Kroger Company (KR)

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The Kroger Co. (NYSE: KR) is the largest operator of traditional grocery stores in the United States and the second largest food retailer in the United States after Wal-Mart.^[1] Kroger operates over 2,400 supermarkets and also manufactures and sells food under 24 of its own brands. ^[2] Kroger's diversified operations also include jewelry stores, convenience stores, gas stations, drug stores, and financial services.

Over the last few decades, the supermarket industry has undergone a transformation in the United States. Twenty years ago, 90% of food shopping was conducted in traditional grocery stores. Today, just 50% of food shopping is done at traditional grocery stores. As a large retail grocer, Kroger faces competition from similar chains, local stores, and niche stores, such as Whole Foods Market (WFMI) and Safeway (SWY). Wal-Mart (WMT), however, represents the most significant long term threat to the firm's continued growth. Wal-Mart (WMT) sells a wide variety of goods ranging from apparel to groceries. Because of its scale, the retailer is often able to offer below-market prices to its customers. In order to compete, Kroger has focused on making its stores a one-stop solution for customers' daily needs.^[3] As of the end of 2010, Kroger had 864 convenience stores and 374 fine jewelry stores in addition to its 2,468 supermarkets, 893 of which also had fuel centers. ^[4]

Business Overview

Kroger, founded in 1883, is the largest traditional supermarket operator in the United States. Kroger operates stores in 44 major markets across 31 states, and has the largest or second largest market share in 39 of those markets.^[5] Unlike other supermarket companies, like SuperValu (SVU), who rely predominantly on acquisitions to grow revenue, Kroger focuses on growing revenue through increasing identical store sales.

Business Financials

In fiscal 2009 Kroger posted $76.7 billion in revenue, a 0.7% increase over 2008 (by comparison, in fiscal 2008 sales increased 8.2% over the previous year) . Net earnings totaled million for 2009, compared to net earnings totaling $1.2 billion in each of 2008 and 2007; the net earnings for 2009 include non-recurring asset impairment charges totaling $1.05 billion, after-tax, related to a division in southern.^[6]

Kroger attributed the declines in large part to falling retail fuel prices. The average retail price for a gallon of fuel sold at Kroger fuel stations was 24% lower in the third quarter of 2009 compared to the third quarter of 2008. In the first three quarters of 2009, comparable supermarket sales were 0.4% (versus 8.1% in the first three quarters of 2008); this figure was 1.7% (versus 5.9%) when fuel sales are excluded. In addition, supermarket sales were pressured in the third quarter of 2009 by decreased consumer spending, persistent deflation in food prices (especially in produce, meat, and dairy), and heightened competitive activity. ^[7] In December 2009, a food price index posted a 0.3% increase in its price basket-- the largest monthly increase in more than a year -- in a sign that deflation is easing in the U.S. If that trend holds, it may be good news for Kroger and the supermarket industry as a whole. The price index is still down 2.4% from a year earlier.^[8]

Q1 FY2010 Earnings Summary

Kroger posted total sales of $24.8 billion in the first quarter of fiscal 2010, a 8.7% compared to the first quarter of FY2009. Excluding fuel sales, total sales would have increased 3.1%. Earnings on the other hand fell to $373.7 million from $435.1 million first quarter last fiscal year, a 14.1% drop.^[9] The decrease in earnings was mainly attributed to an increase of operations, operating, general and administrative costs (excluding retail fuel operations), which increase 13 basis points from same period last year as a direct result of higher health care and pension costs. However, these uprising costs were offset by same-stores sales leverage which benefited from Kroger's active cost cutting throughout the economic downturn.

Kroger continues to target four key areas - people, product, prices and experience. This has led to a decrease of 168 basis points in FIFO gross margin to 22.66% of sales, but strong cash flow overall has still enabled Kroger to invest $79.5 million in share repurchases, a sign of confidence from management.^[10]

Q2 FY2010 Earnings Summary

Kroger posted $261.6 million net profit for the second reporting quarter ending August 14, 2010 from $254.4 million same quarter last year, a 2.83% increase.^[11] Kroger attributes this increase by focusing on keeping current customers rather than cutting prices to attract new ones. As a result, the number of "loyal households," which Kroger calculates using total purchase size and frequency, rose during the quarter.^[12]

Same-store sales also rose 2.7%, though gross margins decreased 12 bps during the quarter, a testament to its philosophy of increasing volume rather than gross profit as its bottom line driver.^[13] Sales, including fuel, also increased 6% to $18.8 billion, which beat analyst estimates of $18.7 billion.^[14]

Q3 FY2010 Earnings Summary

Kroger posted earnings of $202.2 million, or $0.32 EPS, for the third reporting quarter, which reversed the $874.9 million loss seen same quarter FY2009.^[15] Kroger attributes to the negative earnings experienced same quarter last year mainly to one-time charges. Sales for the period rose 5.9% to $18.7 billion, beating analyst consensus estimates of $18.5 billion.

