The Kroger Co. — Form 10-Q Summary
Business context and reporting period
This filing covers the unaudited third quarter and first three quarters of fiscal 2016, ended November 5, 2016, corresponding to 12 and 40 weeks. The filing metadata identifies “2015 Q3,” but the filing itself is for 2016 Q3. Results include the Roundy’s business acquired in December 2015 and the ModernHEALTH specialty-pharmacy business acquired on September 2, 2016.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | First 3 quarters 2016 | First 3 quarters 2015 |
|---|---|---|---|---|
| Sales | $26.557 billion | $25.075 billion | $87.726 billion | $83.665 billion |
| Operating profit | $713 million | $772 million | $2.578 billion | $2.648 billion |
| Operating margin | 2.68% | 3.08% | 2.94% | 3.17% |
| Net earnings attributable to Kroger | $391 million | $428 million | $1.469 billion | $1.480 billion |
| Diluted EPS | $0.41 | $0.43 | $1.52 | $1.50 |
| Operating cash flow | Not separately provided | Not separately provided | $3.456 billion | $3.845 billion |
| Capital investments, excluding mergers and leased-facility purchases | Not separately provided | Not separately provided | $3.006 billion | $2.558 billion |
Gross margin was 22.23% in Q3 2016 versus 22.32% in Q3 2015, while the first-three-quarter gross margin increased to 22.46% from 21.95%. FIFO operating margin was 2.65% for Q3 and 2.96% for the first three quarters, compared with 3.11% and 3.23%, respectively, in the prior-year periods.
At November 5, 2016, cash and temporary cash investments were $374 million. Total debt, excluding capital leases and financing obligations, was $13.085 billion, including $2.190 billion of commercial paper. Total long-term debt and financing obligations reported on the balance sheet were $13.836 billion, consisting of $3.019 billion current and $10.817 billion long-term. The company had $2.2 billion outstanding under commercial paper and no borrowings under its $2.75 billion unsecured revolving credit facility.
Total assets were $36.507 billion and total equity was $6.630 billion at November 5, 2016. The company declared dividends of $0.120 per share in Q3 and $0.345 per share for the first three quarters.
Material changes versus the prior comparable period
- Sales increased 5.9% in Q3 and 4.9% for the first three quarters, supported by Roundy’s, ModernHEALTH, increased supermarket square footage, and non-fuel supermarket sales.
- Identical supermarket sales excluding fuel increased 0.1% in Q3 and 1.5% for the first three quarters. Fuel sales declined 1.4% and 10.5%, respectively, primarily because of lower fuel prices.
- Q3 operating profit declined $59 million and operating margin fell 40 basis points. For the first three quarters, operating profit declined $70 million and margin fell 23 basis points.
- Net earnings attributable to Kroger declined 8.6% in Q3 and 0.7% for the first three quarters. Diluted EPS declined 4.7% in Q3 but increased 1.3% year to date because of share repurchases and lower tax expense.
- Operating cash flow declined $389 million year to date, while investing cash use increased $693 million, primarily because of higher capital investments and the ModernHEALTH acquisition.
- Debt increased approximately $1.7 billion from fiscal year-end 2015, primarily because of higher commercial paper borrowings. Kroger issued $1.75 billion of senior notes in Q3 and repaid $1.25 billion of debt.
- Kroger repurchased $1.401 billion of common stock during the first three quarters, including 39.1 million shares, and paid $316 million of dividends.
Guidance, outlook, risks and unusual items
- Full-year 2016 net earnings guidance was $2.03 to $2.08 per diluted share; adjusted guidance was $2.10 to $2.15, excluding the $0.07 per-share effect of a multi-employer pension restructuring charge.
- Management expected slightly positive Q4 identical supermarket sales excluding fuel, a decline in full-year FIFO operating margin excluding fuel, and 2016 capital investments of $3.6 billion to $3.9 billion.
- Management estimated next-twelve-month liquidity needs of $6.6 billion to $7.1 billion, including approximately $2.2 billion of commercial paper and $600 million of senior notes maturing within the period. Management expected operating cash flow and refinancing capacity to be adequate.
- The first three quarters included a $111 million pretax, $71 million after-tax charge related to restructuring certain multi-employer pension obligations. Adjusted EPS was $1.59 versus reported EPS of $1.52.
- Management cited deflation, unfavorable pricing and cost effects, lower fuel margins, credit-card costs, labor negotiations, underfunded multi-employer pension exposure, competition, pharmacy reimbursement and healthcare-industry consolidation as key risks.
- The company completed the $407 million ModernHEALTH acquisition, financed through commercial paper. Preliminary purchase accounting included $285 million of goodwill and $136 million of intangible assets.
- Various antitrust, wage-and-hour, civil-rights and product-liability claims remain pending. Management believes the aggregate exposure is not material, but acknowledges that outcomes could differ materially from current estimates.
- Kroger adopted ASU 2016-09, which reduced first-three-quarter income tax expense by $42 million through excess tax benefits from share-based compensation. A new lease standard is expected to significantly increase reported assets and liabilities upon adoption.
Investor verification priorities
- Verify the reporting-period discrepancy: the supplied metadata says 2015 Q3, while the filing period ended November 5, 2016.
- Assess whether sales growth from Roundy’s, ModernHEALTH and square-footage expansion is translating into sustainable identical-store sales and margins.
- Reconcile reported versus adjusted EPS, particularly the $71 million after-tax pension restructuring charge and the $42 million tax benefit from ASU 2016-09.
- Monitor debt refinancing, commercial-paper exposure, interest expense and liquidity as approximately $2.8 billion of debt was expected to mature within twelve months.
- Evaluate cash-flow coverage of capital investments, acquisitions, dividends and share repurchases.
- Review labor negotiations and potential multi-employer pension obligations, litigation contingencies, pharmacy reimbursement pressures and the effect of continued deflation.