The Kroger Co. — Form 10-Q Summary
Reporting period: First quarter ended May 25, 2013, a 16-week period, compared with the 16-week period ended May 19, 2012. The provided filing is for fiscal 2013 Q1, although the request metadata identifies 2012 Q1. Amounts are in millions except per-share data.
Business context and reporting period
Kroger operates supermarkets, fuel centers, pharmacies, convenience stores, manufacturing facilities, jewelry stores, specialty pharmacies and in-store health clinics in the United States. The company’s Customer 1st strategy emphasizes customer loyalty, competitive pricing, productivity and market-share growth.
Key financial metrics
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Sales | $30,043 | $29,065 | 3.4% increase |
| Operating profit | $879 | $814 | 8.0% increase |
| Operating margin | 2.93% | 2.80% | Up 13 basis points |
| Net earnings attributable to Kroger | $481 | $439 | 9.6% increase |
| Diluted EPS | $0.92 | $0.78 | 17.9% increase |
| Gross margin | 20.59% | 20.54% | Up 5 basis points |
| FIFO gross margin | 20.65% | 20.70% | Down 5 basis points |
| Net cash from operating activities | $1,617 | $1,299 | $318 increase |
| Capital investments | $646 | $557 | $89 increase |
| Net cash used in financing activities | $(982) | $(449) | Greater cash use |
Identical supermarket sales excluding fuel increased 3.3%; excluding fuel and pharmacy, they increased 4.0%. Fuel sales increased 1.6% to $5,967, reflecting a 5.1% increase in gallons sold partly offset by a 3.3% decline in average retail fuel prices. Identical supermarket sales were positive in all supermarket divisions and had increased for 38 consecutive quarters.
The LIFO charge declined to $17 from $46, supporting reported gross margin and earnings. FIFO operating profit increased to $896 from $860, while FIFO operating profit excluding fuel rose to $872 from $825. OG&A expense as a percentage of sales improved to 15.31% from 15.36%. Interest expense declined to $129 from $141, while the effective tax rate increased to 35.5% from 34.5%.
Liquidity, debt and capital allocation
Cash and temporary cash investments were $247 at May 25, 2013, compared with $238 at fiscal year-end. Total assets were $24,227 and total equity was $4,596. Total debt, including current and long-term portions of capital leases and financing obligations, was approximately $7.9 billion, down from approximately $8.1 billion at the end of Q1 2012 and $8.9 billion at fiscal year-end.
Debt included $1.1 billion of commercial paper and $6.2 billion of long-term debt. Kroger had no borrowings under its $2 billion unsecured revolving credit facility, which can be increased by $500 million, and no borrowings under two uncommitted money-market lines totaling $75. Letters of credit reducing revolving availability totaled $13. The company was in compliance with its debt covenants.
Kroger estimated next-twelve-month liquidity needs of approximately $4.1 billion, including working capital, capital expenditures, interest and scheduled debt payments. Approximately $1.1 billion of commercial paper and $600 million of senior notes were scheduled to mature within twelve months. Management expected to refinance approximately $1.5 billion through additional senior notes and believed operating cash flow and available borrowing capacity would be adequate.
The company repurchased 4.5 million shares for $146 at an average price of $32.44 and declared dividends of $0.150 per common share, up from $0.115. It opened, acquired, expanded or relocated eight food stores and completed 21 remodels during the quarter.
Material changes versus the prior comparable period
- Sales increased 3.4%, driven by positive identical supermarket sales and higher fuel volume.
- Net earnings increased 9.6%, primarily from higher non-fuel FIFO operating profit and the lower LIFO charge; benefits were partly offset by lower fuel earnings and a higher tax rate.
- Diluted EPS increased faster than net earnings because the company repurchased approximately 45 million shares over the preceding four quarters.
- Operating margin improved despite investments in lower prices and higher shrink, warehouse and advertising costs.
- Operating cash flow increased 24.5%, primarily due to stronger working-capital benefits, including lower prepaid expenses.
- Capital investments increased, while financing cash use rose due principally to lower long-term debt issuance proceeds and debt repayments.
- The company repaid $400 of 5.00% senior notes at maturity during the quarter.
Guidance, outlook, risks and unusual items
- Fiscal 2013 diluted EPS guidance was increased to $2.73–$2.80, based on the strength of Q1 results.
- Identical supermarket sales excluding fuel were expected to increase 2.5%–3.5% in 2013.
- Management expected FIFO non-fuel operating margins to expand slightly, an annual LIFO charge of approximately $55, interest expense of approximately $430, and an effective tax rate of approximately 35.5%.
- Capital investments were expected to total $2.1–$2.4 billion, excluding acquisitions and purchases of leased facilities, with food-store square footage expected to grow approximately 1.5% before acquisitions and operational closings.
- Kroger contributed $100 to company-sponsored defined benefit pension plans and expected no additional contributions in 2013. It expected approximately $225 of contributions to multi-employer pension plans, subject to collective bargaining.
- The company recorded a $19 impairment charge on long-lived assets, compared with $2 in the prior-year quarter. Management did not anticipate additional goodwill impairments in 2013.
- Forward-starting interest-rate swaps hedged anticipated debt issuance. Terminated swaps related to $600 of expected debt issuance left an unamortized after-tax loss of $32 in accumulated other comprehensive loss, to be amortized through future interest expense.
- Labor agreements covering employees in Dallas, Seattle, Roanoke and Cincinnati were scheduled for renegotiation in 2013. Work stoppages could materially affect results.
- Key risks include refinancing and commercial-paper market conditions, competition, labor relations, product-cost inflation, fuel costs, consumer spending, pharmacy patent expirations, pension obligations, litigation, weather, impairment charges and interest-rate changes.
- Pending antitrust, wage-and-hour, civil-rights and product-liability matters were considered not likely to have a material adverse effect based on management’s current assessment, although outcomes remain uncertain and antitrust damages may be trebled.
Important facts for investors to verify
- Confirm that the applicable comparison is fiscal 2013 Q1 ended May 25, 2013, rather than the metadata label of 2012 Q1.
- Track the company’s ability to refinance approximately $1.5 billion of debt and manage $1.7 billion of commercial paper and senior-note maturities over the following twelve months.
- Assess whether identical-sales growth, pricing investments and cost savings support the projected 2013 EPS and margin guidance.
- Monitor fuel profitability, product-cost inflation, LIFO adjustments and pharmacy generic substitution, all of which affected margins and earnings.
- Review labor negotiations, multi-employer pension exposure and pending litigation for changes that could increase costs or liabilities.
- Distinguish management’s non-GAAP FIFO and ROIC measures from GAAP results when evaluating performance.