As weak employment and higher gas prices continue to affect consumer confidence, Kroger's margins continues to be pressured. Kroger therefore narrowed its full-year profit forecast to $1.65 to $1.78 EPS from its previous estimate of $1.60 to $1.80. Kroger's stock fell roughly 9% on the day of earnings release.^[16]

Business Segments

Although Kroger does not break-down sales per unit, the company operates five types of stores: combo stores, multi-department stores, price-impact warehouse stores, convenience stores, and jewelry stores.vvvv

• Combo Stores: The majority of Kroger's supermarkets are combo stores with a full selection of food and pharmacy products. They offer an array of food products, as well as specialty departments like bakeries, delis, and organic food sections. ^[17][18]

• Multi-Department Stores: Kroger operates a number of multi-department stores in the Pacific Northwest and Alaska under the banner Fred Meyer. In addition to groceries, these stores sell apparel, furnishings, electronics, automotive products, toys, and jewelry. They are larger in size than the combo stores and many also contain fuel centers.^[17][19]

• Marketplace Stores: Kroger operates marketplace stores in Arizona, Ohio, and Utah. These stores are smaller versions of its multi-department stores. The main difference is that marketplace stores don't contain apparel sections.^[17][19]

• Price-Impact Warehouses: Kroger's price-impact warehouses are the size of a combo store and offer a "no-frills, low cost" experience for grocery, along with health and beauty items. The company operates these stores in California, Illinois, and Nevada.^[17][19]

• Convenience Stores: Kroger operates 777 convenience stores in 15 states and franchises another 87. Most stores are attached to fuel stations and offer an assortment of food choices, including Kroger's private label items. ^[20]

• Jewelry stores: Kroger is the fourth largest fine jewelry retailer in the United States. The company operates 393 jewelry stores in 34 states. Of these, under a third are located in Kroger grocery stores and the remainder are located in shopping malls. ^[21]

Kroger Sales Breakdown FY2007-2009^[22]

Key Trends and Forces

Private Labels provide Kroger with a Higher Gross Margin and Competitive Edge against Discount Retailers

In order to increase its margins and compete against Wal-Mart's lower prices, Kroger continues to invest in its private labels. Kroger sells more than 14,000 private label products at its supermarkets and convenience stores.^[23] The company sells its private label items in three quality tier: private selection, banner brand, and value brand. Kroger is generally considered to have one of the most successful private-label products in the industry. More than 26% of Kroger's sales come from these items, which typically have higher margins and fuel customer loyalty. Kroger applies a “make or buy analysis” to all of its food and retail items, in 2009 selling 39% of its retails units under its 24 brands. As of January 30, 2010, the Company operated 40 manufacturing plants. ^[24]

The Wal-Mart Effect is Pertinent to Kroger despite its Size

Wal-Mart is the greatest external force affecting any grocer. In markets that Wal-Mart has entered, grocery prices drop by an average of 10-15%.^[25] Additionally, Wal-Mart is able to drop grocery prices 10-30% drastically during promotional periods because it can remain profitable on extremely low margins due to its volume of sales.^[26] Although Kroger has introduced its price impact warehouse stores to compete with Wal-Mart (WMT) and other low cost competitors, its other stores may suffer from increased price competition.

