The Kroger Co. Form 10-Q Summary
Filing-period note: The request metadata identifies “2015 Q2,” but the supplied filing is for the quarter ended August 13, 2016, covering 12 and 28 weeks ended August 13, 2016, compared with August 15, 2015.
Business Context and Reporting Period
Kroger is a grocery retailer with supermarket, fuel, convenience, pharmacy, digital and related operations. Results include the Roundy’s merger, which closed December 18, 2015. The statements are unaudited and should be read with the fiscal 2015 Form 10-K.
Financial Performance and Position
| Metric | Second quarter 2016 | Second quarter 2015 | Change |
|---|---|---|---|
| Sales | $26.565 billion | $25.539 billion | 4.0% |
| Operating profit | $665 million | $774 million | (14.1%) |
| Operating margin | 2.50% | 3.03% | (53) basis points |
| Net earnings attributable to Kroger | $383 million | $433 million | (11.5%) |
| Diluted EPS | $0.40 | $0.44 | (9.1%) |
| Adjusted diluted EPS | $0.47 | $0.44 | 6.8% |
- For the first two quarters, sales were $61.169 billion, up 4.4%; operating profit was $1.865 billion versus $1.876 billion; net earnings attributable to Kroger were $1.079 billion versus $1.052 billion; and diluted EPS was $1.11 versus $1.06.
- Identical supermarket sales excluding fuel increased 1.7% in the quarter and 2.1% year to date. Total supermarket sales excluding fuel rose 7.2% and 7.7%, respectively.
- Fuel sales declined 13.4% in the quarter and 14.1% year to date, primarily because average retail fuel prices fell 17.5% and 18.4%, respectively.
- Gross margin was 22.09% in the quarter and 22.57% year to date, compared with 21.44% and 21.79% in the prior periods. FIFO gross margin was 22.13% and 22.61%, respectively.
- Operating, general and administrative expense increased to 16.84% of sales from 15.93% in the quarter and to 16.76% from 16.08% year to date.
- Cash provided by operating activities was $3.032 billion year to date, compared with $2.832 billion in 2015. Capital investments were $2.188 billion, excluding lease buyouts, versus $1.727 billion.
- Cash and temporary cash investments were $319 million at August 13, 2016, versus $277 million at fiscal year-end.
- Total debt excluding capital leases and financing obligations was $11.667 billion, including $1.275 billion of commercial paper. Total debt including capital leases and financing obligations increased to approximately $12.4 billion from $12.1 billion at fiscal year-end.
- Kroger had no borrowings under its $2.75 billion unsecured revolving credit facility, with the ability to increase capacity by $750 million. It had $13 million of outstanding letters of credit reducing availability.
- Return on invested capital was 13.95% for the rolling four quarters, compared with 14.24% in the prior comparable period.
Material Changes Versus the Prior Comparable Period
- Quarterly reported earnings declined primarily because of a $111 million pretax, $71 million after-tax charge related to restructuring certain multi-employer pension obligations. Excluding the charge, adjusted net earnings increased 4.8% and adjusted diluted EPS increased to $0.47 from $0.44.
- Sales growth benefited from the Roundy’s merger, increased supermarket square footage and higher customer households and visits, while product-cost deflation and lower fuel prices affected results.
- Operating margin declined because of price investments, additional labor hours, deflation-related sales leverage, Roundy’s historically lower margin profile and higher credit card, warehousing, advertising, shrink and healthcare costs.
- Share repurchases reduced diluted shares to 959 million in the quarter from 977 million. Kroger repurchased $1.071 billion of shares during the first two quarters and paid $202 million of dividends.
- The company adopted ASU 2016-09, recognizing $23 million of second-quarter and $39 million of year-to-date excess tax benefits in income tax expense. This contributed to lower effective tax rates of 31.1% and 32.7%, respectively.
Guidance, Outlook, Risks and Unusual Items
- 2016 reported diluted EPS guidance was $2.03 to $2.13; adjusted diluted EPS guidance was $2.10 to $2.20, excluding the $0.07 pension-related charge.
- Full-year identical supermarket sales excluding fuel were expected to increase 1.4% to 1.8%, with second-half growth of 0.5% to 1.5%. Full-year FIFO operating margin excluding fuel was expected to decline slightly.
- 2016 capital investments excluding mergers, acquisitions and leased-facility purchases were expected to be $3.6 billion to $3.9 billion. Supermarket square footage growth was expected to be approximately 2.9% to 3.3% excluding mergers, acquisitions and operational closings.
- Management estimated next-twelve-month liquidity needs of $6.4 billion to $6.9 billion and expected operating cash flow, commercial paper and credit facilities to be adequate. Approximately $1.3 billion of commercial paper and $1.3 billion of senior notes were due within twelve months and were expected to be refinanced.
- Management expected product-cost deflation, excluding fuel, through early 2017 and an annualized LIFO charge of approximately $50 million.
- Kroger closed its approximately $390 million ModernHEALTH specialty-pharmacy acquisition on September 2, 2016, financed with commercial paper. The purchase price allocation was still in process.
- Key risks include labor negotiations, multi-employer pension obligations, competitive pricing, deflation, fuel-price and fuel-margin volatility, pharmacy reimbursement and healthcare-industry consolidation, cyberattacks, weather, liquidity and debt refinancing, and integration of Roundy’s and other acquisitions.
- Various antitrust, wage-and-hour, civil-rights and product-liability matters were pending. Management considered the aggregate probable exposure immaterial, but acknowledged that outcomes could differ materially from estimates.
- The company entered into additional forward-starting interest-rate swaps, bringing the total notional amount to $1.9 billion, in anticipation of future refinancing.
Facts Investors Should Verify
- Confirm the intended period because the supplied filing is 2016 Q2, not 2015 Q2.
- Assess whether the reported margin pressure persists after excluding the pension restructuring charge and the effects of Roundy’s and fuel.
- Monitor identical-store sales, product-cost deflation, price investments and FIFO operating margin.
- Evaluate refinancing requirements for commercial paper and senior notes and the company’s ability to maintain investment-grade ratings.
- Review the financial and integration effects of the ModernHEALTH acquisition and Roundy’s merger.
- Track multi-employer pension commitments, labor negotiations and related potential charges.
- Consider the effect of planned capital spending and share repurchases on leverage, liquidity and return on invested capital.
- Review the eventual effects of the new lease accounting standard, which management expects to materially increase reported lease assets and liabilities.