased-facility purchases are expected to be $3.0 billion to $3.2 billion.
- Management no longer expects a higher weighted-average interest rate in 2019 than in 2018 and did not reconfirm the prior three-year $400 million incremental operating-profit expectation.
- Management estimates next-twelve-month liquidity needs of approximately $4.5 billion, including approximately $1.3 billion of senior-note maturities. It expects operating cash flow, commercial paper and its revolving credit facility to be sufficient.
- The company had a $2.75 billion unsecured revolving credit facility, no commercial-paper borrowings and no revolver borrowings at August 17, 2019. It was in compliance with debt covenants.
- Key risks include labor negotiations, competitive pricing, fuel-price and fuel-margin volatility, inflation or deflation, pharmacy reimbursement and industry consolidation, multi-employer pension obligations, cyberattacks, weather, execution of Restock Kroger and access to capital markets.
- Pending litigation includes antitrust, wage-and-hour, civil-rights and product-liability matters. Management considers the expected aggregate exposure not material, but acknowledges that outcomes could differ materially from current estimates.
Most Important Facts for Investors to Verify
- Confirm the reporting-period mismatch: the supplied filing is for 2019 Q2, not 2018 Q2.
- Reconcile reported EPS with adjusted EPS and isolate the effects of business-sale gains, Ocado mark-to-market changes and pension withdrawal charges.
- Monitor fuel sales, pharmacy margins, pricing investments, labor costs and the effect of digital growth on profitability.
- Evaluate leverage including operating and finance lease liabilities, upcoming debt maturities and refinancing assumptions.
- Assess whether identical-sales and FIFO operating-profit guidance remains achievable amid competitive, labor, fuel and macroeconomic pressures.
- Review the potential variability of multi-employer pension obligations, litigation outcomes, tax audits and other contingencies.