Despite Wal-Mart's large size though, Kroger has been able to stick it out. While Wal-mart has a big piece of its sales coming from general merchandise, Kroger has oriented itself by treading around Wal-Mart and offering products that balances its own mix so it will not go into direct competition with Wal-Mart. By doing so, Kroger has allowed Wal-Mart to continue its foreign markets for expansion and Kroger has focused on developing its domestic markets.^[27]

By Analyzing Consumer Trends, Information Technology is Crucial for Kroger's Sustainability

In 2003, Kroger formed a joint venture with London-based data management and analytic company Dunnhumby to create Dunnhumby USA. With Dunnhumby's technology, Kroger can analyze a tremendous amount of information about its customers.^[28] Kroger is utilizing that knowledge to design its stores to match the needs of local markets. For instance, some of Kroger's supermarkets now have office supply stores built inside them. Kroger also used Dunnhumby's data to build Kroger Personal Finance, which offers home equity loans and mortgages at some Kroger locations. Analysts partly credit dunnhumby for boosting Kroger's sales per square foot, which have risen 20% since 2003.^[29]

Competition

Among traditional supermarket chains, Kroger has been able to use its own size to offer lower prices. In fact, despite the fierce competition, Kroger has increased its market share in most of its markets. In 2007, Kroger's market share increased by .65% in its 44 major markets.^[5]

In 2006, the most recent year for which data is available, US consumers spent a total of $1.1 trillion on food, 51.1% of it on groceries. ^[30] As a retail grocer, Kroger faces its stiffest competition several sources:

Wal-Mart Stores (WMT) Wal-Mart is the largest food retailer in the US with more than 3,550 stores and supercenters^[31], with groceries accounting for 51% of Wal-Mart's $258.2 billion in 2009 US sales,. ^[32] Wal-Mart is able to provide low prices through its distribution network and economies of scale. Generally, Wal-Mart charges about 8% less than Kroger for the same products. Kroger stores cater to a similar broad public as Wal-Mart. Consumers turn to discount stores such as Wal-Mart when their disposable income falls.

Safeway (SWY) Safeway is the third largest food retailer and largest operator of traditional supermarkets in the US, with 1743 stores nationwide.^[33]

SuperValu (SVU) SuperValu is the third largest food retailer and second largest operator of tradition supermarkets in the US, with 2,200 stores nationwide.^[34]

References

1. ↑ Kroger Co's Google Finance Profile Page
2. ↑ [[1]]
3. ↑ US: Kroger Q3 sales up, earnings dip.
4. ↑ [ http://www.sec.gov/Archives/edgar/data/56873/000110465910017258/a09-36165_110k.htm]
5. ↑ ^{5.0 5.1} KR 2007 10-K pg. 10  
6. ↑ [ http://www.sec.gov/Archives/edgar/data/56873/000110465910017258/a09-36165_110k.htm]
7. ↑ 2009 10-Q 3rd Quarter 2009
8. ↑ [2]
9. ↑ The Kroger Co. Reports Operating Results (10-Q)
10. ↑ KROGER REPORTS FIRST QUARTER 2010 RESULTS
11. ↑ Kroger sales rise to $18.8B for 2Q
12. ↑ UPDATE 3-Kroger says 'loyal' customers helped it beat views
13. ↑ The Kroger Co. Reports 2Q Net Earnings Of $261.6 Million
14. ↑ Kroger Posts Higher Earnings; Shares Rise
15. ↑ Kroger Hits Profit Estimates, but Cuts Forecast
16. ↑ Kroger Reports Decent 3Q; We Believe Shares Are Undervalued
17. ↑ ^{17.0 17.1 17.2 17.3}
18. ↑ ^{18.0 18.1}
19. ↑ ^{19.0 19.1 19.2}
20. ↑ [ http://www.sec.gov/Archives/edgar/data/56873/000110465910017258/a09-36165_110k.htm]
21. ↑ [ http://www.sec.gov/Archives/edgar/data/56873/000110465910017258/a09-36165_110k.htm]
22. ↑ KR FY2009 Form 10-K, Page 46
23. ↑
24. ↑ [ http://www.sec.gov/Archives/edgar/data/56873/000110465910017258/a09-36165_110k.htm]
25. ↑ [3] Ideas & Trends: Discount Nation; Is Wal-Mart Good for America? - New York Times
26. ↑ [4]Wal-Mart chops prices in bid to lure shoppers - CNN Money
27. ↑ Can Kroger Beat Wal-Mart?
28. ↑ What We Do.
29. ↑ Kroger's Secret Weapon.
30. ↑ [5]Food CPI, Prices, and Expenditures - US Economic Research Service
31. ↑ [6]Wikinvest Wal-Mart Article
32. ↑ [7]
33. ↑ Wikinvest Safeway Article.
34. ↑ SUPERVALU INC (New York Stock Exchange).
35. ↑ WFMI 10-K FY2010
36. ↑ SWY 10-K FY2009
37. ↑ KR FY2010 10-K
38. ↑ SVU 10-K FY2009