The Kroger Co. Form 10-Q Summary
Period covered: First quarter ended May 25, 2019, a 16-week period, compared with the 16-week period ended May 26, 2018. The request metadata identifies “2018 Q1,” but the filing is for 2019 Q1.
Business Context and Reporting Period
Kroger is a food and grocery retailer with supermarket, fuel, pharmacy, digital, personal finance, data analytics and media operations. The company completed the sale of its convenience store business in the first quarter of 2018 and sold its You Technology and Turkey Hill Dairy businesses during the first quarter of 2019.
Financial Performance and Key Metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Sales | $37.251 billion | $37.722 billion | (1.2%) |
| Operating profit | $901 million | $1.029 billion | Down $128 million |
| Operating margin | 2.42% | 2.73% | Down 31 basis points |
| Net earnings attributable to Kroger | $772 million | $2.026 billion | Down $1.254 billion |
| Diluted earnings per share | $0.95 | $2.37 | Down 59.9% |
| Adjusted diluted EPS | $0.72 | $0.73 | Down 1.4% |
| Net cash from operating activities | $2.268 billion | $2.368 billion | Down $100 million |
| Capital investments | $876 million | $849 million | Up $27 million |
Identical sales excluding fuel increased 1.5%. Sales to retail customers excluding fuel increased 2.0%, while digital revenue grew approximately 42%, driven by Pickup and Delivery. Fuel sales decreased 3.6% due primarily to lower gallons sold and lower average fuel prices.
Gross margin increased to 22.20% from 22.01%; FIFO gross margin increased to 22.24% from 22.05%. Excluding fuel, FIFO gross margin declined 40 basis points, reflecting price investments, lower pharmacy margins and warehouse start-up costs. OG&A expenses increased to 16.95% of sales from 16.59%.
Cash used in investing activities was $464 million, compared with $1.349 billion of cash provided in the prior-year quarter. Cash used in financing activities was $1.824 billion, including $1.013 billion of long-term debt repayments and $700 million of net commercial paper repayments. Dividends paid were $113 million, or $0.14 per share.
Balance Sheet, Debt and Liquidity
- Cash and temporary cash investments were $409 million at May 25, 2019, compared with $429 million at February 2, 2019.
- Total debt, excluding finance lease obligations, was $12.661 billion, compared with $14.351 billion at fiscal year-end. Total debt including finance lease and lease-financing obligations declined approximately $1.8 billion to $13.469 billion, based on the filing’s reported components.
- The company had $100 million of commercial paper outstanding and no borrowings under its $2.75 billion unsecured revolving credit facility, which can be increased by $1 billion.
- Operating lease assets and liabilities recognized under the new lease standard were approximately $6.8 billion and $7.0 billion, respectively, at adoption. Total lease liabilities were $7.910 billion at May 25, 2019.
- Management estimates next-twelve-month liquidity needs of approximately $4.8 billion, including working capital, capital investments, interest and scheduled debt maturities. Approximately $1.3 billion of senior notes and $100 million of commercial paper mature during the next twelve months.
- Management states that operating cash flow, commercial paper capacity and the revolving credit facility should be adequate to meet liquidity needs and that the company was in compliance with financial covenants.
Material Changes Versus the Prior Comparable Period
- Reported earnings declined substantially because the prior-year quarter included a $1.771 billion gain on the sale of the convenience store business. The 2019 quarter included $176 million of business-sale gains and a $106 million mark-to-market gain on Ocado securities.
- Adjusted diluted EPS was broadly stable at $0.72 versus $0.73, despite lower FIFO operating profit, supported by lower taxes and a lower share count.
- The company incurred a $59 million pre-tax charge related to withdrawal liabilities for certain Central States multi-employer pension obligations, partly offset by a $24 million reduction in expense related to contingent consideration revaluation.
- Kroger sold You Technology for total consideration of $565 million, including $396 million of cash and $64 million of preferred equity at closing, plus potential future cash payments of $105 million. It sold Turkey Hill Dairy for $225 million.
- The company adopted lease accounting guidance, adding significant lease assets and liabilities without a material effect on net earnings or cash flow. It also reclassified $146 million from accumulated other comprehensive income to accumulated earnings under ASU 2018-02.
- Share repurchases declined sharply from the prior year. The company repurchased $15 million of shares during the quarter and had $546 million remaining under its March 2018 repurchase authorization.
Guidance, Outlook, Commentary and Risks
- 2019 identical sales excluding fuel target: 2.0% to 2.25% growth.
- 2019 GAAP diluted EPS guidance: $2.38 to $2.48.
- 2019 adjusted diluted EPS guidance: $2.15 to $2.25.
- 2019 FIFO operating profit expectation: $2.9 billion to $3.0 billion.
- Alternative profit streams are expected to contribute an incremental $100 million of operating profit in 2019 compared with 2018.
- Expected 2019 tax rate: approximately 23%, or approximately 22% excluding 2019 adjusted items.
- Expected 2019 capital investments, excluding mergers, acquisitions and leased facilities: $3.0 billion to $3.2 billion.
- Key risks include labor negotiations, competitive pricing, fuel-margin volatility, inflation or deflation, healthcare and pharmacy reimbursement changes, multi-employer pension obligations, cyber and data-security incidents, weather and natural disasters, execution of Restock Kroger, integration of acquisitions and partnerships, and access to capital markets.
- Pending litigation includes antitrust, wage-and-hour, civil-rights and product-liability claims, including purported class actions. Management believes probable and estimable liabilities have been provided for and that aggregate exposure is not currently material, while acknowledging that outcomes remain uncertain.
Most Important Facts for Investors to Verify
- Confirm that reported 2019 earnings comparisons are adjusted for the unusually large 2018 convenience-store sale gain.
- Reconcile GAAP diluted EPS of $0.95 with adjusted diluted EPS of $0.72 and review each adjustment, particularly pension liabilities, business-sale gains and Ocado valuation gains.
- Assess whether identical-sales growth and digital growth can offset pressure from lower fuel sales, price investments, pharmacy margins and warehouse start-up costs.
- Review debt maturities, refinancing requirements and the company’s continued access to commercial paper and revolving-credit capacity.
- Evaluate the effect of the newly recognized lease liabilities on leverage and liquidity analysis.
- Monitor multi-employer pension withdrawal liabilities, pending litigation and other contingencies for changes that could become material.
- Compare subsequent results with the company’s 2019 guidance for identical sales, adjusted EPS, FIFO operating profit, taxes and capital investments.