The Kroger Co. 10-K Summary
Period covered: Fiscal year ended February 1, 2020, consisting of 52 weeks. The requested period metadata states “2018 Q4,” but the supplied filing is Kroger’s fiscal 2019 Form 10-K, filed April 1, 2020; its fourth quarter consisted of three 28-day periods.
Business context
Kroger is a U.S. food retailer operating 2,757 supermarkets in 35 states and the District of Columbia, with 2,270 pharmacies, 1,567 fuel centers, 1,989 stores offering pickup, and home delivery coverage for 97% of households. Retail operations represent approximately 97% of consolidated sales and are the company’s only reportable segment. Kroger employed approximately 435,000 people and operated 35 food production plants at year-end.
Financial performance and liquidity
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Sales | $122.286 billion | $121.852 billion | 0.4% |
| Net earnings attributable to Kroger | $1.659 billion | $3.110 billion | (46.7%) |
| Diluted EPS | $2.04 | $3.76 | (45.7%) |
| Adjusted diluted EPS | $2.19 | $2.11 | 3.8% |
| Operating profit | $2.251 billion | $2.614 billion | (13.9%) |
| Adjusted FIFO operating profit | $2.995 billion | $2.880 billion | 4.0% |
| Cash flow from operations | $4.664 billion | $4.164 billion | 12.0% |
| Capital investments, excluding lease buyouts | $3.044 billion | $3.018 billion | 0.9% |
| Cash dividends paid | $486 million | $437 million | 11.2% |
Identical sales excluding fuel increased 2.0%, while digital revenue grew approximately 29%. Fuel sales declined 5.7%, reflecting lower fuel gallons sold and lower average retail fuel prices. Gross margin was 22.07%, compared with 21.95% in 2018; FIFO gross margin was 22.16%, compared with 21.98%. Excluding fuel and adjusted items, FIFO gross margin declined 23 basis points. The OG&A rate increased to 17.34% from 17.06%, although the rate excluding fuel and adjusted items improved by 29 basis points.
Interest expense declined to $603 million from $620 million. The effective tax rate increased to 23.7% from 22.6%. Total assets were $45.256 billion, including $399 million of cash and temporary cash investments. Shareholders’ equity attributable to Kroger was $8.602 billion.
Total debt, including finance lease obligations, declined by approximately $1.2 billion to $14.1 billion. Debt reduction included repayment of a $1.0 billion term loan and senior notes, partially offset by increased commercial paper borrowings and issuance of $750 million of senior notes. Kroger had $1.2 billion of commercial paper outstanding at year-end and access to a $2.75 billion revolving credit facility, expandable by up to $1.0 billion.
Management estimated next-twelve-month liquidity needs at approximately $5.5 billion, including working capital, capital investments, interest and scheduled debt payments. Management stated that operating cash flow and available financing sources should meet liquidity needs. The year-end leverage ratio was 2.30 to 1, versus a 3.50 to 1 covenant limit; the fixed-charge coverage ratio was 4.39 to 1, versus a 1.70 to 1 minimum.
Material changes and unusual items
- GAAP earnings were reduced by significant nonrecurring or unusual items, including $412 million of Lucky’s Market impairment and deconsolidation charges, $135 million of multi-employer pension withdrawal liabilities, $80 million of severance costs, and $52 million of transformation costs primarily related to 35 planned store closures.
- Kroger recognized gains of $106 million on the sale of Turkey Hill Dairy and $70 million on the sale of You Technology, plus a $157 million mark-to-market gain on Ocado securities.
- Lucky’s Market filed for bankruptcy in January 2020. Kroger fully wrote off its investment and retained certain property-related guarantee obligations.
- Kroger sold its You Technology business for total consideration of $565 million, including $396 million of cash and $64 million of preferred equity, and sold Turkey Hill Dairy for $225 million.
- Kroger adopted new lease accounting guidance, recognizing approximately $6.8 billion of operating lease assets and $7.0 billion of operating lease liabilities. The adoption materially increased reported assets and liabilities but did not materially affect net earnings or cash flows.
- Share repurchases fell to $465 million from $2.010 billion. The company had $600 million remaining under its November 2019 repurchase authorization at year-end and later paused additional repurchases during the first quarter of 2020.
Outlook, management commentary and risks
Management emphasized the “Restock Kroger” strategy, including customer experience, digital and e-commerce capabilities, alternative profit streams, productivity initiatives, supply-chain investment and talent development. Management targeted a net debt-to-adjusted EBITDA range of 2.30 to 2.50, continued dividend growth and long-term total shareholder returns of 8% to 11%. Specific full-year 2020 guidance amounts are not clearly provided in the supplied filing text.
On March 18, 2020, after year-end, Kroger borrowed $1.0 billion under its revolving credit facility as a precautionary measure in response to the COVID-19 pandemic. Cash and temporary cash investments immediately afterward were approximately $2.336 billion; by March 25, 2020, Kroger reported no commercial paper borrowings outstanding.
COVID-19 created substantial uncertainty around customer demand, workforce availability, supply-chain continuity, store operations, financing markets and liquidity. Other principal risks include intense price and digital competition, labor negotiations and multi-employer pension obligations, cybersecurity and data privacy, product safety, fuel volatility, weather and natural disasters, regulatory changes, litigation and execution of strategic partnerships and acquisitions.
Kroger estimated its share of multi-employer pension plan underfunding at approximately $2.3 billion, or $1.8 billion net of tax, as of December 31, 2019. This is not generally recorded as a direct liability, but future withdrawal liabilities and contribution requirements could be material.
Investor verification items
- Reconcile GAAP EPS of $2.04 with adjusted EPS of $2.19 and assess the sustainability of the underlying earnings improvement.
- Review the impact of Lucky’s Market, store closures, pension withdrawal liabilities, severance and other adjusted items on future operating results and cash flow.
- Verify 2020 guidance and subsequent COVID-19 operating updates, which are not fully quantified in the supplied filing text.
- Monitor debt maturities, commercial paper access, revolving-credit availability and compliance with leverage and fixed-charge coverage covenants.
- Assess digital growth, fulfillment costs, pharmacy margin pressure, fuel profitability and the effect of continued price investments on margins.
- Evaluate exposure to multi-employer pension underfunding, collective bargaining expirations, litigation and property-related guarantees associated with Lucky’s Market.
- Consider the effect of lease accounting adoption when comparing reported assets, liabilities, leverage and return measures with prior periods or peers.