The Kroger Co. Form 10-Q Summary
Reporting period: Second quarter and first two quarters ended August 15, 2020, compared with August 17, 2019. The filing covers 12-week and 28-week periods, respectively. The request metadata identifies “2019 Q2,” but the supplied filing is the 2020 second-quarter Form 10-Q, filed September 22, 2020.
Business Context and Financial Position
Kroger operates retail supermarkets, fuel centers, pharmacy and health-and-wellness businesses, digital shopping channels, and alternative profit businesses. Results were significantly affected by COVID-19, including elevated grocery demand, reduced fuel demand, rapid digital growth, associate and customer safety investments, and favorable working-capital changes.
| Metric | Second quarter 2020 | Second quarter 2019 | First two quarters 2020 | First two quarters 2019 |
|---|---|---|---|---|
| Sales | $30.489 billion | $28.168 billion | $72.038 billion | $65.419 billion |
| Operating profit | $820 million | $559 million | $2.146 billion | $1.460 billion |
| Net earnings attributable to Kroger | $819 million | $297 million | $2.031 billion | $1.069 billion |
| Diluted earnings per share | $1.03 | $0.37 | $2.55 | $1.31 |
| Adjusted diluted earnings per share | $0.73 | $0.44 | $1.95 | $1.16 |
| Cash flow from operations | Not separately provided | Not separately provided | $5.405 billion | $3.277 billion |
Margins and Sales Trends
- Operating margin was 2.69% in the second quarter of 2020 versus 1.98% in the prior-year quarter; for the first two quarters, it was 2.98% versus 2.23%.
- Gross margin was 22.76% in the second quarter versus 21.87% in 2019, and 23.64% for the first two quarters versus 22.06%.
- Identical sales excluding fuel increased 14.6% in the second quarter and 17.1% for the first two quarters.
- Digital revenue increased approximately 127% in the second quarter and 107% for the first two quarters.
- Supermarket fuel sales declined 33.0% in the second quarter and 36.3% for the first two quarters, reflecting lower gallons sold and lower fuel prices.
- Adjusted net earnings attributable to Kroger increased 62.7% in the second quarter and 64.7% for the first two quarters.
Liquidity, Debt and Capital Allocation
- Cash and temporary cash investments were $2.820 billion at August 15, 2020, compared with $399 million at February 1, 2020.
- Total debt, including finance-lease obligations, decreased by $594 million from fiscal year-end to approximately $13.5 billion. Debt excluding finance-lease obligations was $12.610 billion at August 15, 2020.
- Kroger had no outstanding commercial paper and no borrowings under its $2.75 billion revolving credit facility; only $2 million of letters of credit reduced availability.
- The company generated $5.405 billion of operating cash flow, used $1.348 billion in investing activities, and used $1.636 billion in financing activities during the first two quarters.
- Capital investments were $1.4 billion for the first two quarters, compared with $1.6 billion in 2019.
- Kroger paid $254 million of dividends and repurchased $669 million of shares during the first two quarters. The quarterly dividend was $0.16 per share, compared with $0.14 in 2019.
- Management stated that liquidity should be adequate for the next 12 months and beyond, including approximately $1.0 billion of senior notes maturing within the next 12 months.
Material Changes Versus the Prior Comparable Period
- Sales growth accelerated sharply because of COVID-19-driven grocery demand and market-share gains, while fuel sales declined substantially.
- Operating profit increased 46.7% in the second quarter and 47.0% for the first two quarters.
- Reported net earnings benefited from a $368 million second-quarter gain and a $790 million year-to-date gain on investments. Excluding unusual items, adjusted diluted EPS still increased 65.9% and 68.1%, respectively.
- Operating expenses included more than $1 billion of COVID-19 investments during the first two quarters, including approximately $250 million in the second quarter, for associate compensation, leave, and safety measures.
- Kroger contributed an incremental $236 million to multi-employer pension plans in the first quarter.
- OG&A included $85 million of Home Chef contingent-consideration revaluation charges and $67 million of transformation costs during the first two quarters.
- The company deferred $329 million of employer Social Security taxes under the CARES Act and expects total 2020 deferrals of approximately $600 million to $650 million.
- On September 11, 2020, the board approved a new $1.0 billion share-repurchase authorization, replacing the November 2019 authorization.
Guidance, Outlook, Risks and Unusual Items
- Management updated its 2020 guidance following the strong COVID-19-related performance and stated that it expects 2021 business results to be higher than pre-pandemic expectations.
- Management targets net debt to adjusted EBITDA of 2.30 to 2.50 to support its investment-grade debt rating and expects long-term total shareholder returns of 8% to 11%.
- A tentative agreement to withdraw from a UFCW multi-employer pension fund was expected to be approved in the third quarter of 2020. Upon ratification, Kroger expected a $962 million pre-tax withdrawal-liability charge, plus a $27 million transition-reserve contribution, totaling approximately $760 million after tax. The liability would be paid over three years.
- Key risks include the duration and effects of COVID-19, labor availability and negotiations, product shortages, economic weakness, fuel-price volatility, competition, pharmacy reimbursement and benefit-program changes, cyberattacks, weather and natural disasters, pension obligations, refinancing and commercial-paper access, and execution of the Restock Kroger strategy.
- Kroger disclosed ordinary-course litigation involving antitrust, wage-and-hour, civil-rights, and product-liability matters. Management believes the aggregate exposure is not material, but adverse outcomes could differ from current estimates.
Most Important Facts for Investors to Verify
- Confirm that the exceptionally strong sales and margin performance was sustained after the initial COVID-19 demand surge and that digital growth remained profitable.
- Separate recurring operating performance from the $790 million year-to-date investment gain, Home Chef revaluation charges, transformation costs, COVID-19 investments, and pension-related items.
- Monitor the expected approximately $760 million after-tax multi-employer pension withdrawal obligation and its timing following ratification.
- Assess whether working-capital-driven cash generation and CARES Act tax deferrals are sustainable, since management expects later working-capital improvement to be below the first-half level.
- Verify refinancing plans for approximately $1.0 billion of senior notes maturing within 12 months and continued compliance with debt covenants.
- Evaluate the effect of fuel-price and fuel-volume declines, increased digital fulfillment costs, labor costs, and ongoing COVID-19 safety spending on future margins.