The Kroger Co. Form 10-Q Summary
Reporting period: The supplied filing is for the third quarter and first three quarters ended November 7, 2020, compared with November 9, 2019. The request metadata identifies “2019 Q3,” but the filing itself is a 2020 third-quarter report.
Business Context and Reporting Period
Kroger operates retail supermarkets, fuel centers, pharmacy and health-and-wellness businesses, digital channels, and alternative profit businesses including Kroger Precision Marketing. Management attributed elevated sales and market-share gains primarily to increased food-at-home consumption during the COVID-19 pandemic. The third quarter comprised 12 weeks; the first three quarters comprised 40 weeks.
Financial Performance
| Metric | Third quarter 2020 | Third quarter 2019 | First three quarters 2020 | First three quarters 2019 |
|---|---|---|---|---|
| Sales | $29.7 billion | $28.0 billion | $101.8 billion | $93.4 billion |
| Sales growth | 6.3% | 0.5% | 9.0% | (0.2)% |
| Identical sales excluding fuel | 10.9% | 2.5% | 15.3% | 2.0% |
| Operating profit | $792 million | $254 million | $2.938 billion | $1.714 billion |
| Operating margin | 2.67% | 0.91% | 2.89% | 1.83% |
| Net earnings attributable to Kroger | $631 million | $263 million | $2.662 billion | $1.332 billion |
| Diluted earnings per share | $0.80 | $0.32 | $3.35 | $1.64 |
| Adjusted diluted earnings per share | $0.71 | $0.47 | $2.66 | $1.62 |
- Digital revenue increased 108% in the quarter and 115% year to date. Kroger Precision Marketing revenue increased 192% and 135%, respectively.
- FIFO gross margin was 23.03% in the quarter and 23.52% year to date, compared with 22.16% and 22.14% in the comparable 2019 periods. Excluding fuel, FIFO margin decreased 2 basis points in the quarter but increased 20 basis points year to date.
- Adjusted FIFO operating profit was $871 million in the quarter and $3.218 billion year to date, compared with $653 million and $2.237 billion, respectively.
- The effective tax rate was 24.2% in the quarter and 23.4% year to date, compared with 35.6% and 25.0% in 2019.
Cash Flow, Debt, and Liquidity
- Operating cash flow was $5.897 billion for the first three quarters of 2020, compared with $4.048 billion in 2019.
- Investing activities used $2.048 billion, including $2.062 billion for property and equipment and lease buyouts.
- Financing activities used $2.068 billion, including $989 million of share repurchases and $395 million of dividends.
- Cash and temporary cash investments increased to $2.180 billion from $399 million at fiscal year-end.
- Total debt, including finance-lease obligations, declined $556 million from fiscal year-end. Debt included $12.102 billion of senior notes, no commercial paper borrowings, and $527 million of other debt.
- Kroger had no borrowings under its $2.75 billion revolving credit facility and no commercial paper outstanding at November 7, 2020. Only $1 million of letters of credit reduced facility availability.
- The company was in compliance with its debt covenants and stated that operating cash flow and other liquidity sources should meet needs for the next 12 months and beyond.
- Capital investments were $2.1 billion year to date, compared with $2.2 billion in 2019. The company repurchased 31.1 million shares for $989 million and paid $395 million of dividends.
Material Changes Versus the Prior Comparable Period
- COVID-19-related demand drove substantially higher identical sales, larger customer baskets, and increased market share, while fuel sales declined because of lower gallons sold and lower fuel prices.
- Operating profit and reported earnings increased materially, reflecting sales leverage, higher gross margin, lower expense rates, increased fuel earnings, and the absence of several significant 2019 charges.
- Reported earnings benefited from a $952 million gain on investments year to date, principally the increase in the fair value of Kroger’s Ocado investment. The comparable 2019 investment gain was $166 million.
- Year-to-date 2020 results included approximately $1.3 billion of COVID-19 investments, a $236 million incremental multi-employer pension contribution, $109 million of Home Chef contingent-consideration charges, and $100 million of transformation costs.
- 2019 included Lucky’s Market impairment, severance, multi-employer pension withdrawal-liability charges, and gains on the sales of Turkey Hill Dairy and You Technology, making reported year-over-year comparisons less representative of recurring operations.
- Kroger deferred $505 million of employer Social Security taxes under the CARES Act and expects total 2020 deferrals of approximately $600 million to $650 million.
Guidance, Outlook, Risks, and Unusual Items
- Management raised full-year 2020 guidance because of continued strong performance, market-share gains, and expectations for sustained food-at-home demand. The filing text supplied does not provide the specific revised guidance ranges.
- Management expects 2021 results to be stronger than pre-pandemic expectations on a two-year basis and targets long-term total shareholder returns of 8% to 11%.
- Kroger intends to maintain net debt to adjusted EBITDA between 2.30 and 2.50 to support its investment-grade debt rating, while continuing dividends and share repurchases.
- In the fourth quarter of 2020, Kroger expected a $962 million pre-tax withdrawal-liability charge related to exiting the UFCW International Union-Industry Pension Fund, plus a $27 million transition-reserve contribution. The expected after-tax impact was approximately $760 million, payable over three years.
- Liquidity requirements include approximately $1.5 billion of senior notes maturing over the next 12 months and approximately $500 million of UFCW National Fund payments expected in the fourth quarter of 2020 and first half of 2021.
- Key risks include the duration and operational effects of COVID-19, labor negotiations, competition and pricing pressure, supply disruptions, workforce availability, fuel-price volatility, economic conditions, pharmacy reimbursement and consolidation, cyberattacks, pension obligations, litigation, refinancing access, and execution of the Restock Kroger strategy.
- Pending litigation includes antitrust, wage-and-hour, civil-rights, and product-liability matters. Management believes aggregate exposure is not material, but acknowledges that outcomes could differ materially from current estimates.
Most Important Facts to Verify
- Confirm the intended period: the supplied filing is for 2020 Q3, not 2019 Q3.
- Review the specific full-year 2020 guidance ranges in the related earnings release or filing materials, as the supplied text describes an increase but does not state the ranges.
- Assess the recurring operating trend separately from the $952 million investment gain and other adjusted items.
- Evaluate the cash and leverage impact of the expected approximately $760 million after-tax pension withdrawal-related charge and scheduled payments.
- Monitor whether pandemic-driven identical sales and digital growth persist as consumer behavior normalizes.
- Reconcile non-GAAP adjusted earnings and FIFO measures to GAAP results before using them for valuation or performance comparisons.