The Kroger Co. Form 10-Q Summary
Reporting period: The supplied filing is for the third quarter and first three quarters ended November 9, 2019, with comparisons to November 10, 2018. The request metadata identifies “2018 Q3,” but the filing itself is a 2019 third-quarter report. The quarter covered 12 weeks and the year-to-date period covered 40 weeks.
Business Context and Key Metrics
Kroger is a large U.S. supermarket operator with fuel, pharmacy, digital, data analytics, media, personal finance and other alternative profit streams. Management emphasized identical sales growth, digital expansion, cost savings under Restock Kroger, and continued investment in stores, technology and employee compensation.
| Metric | Third quarter 2019 | Third quarter 2018 | First three quarters 2019 | First three quarters 2018 |
|---|---|---|---|---|
| Sales | $27.974 billion | $27.831 billion | $93.393 billion | $93.566 billion |
| Operating profit | $254 million | $647 million | $1.714 billion | $2.225 billion |
| Net earnings attributable to Kroger | $263 million | $317 million | $1.332 billion | $2.851 billion |
| Diluted earnings per share | $0.32 | $0.39 | $1.64 | $3.43 |
| Net cash from operating activities | Not separately provided for the quarter | Not separately provided for the quarter | $4.048 billion | $3.733 billion |
Revenue, Profitability and Margins
- Third-quarter total sales increased 0.5%; year-to-date sales decreased 0.2%, primarily because of lower fuel sales and business dispositions.
- Identical sales excluding fuel increased 2.5% in the quarter and 2.0% year to date.
- Digital revenue grew 21% in the quarter and 31% year to date, although growth moderated because of the comparison with the Home Chef merger.
- Gross margin increased to 22.08% from 21.84% in the quarter and to 22.06% from 21.82% year to date. FIFO gross margin was 22.16% in the quarter and 22.14% year to date.
- Operating margin declined to 0.91% from 2.33% in the quarter and to 1.83% from 2.38% year to date. Higher OG&A and depreciation expense more than offset the gross-margin improvement.
- Adjusted diluted EPS was $0.47 versus $0.48 in the quarter and $1.62 versus $1.63 year to date. Adjusted results exclude specified pension, severance, impairment, disposal, Ocado and other unusual items.
- The effective tax rate increased to 35.6% from 22.8% in the quarter and to 25.0% from 22.8% year to date, substantially affected by the Lucky’s Market impairment attributable to the minority interest.
Cash Flow, Debt and Liquidity
- Year-to-date operating cash flow was $4.048 billion, up from $3.733 billion. Capital investments excluding mergers, acquisitions and purchases of leased facilities were $2.2 billion versus $2.3 billion.
- Investing activities used $1.824 billion, compared with $630 million in the prior-year period. Financing activities used $2.108 billion, compared with $3.021 billion.
- Cash and temporary cash investments were $545 million at November 9, 2019, compared with $429 million at February 2, 2019.
- Total debt excluding finance-lease obligations was $12.678 billion, compared with $14.351 billion at fiscal year-end. Including finance leases, management reported a $1.6 billion year-to-date reduction in total debt.
- Kroger had $565 million of commercial paper outstanding, no borrowings under its $2.75 billion revolving credit facility, and $2 million of letters of credit reducing facility availability. The facility may be increased by $1 billion and terminates in August 2022 unless extended.
- Management estimated next-twelve-month liquidity needs of approximately $4.8 billion, including working capital, capital investments, interest and scheduled debt payments. Management believes operating cash flow and available borrowing capacity will be adequate.
- Operating lease assets and liabilities recognized under the new lease standard totaled $6.847 billion and $7.122 billion, respectively, at quarter-end. Total lease liabilities, including finance leases, were $8.088 billion.
Material Changes and Unusual Items
- Kroger recorded a $238 million Lucky’s Market impairment charge, including $131 million attributable to Kroger, and decided to divest its interest in the business.
- A division-management reorganization generated an $80 million severance and related-benefits charge, or $61 million after tax.
- The company recorded $131 million of charges year to date for multi-employer pension withdrawal liabilities, including $45 million in the quarter.
- Kroger recognized a $106 million mark-to-market gain on Ocado securities in the quarter, compared with a $100 million loss in the prior-year quarter.
- Year to date, Kroger recorded gains of $106 million on the sale of Turkey Hill Dairy and $70 million on the sale of You Technology. The prior-year period included a $1.782 billion gain from the sale of the convenience-store business, making reported earnings comparisons substantially less meaningful.
- A $29 million out-of-period reduction to sales was recorded for a pharmacy-contract provision relating to the prior six quarters. Management considered the impact immaterial to current and prior periods, but it reduced third-quarter adjusted EPS by $0.03 and gross margin by nine basis points.
- Kroger adopted lease accounting guidance and reclassified certain tax effects from accumulated other comprehensive income to retained earnings. Management stated that these adoptions did not materially affect earnings or cash flow.
Guidance, Outlook and Risks
- For 2019, management targeted identical sales growth excluding fuel of 2.0% to 2.25%, GAAP diluted EPS of $2.17 to $2.27, adjusted diluted EPS of $2.15 to $2.25, operating profit of $2.4 billion to $2.5 billion, and adjusted FIFO operating profit of $2.9 billion to $3.0 billion.
- 2019 capital investments were expected to range from $3.0 billion to $3.2 billion, excluding mergers, acquisitions and leased-facility purchases.
- For 2020, management targeted identical sales growth excluding fuel above 2.25%, adjusted diluted EPS of $2.30 to $2.40, adjusted FIFO operating profit of $3.0 billion to $3.1 billion, and capital investments of $3.2 billion to $3.4 billion.
- Management expected 2020 share repurchases of $500 million to $1.0 billion and incremental 2020 alternative-profit-stream operating profit of $125 million to $150 million.
- Key risks include labor negotiations, competitive pricing, fuel-price and fuel-margin volatility, pharmacy reimbursement and pharmacy-benefit-manager consolidation, multi-employer pension obligations, economic conditions, commodity and logistics costs, cyberattacks, execution of Restock Kroger, integration of partnerships and businesses, debt refinancing and access to commercial-paper markets.
- Kroger reported compliance with its debt covenants and stated that disclosure controls were effective as of November 9, 2019.
Most Important Facts to Verify
- Confirm that the intended period is third quarter 2019, not third quarter 2018, because the filing dates and financial statements cover 2019.
- Assess whether reported margin pressure, particularly in pharmacy and from digital and labor investments, is temporary or structural.
- Reconcile GAAP and adjusted earnings, including the Lucky’s Market impairment, pension withdrawal liabilities, severance, Ocado valuation gains and business-sale gains.
- Evaluate the sustainability of $4.0 billion of year-to-date operating cash flow against capital investments, lease obligations, debt maturities and shareholder returns.
- Monitor the divestiture of Lucky’s Market, the performance of alternative profit streams, and the pace and profitability of digital revenue growth.
- Review the $4.8 billion liquidity requirement, upcoming senior-note and commercial-paper maturities, refinancing assumptions and continued covenant compliance.
- Review pending antitrust, wage-and-hour, civil-rights and product-liability litigation; management considers the aggregate exposure immaterial but acknowledges that outcomes remain uncertain.