Shopping carts were a bit fuller at Kroger (NYSE: KR) last quarter, largely the result of its competitive strategy for dealing with tougher economic conditions. Sales were strong and earnings were in line with expectations, but those numbers were not easily achieved, as evidenced by a slipping gross margin.
Adjusting year-over-year comparisons for an extra week in 2006 reveals a healthy pickup in revenues. Total sales grew 10.2%, and same-store sales were up 8.2% (including fuel). Earnings per share came in at $0.48, one cent more than expected.
Consumers facing higher food and fuel costs are adjusting their behaviors accordingly. Many are choosing to eat at home rather than dine out at restaurants. This trade-off clearly benefits grocers, especially to the extent that shoppers purchase greater quantities of meats, produce, and prepared foods, all of which are more profitable for supermarkets than standard grocery fare.
Some retailers will use wholesale inflation as cover to expand prices a bit more than needed to ultimately raise profit margins. Kroger seems to be fairly aggressive in its pricing to attract cost-conscious shoppers, but its margins have been declining of late as a consequence. Gross margin was 23.56%, down 92 basis points from a year ago.
While operating costs were trimmed by 84 basis points, the operating margin slipped roughly half of a percent. By comparison, Safeway (NYSE: SWY) increased its operating margin slightly in the same period.
The financials suggest Kroger's strategy is to establish its cost competitiveness in shoppers' minds, thereby keeping them from taking more business to discounters and club stores like Wal-Mart (NYSE: WMT), Target (NYSE: TGT), and Costco (Nasdaq: COST). Accordingly, the company picked up additional market share throughout the year. But at the same time, Kroger will eventually need to pass on price increases and reinflate those profit margins as inflationary pressure continue to pinch margins. Hopefully, its current strategy will build enough customer loyalty so that resistance will be minimized and longer-term profit growth enhanced.
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