This summary is based on the first quarter fiscal 2008 earnings call conducted by The Kroger Co. (KR) on June 24, 2008.
Management:
Investor Relations: Carin Fike
Chairman of the Board, Chief Executive Officer: David B. Dillon
Vice Chairman of the Board: W. Rodney McMullen
President, Chief Operating Officer, Director: Don W. McGeorge
Chief Financial Officer, Senior Vice President: J. Michael Schlotman
Key Investors Issues
- EPS were 58 cents a share compared to 47 cents a share last year.
- Earnings rose to $386 million from the year-earlier $336.6 million a year ago.
- Sales rose to $23.1 billion from $20.7 billion a year earlier.
First Quarter Highlights
The company reported earnings of 58 cents per share.
- Net earnings in the same period last year were 47 cents per share and recall that 2007 results included charges related to labor unrest at one of distribution centers. This reduced earnings by approximately 2 cents per share.
- Total sales increased 11.5% to $23.1 billion.
- Identical supermarket sales increased 9.2% with fuel and 5.8% without fuel. Growth was broad-based across all geographic regions and most departments with particular strength in grocery, nutrition, and deli/bakery.
- Kroger’s performance demonstrates the resiliency of Customer First strategy.
On a rolling four-quarter basis, the blended cents per gallon fuel margin for convenience stores and supermarket fuel centers was $0.114 this year compared to $0.117 last year, a decline of $0.003 per gallon.
- The blended cents per gallon margin was $0.092 compared to $0.087 in the prior year. While gallons sold were up on a year-over-year basis, retail fuel operations had no impact on Kroger’s first quarter earnings per share growth in 2008. This is largely due to the impact of higher credit card fees on fuel sales compared to the prior year.
- Retail fuel business is a highly valuable asset, particularly because it strengthens connection with customers. Fuel centers eliminate an extra trip for shoppers and customers know they can count on a competitive fuel price at Kroger.
- Excluding the effect of retail fuel operations and the non-recurring labor expenses of the prior year, FIFO gross margin declined 5 basis points. Improvement in shrink expense helped fund continued investments in good prices for customers. Kroger’s supermarket selling gross margin on non-fuel sales declined 9 basis points year-over-year.
- Kroger continues to experience product cost inflation at levels not seen in several years. The company estimates that product cost inflation was 3.5% excluding fuel. This relatively high inflation rate is reflected in $40 million LIFO charge. This amount is almost $20 million higher than the previous year and reduced Kroger’s non-fuel operating margin by 9 basis points.
- The year-over-year increase in LIFO mainly reflects the timing of when inflation affected business in 2008 compared to 2007. Full-year LIFO charge for fiscal 2007 was $154 million after rising product cost inflation caused to increase LIFO charge estimate every quarter last year.
The LIFO charge is a non-cash expense that results from the company’s choice of accounting method for its product inventories.
But beyond the mechanics of the LIFO charge, the company realizes that what many investors want to understand is how inflation is affecting business. On the whole, the company believes that a moderate level of food inflation is a positive for business. At moderate levels, the company is generally able to pass suppliers’ product cost increases on to customers without negatively impacting unit volume. It gets the benefit of the additional sales leverage over fixed costs in business.
Excluding the effect of retail fuel operations, OG&A declined 17 basis points. The improvement in OG&A rate is primarily due to strong identical sales leverage. The company benefited from lower benefit costs associated with some labor contracts. While the effect of this particular benefit will diminish over time, the company continues to identify other ways to reduce operating costs as part of ongoing strategy.
Since 2000, the company has reduced overall energy consumption by over 22%, or 1.6 billion kilowatt-hours.
Kroger’s non-fuel operating margin expanded 2 basis points.
- This also excludes the non-recurring labor expense in the prior year. Fiscal 2008 earnings guidance incorporates expansion in Kroger’s non-fuel operating margins on a full-year basis.
- Tax rate was 37%, compared to 38.1% in the prior year. The first quarter rate was lower in the current year due to the resolution of certain tax issues. The company anticipates a full-year tax rate in the range of 37% to 37.5%.
- Capital investment, excluding acquisitions, totaled $637 million, compared to $556 million in the prior year. The company continues to project fiscal 2008 capital spending of $2 billion to $2.2 billion, excluding acquisitions. This investment is expected to cover 70 to 80 major store projects and 175 to 200 store remodels, plus other investments to support Customer First strategy.
- 2008 capital budget also includes approximately $160 million for several high-return projects in Kroger’s logistics network. These projects will cause logistics capital spending in 2009 to be higher than normal as well.
- Long-term financial strategy is to manage free cash flow to repurchase shares and pay dividends, while maintaining a leverage ratio that supports investment grade rating. On a rolling four-quarter basis, Kroger’s net total debt to EBITDA ratio was 1.95, compared with 1.85 during the same period last year and 2.03 for the fourth quarter of fiscal 2007. Since year-end, the company has improved ratio. Total debt was $7.8 billion, an increase of $1.2 billion from a year earlier.
- Share repurchase and dividend programs delivered substantial value to shareholders. Kroger returned over $430 million to shareholders in share repurchases and dividends. Of this amount, $381 million was invested to repurchase 15 million shares of stock at an average price of $25.46 per share. At the end of the first quarter, approximately $644 million remained under the $1 billion stock repurchase program announced in January 2008. At current share prices, the company expects this amount will be sufficient to fund repurchases through the remainder of fiscal 2008.
- Kroger paid nearly $50 million in dividends to shareholders, compared to $46 million during the same period of the prior year.
Second Quarter 2008 Outlook
- Based on the strength of first quarter results, the company is raising its identical sales and earnings guidance for fiscal 2008. The company anticipates full-year identical sales growth of 4% to 5.5%, excluding fuel. Previous guidance on identical sales growth was 3% to 5%, also excluding fuel.
- For earnings, the guidance given in March was $1.83 to $1.90 per share. The company is raising the lower end of that range to $1.85 with the upper end remaining at $1.90.
Updated earnings guidance reflects 9% to 12% growth over fiscal 2007 earnings of $1.69 per share, which is a solid growth rate in a challenging economy. This compares favorably with the most recent earnings per share growth rate for non-financial companies in the S&P 500.
- The company continues to expect 2008 earnings per share growth will be driven by strong identical sales, improvement in non-fuel operating margin, and fewer shares outstanding.
