The Kroger Co. Form 10-Q Summary
Reporting period: The filing covers the 16-week first quarter ended May 20, 2023, compared with the 16-week first quarter ended May 21, 2022. The request metadata identifies “2022 Q1,” but the filing is for 2023 Q1. Financial statements are unaudited and presented in accordance with U.S. GAAP.
Business Context and Key Metrics
Kroger operates an omnichannel food retail business supported by supermarkets, fuel, digital commerce, Our Brands, pharmacy, data analytics, and other alternative profit businesses. Management emphasized its “Leading with Fresh and Accelerating with Digital” strategy, cost savings, customer loyalty, and investment in associates and technology.
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Sales | $45.165 billion | $44.600 billion | 1.3% |
| Sales excluding fuel | $40.070 billion | $38.711 billion | 3.5% |
| Identical sales excluding fuel | 3.5% | 4.1% | Decreased 0.6 percentage points |
| Operating profit | $1.470 billion | $1.505 billion | (2.3)% |
| Operating margin | 3.3% | 3.4% | Decreased 12 basis points |
| Net earnings attributable to Kroger | $962 million | $664 million | 44.9% |
| Diluted EPS | $1.32 | $0.90 | 46.7% |
| Adjusted diluted EPS | $1.51 | $1.45 | 4.1% |
| Cash from operating activities | $2.860 billion | $1.102 billion | 160% |
Revenue, Profitability, Cash Flow, Debt and Liquidity
- Revenue: Total sales growth was constrained by a 13.5% decline in supermarket fuel sales, reflecting lower fuel prices and gallons sold. Digital sales increased approximately 15%, including 11% growth in Pickup and 30% growth in Delivery.
- Margins: Gross margin increased to 22.33% from 21.63%; FIFO gross margin increased to 22.55% from 21.84%. Excluding fuel, FIFO gross margin increased 21 basis points. The improvement was attributed to Our Brands, sourcing performance, lower transportation costs, and the Express Scripts contract change, partly offset by higher shrink and promotional investments.
- Expenses: Operating, general and administrative expenses increased to $7.393 billion from $6.997 billion. The OG&A rate increased to 16.37% from 15.69%, driven by associate investments, strategic initiatives, lower fuel sales, and the Express Scripts effect.
- Adjusted performance: Adjusted FIFO operating profit increased to $1.669 billion from $1.601 billion. Adjusted net earnings increased to $1.104 billion from $1.074 billion.
- Cash flow: Operating cash flow rose to $2.860 billion, primarily due to more favorable working-capital changes, including inventory, receivables, taxes, and payables. Investing cash use increased to $947 million, including $1.028 billion of property and equipment payments. Financing cash use was $296 million, including $188 million of dividends.
- Capital investments: Capital investments excluding mergers, acquisitions, and leased facilities were approximately $1.1 billion, compared with $971 million in the prior-year quarter.
- Liquidity: Cash and temporary cash investments increased to $2.632 billion from $1.015 billion at fiscal year-end. Kroger had no commercial paper borrowings and no borrowings under its revolving credit facility as of May 20, 2023. The $2.75 billion unsecured revolving facility, which may be increased by $1.25 billion, terminates July 6, 2026 unless extended.
- Debt: Total debt excluding finance leases was $11.288 billion, while consolidated balance-sheet debt including finance-lease obligations was approximately $13.433 billion. Total debt including finance leases increased $55 million from fiscal year-end, primarily due to new finance-lease obligations for an Ocado fulfillment center. The fair value of total debt was $10.300 billion versus a carrying value of $11.288 billion.
- Shareholder returns: Kroger paid $188 million in dividends and repurchased $29 million of shares. The broader $1.0 billion September 2022 repurchase authorization remained unused; repurchases were paused to prioritize deleveraging related to the proposed Albertsons transaction.
Material Changes Versus the Prior Comparable Period
- Net earnings and reported EPS increased substantially, but the improvement was largely influenced by a much smaller unrealized investment loss: $78 million in Q1 2023 versus $532 million in Q1 2022.
- Adjusted diluted EPS increased 4.1%, providing a more comparable measure of underlying performance.
- Sales excluding fuel increased 3.5%, while fuel sales declined 13.5%. Identical sales excluding fuel slowed to 3.5% from 4.1%.
- Operating profit declined modestly, and operating margin narrowed, despite higher gross and FIFO gross margins, because of increased OG&A and depreciation and amortization.
- Operating cash flow increased by $1.758 billion, primarily because working-capital movements were significantly more favorable than in the prior-year period.
- The first quarter included $40 million of merger-related costs, a $62 million opioid litigation settlement charge, and a $78 million unrealized investment loss. These items were excluded from adjusted results.
- Kroger opened an additional Ocado-powered customer fulfillment center in Frederick, Maryland, recording $139 million of related finance-lease assets and $129 million of finance-lease liabilities.
Guidance, Outlook, Risks and Unusual Items
- Management reaffirmed full-year guidance for identical sales excluding fuel and adjusted net earnings per diluted share, but the filing text provided does not state the numerical guidance ranges.
- Management expects digital sales to grow at a double-digit rate over time and targets a net total debt-to-adjusted-EBITDA ratio of 2.30 to 2.50. It also targets long-term total shareholder return of 8% to 11%, excluding the proposed Albertsons merger.
- The proposed Albertsons merger has an implied enterprise value of approximately $24.6 billion. The expected adjusted cash purchase price was approximately $27.25 per Albertsons share, subject to further adjustments and any stores contributed to SpinCo.
- The merger remains subject to regulatory clearance and other closing conditions. The transaction was expected to close in early 2024. The agreement includes potential store divestitures, substantial financing commitments, and a possible $600 million termination fee under specified circumstances.
- Kroger had committed financing consisting of a reduced $12.65 billion bridge facility commitment and $4.75 billion of term loan commitments, with additional expected financing from senior notes, commercial paper, credit facilities, and cash.
- Material risks include regulatory opposition to the Albertsons merger, inflation and deflation, labor negotiations and work stoppages, competition, supply-chain constraints, fuel-margin volatility, pharmacy sales pressure after termination of the Express Scripts agreement, cyberattacks, economic conditions, interest rates, and the ability to maintain liquidity and investment-grade ratings.
- Kroger recorded the net present value of a $68 million West Virginia opioid settlement, or a $62 million pretax charge and $49 million after-tax charge. The company stated that the settlement should not be extrapolated to other opioid litigation.
- Kroger faces numerous opioid-related lawsuits and government inquiries but stated that it currently cannot determine the probability or reasonably possible loss range. Other ordinary-course litigation is not expected by management to have a material effect, although outcomes remain uncertain.
Most Important Facts for Investors to Verify
- Confirm the numerical full-year identical-sales and adjusted-EPS guidance ranges, which are not clearly provided in the filing text.
- Monitor regulatory developments, divestiture requirements, financing, timing, and termination-fee exposure related to the Albertsons merger.
- Separate reported earnings growth from adjusted growth because Q1 2023 and Q1 2022 included materially different investment losses and other unusual items.
- Assess whether gross-margin gains can offset higher associate, technology, depreciation, shrink, promotional, and merger-related costs.
- Track pharmacy sales following the Express Scripts termination and its impact on identical sales, gross margin, and OG&A leverage.
- Evaluate cash generation, capital investment, lease obligations, debt refinancing needs, and the company’s ability to maintain its targeted leverage range after any merger.
- Follow opioid litigation and other contingencies because the company cannot yet estimate the potential loss range for many opioid-related matters.