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What Kroger Co. Wants Investors to Know After Taking an Axe to Its Profit Outlook

By Demitri Kalogeropoulos - Jun 16, 2017 at 6:38PM

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Price cuts pinched results this quarter and threaten to lower earnings for the full 2017 fiscal year.

Kroger (KR 1.38%) is living through the toughest operating environment it has seen in over a decade. After 13 years of consistent quarterly revenue growth, comparable-store sales turned negative six months ago as competition spiked. 

This week, the supermarket giant's stock slumped following surprising news that earnings will decline in 2017 thanks to rising expenses and its commitment to stay competitive on grocery prices. Here are a few highlights from CEO Rodney McMullen's conference call with investors that sought to put the weakening operating trends in perspective.

A grocery cart moving down the aisle.

Image source: Getty Images.

What's working

We are happy with the better [comp] sales results in the first quarter compared to the fourth quarter, and we are pleased to see that our current [comp] sales trend is positive.
-- McMullen

Management was encouraged to see a return to modest sales growth toward the end of the quarter and into the start of the current quarter. As a result, the company still believes it will boost comps by as much as 1% in 2017 to mark just a slight deceleration from last year's result.

The bright spots they highlighted included Kroger's corporate brands like Simple Truth and Private Selection, which outperform even national rivals and accounted for 28% of sales volume this quarter. The retailer also plans to scale up a recent successful prepared meal kit offering that's seeing strong early demand in its test market.

Willing to sacrifice margins

In the first quarter, our gross margin was down, operating costs were up, and operating profit was down.
-- Chief Financial Officer Mike Schlotman

Executives explained that the sharp drop in profits this quarter (net income was cut in half to $445 million) is mostly the result of a few one-time charges. However, management sees spending rising significantly from here. It is raising wages for employees and boosting investments in its e-commerce initiatives, but the major -- and continuing -- factor will be price cuts. As industry rivals get more aggressive in their promotions, "We have no intention of giving up the momentum we've gained on low prices," McMullen said.

Market share questions

Market share, as traditionally calculated, was up in the first quarter. That said, we recognize there is no perfect metric for capturing market share. We are doing a lot of work to better define -- or redefine -- the market as "share of stomach" rather than "share among traditional grocery stores."
-- Schlotman

Kroger increased its sales volume last quarter and counted a slight boost in overall shopper traffic even though customer frequency was flat and average spending per visit declined. Executives suggested that their old way of tallying market share showed gains, but that this might be a less reliable metric today as people increasingly get groceries from non-traditional stores and from online vendors.

The bottom line: Kroger has improved grocery market share for the last 12 years straight, but that impressive streak is under threat right now and might already be slipping when considered in a broader sense. 

Lowering guidance

There is a lot of change in the food retail industry. That, coupled with the transition from deflation to inflation creates a challenging operating environment.
-- Schlotman

Kroger's new earnings forecast falls well below its long-term goal of 8% to 11% gains. In fact, it predicts a profit decline, even though this fiscal year benefits from an extra sales week.

The key contributor to this profit downgrade was a price war that showed up in the first quarter, this time on the grocery staples of milk and eggs. Kroger executives made it clear that, when faced with the choice of losing market share or sacrificing temporary profits, the retailer will always chose the earnings hit. "While this affects gross margin in the short term, it is less expensive than regaining a customer's loyalty," Schlotman said.

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