Restock Kroger 'right framework to reposition our business'

CINCINNATI — Both operating and net income tumbled by double digits during the third quarter at Kroger Co., while both sales and adjusted earnings fell short of analysts’ forecasts. As a result, the share price of the nation’s largest supermarket operator fell approximately 2% in early trading after results were announced.

Reported net income for the quarter ended November 9 slid 17% to $263 million, or 32 cents per diluted share. The bottom line for the quarter reflected $118 million, or 15 cents per share, in unusual items, most notable of which were a $100 million after-tax impairment charge related to Kroger’s Lucky’s Market banner, which the company has decided to divest; a $61 million adjustment of severance charges and related benefits; and a $35 million adjustment to pension plan withdrawal liabilities — all partially offset by an $81 million mark to market gain on Ocado securities.

Factoring out $77 million, or 11 cents per share, in special items in the fiscal 2018 period, adjusted net income fell 3.3% to $381 million from $394 million. On a per share basis, adjusted earnings dipped to 47 cents from 48 cents, two cents shy of the 49 cents per share consensus among analysts.

Turning to the top line, sales edged up 0.5% to $27.97 billion, short of the $28.18 billion projected by analysts. Identical sales (excluding fuel) expanded 2.5%, a considerable improvement over the 1.7% gain in the prior-year quarter. Excluding fuel and store closures, total sales would have increased 2.7%, according to the company.

“Kroger’s customer obsession and focus on operational excellence continued to generate positive results in the third quarter,” said chairman and chief executive officer Rodney McMullen in a statement. “Identical sales were the strongest since we started Restock Kroger and gross margin rate, excluding fuel and pharmacy, improved slightly in the quarter. At the same time, we continued to reduce costs as a percentage of sales.”

McMullen went on to defend the Restock Kroger initiative as the “right framework to reposition our business,” and emphasized the profit contribution of Kroger’s non-supermarket businesses. “We are using the power of Kroger’s stable and growing supermarket business to create meaningful incremental operating profit through the alternative profit stream businesses, which adds up to a business built for long-term growth,” he said.

Reported gross margin grew 24 basis points to 22.08%, but FIFO gross margin (which excludes the LIFO charge) excluding fuel contracted 24 basis points, mainly due to industry-wide lower gross margin in pharmacy, intensified by the continued growth of low-margin specialty pharmacy. Excluding both fuel and pharmacy, gross margin improved slightly, according to Kroger.

However, the margin improvement was more than offset by operating, general and administrative (OG&A) expense, which swelled 147 basis points to 18.22% of sales. According to Kroger, backing out the impact of fuel and adjustment items, the OG&A rate improved by 15 basis points due to the positive impact of cost savings initiatives.

Factoring in a 9.5% jump in depreciation and amortization expense to $624 million, reported operating profit plummeted 60.7% to $254 million. Adjusted FIFO operating profit, though, slipped just 1.7% to $653 million.

Moving down the income statement, interest expense declined 3.5% to $137 million, and Kroger booked a $106 million pretax mark to market gain on Ocado securities compared to a $100 million loss a year ago. Nonetheless, pretax earnings still dove 44.4% to $222 million.

Year-to-date net income plunged 53.3% to $1.33 billion, reflecting a $1.36 billion gain on the sale of its convenience store business last year. Adjusted net profit dipped 2.3% to $1.32 billion.

Sales for the nine months inched down 0.2% to $93.39 billion, although identical sales gained 2%, while operating project decreased 23% to $1.71 billion.

Kroger confirmed its 2019 full-year guidance for identical sales, adjusted FIFO operating income and adjusted earnings per share. GAAP earnings are projected to total between $2.17 and $2.27 per share, with adjusted earnings ranging from $2.15 to $2.25 per share. Analysts on average are expecting $2.19 per share.

Identical sales are expected to grow from 2% to 2.25% and adjusted FIFO operating profit is calculated to come in between $2.9 billion and $3 billion, while GAAP operating income should total $2.4 billion to $2.5 billion.

Looking ahead to fiscal 2020, the company is forecasting earnings of $2.30 to $2.40 per share, compared to analysts’ average outlook of $2.33 per share. The company is looking for adjusted identical sales growth in excess of 2.25% and operating profit of $3 billion to $3.1 billion. Kroger anticipates that its incremental alternative profit streams will contribute between $125 million and $150 million next year.