The Kroger Co. 2015 Form 10-K Summary
Reporting period: The filing is a Form 10-K for the 52-week fiscal year ended January 30, 2016, with comparisons to fiscal 2014 and 2013. The request metadata references “2014 Q4,” but the supplied filing is the annual report for fiscal 2015, not a 2014 quarterly filing.
Business context
- Kroger is a U.S. food and drug retailer with one reportable retail segment representing more than 99% of consolidated sales and EBITDA.
- At year-end, the company operated 2,778 supermarkets, 784 convenience stores, 323 fine jewelry stores, an online retailer and 38 food production plants. It employed approximately 431,000 people.
- Retail operations are concentrated in the United States. Fuel centers were present at 1,387 supermarkets.
- Kroger completed its $866 million Roundy’s acquisition on December 18, 2015; Roundy’s contributed only six weeks of operating results and was not material to 2015 earnings.
Financial performance and key metrics
| Metric | Fiscal 2015 | Fiscal 2014 | Change |
|---|---|---|---|
| Sales | $109.830 billion | $108.465 billion | +1.3% |
| Operating profit | $3.576 billion | $3.137 billion | +14.0% |
| Operating margin | 3.26% | 2.89% | +37 basis points |
| Net earnings attributable to Kroger | $2.039 billion | $1.728 billion | +18.0% |
| Diluted earnings per share | $2.06 | $1.72 | +19.8% |
| Gross margin | 22.16% | 21.16% | +100 basis points |
| FIFO operating margin | 3.28% | 3.03% | +25 basis points |
| Effective tax rate | 33.8% | 34.1% | Down 30 basis points |
- Identical supermarket sales increased 5.0%, excluding fuel, marking the 49th consecutive quarter of positive growth on that basis. Market share increased approximately 40 basis points.
- Sales excluding fuel increased 5.8% to $91.310 billion. Fuel sales declined 21.5% to $14.804 billion, primarily because the average retail fuel price fell 26.7%, partly offset by a 7.1% increase in gallons sold.
- Fuel margin declined to $0.17 per gallon from $0.19 in 2014, reducing fuel operating profit.
- The LIFO charge fell to $28 million from $147 million in 2014, supporting the improvement in gross and operating margins.
- Operating, general and administrative expense rose to 16.34% of sales from 15.82%, reflecting lower fuel sales, higher EMV chargebacks, pension, healthcare, incentive-plan and shrink costs, and a $110 million UFCW pension contribution.
- Return on invested capital increased to 13.93% from 13.76%, excluding the Roundy’s financial position, results and merger costs from the 2015 calculation.
Cash flow, capital allocation, debt and liquidity
- Net cash provided by operating activities was $4.833 billion, compared with $4.163 billion in 2014.
- Cash used in investing activities was $3.570 billion, including $3.349 billion for property and equipment and lease buyouts and $168 million for mergers.
- Cash used in financing activities was $1.254 billion. Kroger repurchased $703 million of shares and paid $385 million of dividends.
- Total debt, including current debt, capital leases and financing obligations, was approximately $12.1 billion at year-end, compared with $11.7 billion in 2014. Debt carrying value was $11.396 billion, while estimated fair value was $12.344 billion.
- Commercial paper borrowings were $990 million; no borrowings were outstanding under the $2.75 billion revolving credit facility. The facility can be increased by an additional $750 million and expires June 30, 2019, unless extended.
- Cash and temporary cash investments were $277 million. Total assets were $33.897 billion and Kroger shareholders’ equity was $6.820 billion.
- Management estimated next-twelve-month liquidity needs of $6.6 billion to $6.9 billion, including working capital, capital expenditures, interest and scheduled debt maturities. Approximately $990 million of commercial paper and $1.3 billion of senior notes were due within twelve months.
- The company reported compliance with its debt covenants. The leverage ratio was 1.97 to 1 versus a maximum of 3.50 to 1, and the fixed-charge coverage ratio was 5.30 to 1 versus a minimum of 1.70 to 1.
Material changes, outlook and unusual items
- The Roundy’s acquisition added stores and operations in Wisconsin and the greater Chicago market and increased goodwill by approximately $420 million. Integration and valuation work remained subject to finalization.
- 2015 included $110 million of UFCW Consolidated Pension Plan contributions. In 2014, Kroger recorded a $39 million after-tax net charge related to multi-employer pension obligations and tax items, along with unusually high fuel margins and $140 million of charitable and pension contributions.
- Kroger estimated its share of multi-employer pension-plan underfunding at approximately $2.9 billion pre-tax, or $1.8 billion after tax, as of December 31, 2015. This is not recorded as a direct liability, but could increase future contributions, expense or withdrawal liabilities.
- Management expected 2016 diluted EPS of $2.19 to $2.28, identical supermarket sales growth excluding fuel of 2.5% to 3.5%, and a slight expansion in FIFO operating margin excluding fuel.
- 2016 capital investments were expected to be $4.1 billion to $4.4 billion, excluding mergers, acquisitions and purchases of leased facilities. Planned investments included approximately 100 major projects and 200 to 220 major remodels.
- Management expected 2016 product-cost inflation excluding fuel of 1.0% to 2.0%, an annualized LIFO charge of approximately $50 million, an effective tax rate of approximately 35%, and approximately $260 million of multi-employer pension contributions.
- Major risks include intense price competition, fuel-margin volatility, labor negotiations and work stoppages, underfunded multi-employer pensions, debt refinancing, cybersecurity and EMV-related costs, product safety, litigation, adverse weather, regulation and the integration of acquired businesses.
- The company recorded $46 million of asset impairments in 2015. No goodwill impairment was identified. Most leases remained off balance sheet under the applicable accounting rules; Kroger expected the future lease standard to materially increase reported assets and liabilities.
Most important facts for investors to verify
- Confirm that the relevant period is fiscal 2015 ended January 30, 2016 rather than “2014 Q4” in the request metadata.
- Review the sustainability of 5.0% identical-sales growth and the effect of lower product inflation on future sales and margins.
- Assess exposure to fuel-margin volatility, particularly because fuel sales carry lower margins than supermarket sales.
- Monitor the estimated $2.9 billion share of multi-employer pension underfunding, expected contributions and potential withdrawal liabilities.
- Evaluate the refinancing of approximately $2.3 billion of 2016 long-term debt maturities and commercial paper obligations.
- Track Roundy’s integration, final purchase-price allocation and any resulting goodwill or impairment changes.
- Reconcile GAAP results with management’s non-GAAP FIFO and adjusted measures, including the effect of pension contributions and LIFO charges.
- Review labor negotiations, cybersecurity and EMV chargebacks, litigation reserves, lease commitments and the impact of future lease accounting adoption.