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The Science of Hitting
The Science of Hitting
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Kroger Q2 2011 Highlights

September 11, 2011 | About:

The Kroger (NYSE:KR), one of the largest retailers in the United States (with 2,439 stores under operation and more than $82 billion in revenues in 2010), held a conference call on Friday to discuss second quarter 2011 results. Here are some of the highlights from the Q&A and major developments that are occurring at Kroger:

Total sales (including fuel) increased 11.5% to $20.9 billion in Q2, compared with $18.8 billion in the same period last year; excluding fuel, sales increased 5.2% over Q2 2010.

Same store sales (excluding fuel) increased 5.3% year over year, with positive growth in all 18 of the company’s retail divisions (which are split up based on banner name and geographic region) and every supermarket department; this marked the 31st consecutive quarter of positive same store sales growth at Kroger. For the full year, management increased their same store sales guidance (excluding fuel) to 4-5%, compared to a previous range of 3.5-4.5%.

Net earnings for the second quarter were $280.8 million, an increase of 7.3% from $261.6 million in Q2 2010. On a per share basis, earnings increased 12.2% to $0.46 per diluted share. Excluding the impact of tax adjustments in both quarters, earnings increased 7.9% to $0.41 per share (from $0.38 in 2010), in line with management’s long term growth expectations of 6-8% EPS growth.

Management left their full-year earnings guidance unchanged at $1.85-$1.95 per diluted share; the press release noted that they expect “to achieve results near the top end of this range”, which was identical to wording found in the press release from Q1.

As one of the largest U.S. retailers, Kroger is in a position to aggregate wide-spread consumer data and develop a comprehensive national picture of the consumer; as such, I think it is logical to listen to management’s anecdotal and empirical evidence on economic developments. Here is what CEO David Dillon had to say about the consumer in Q2:

“First, the sluggish economy continues to strain household budgets while increasing consumer anxiety. In fact, customers tell us their expectations for the economy are more pessimistic now than at any time this year. And for the first time, customers list instability of the financial markets as one of the top economic concerns. These examples illustrate how consumer sentiment changed during the quarter and are important because most discretionary spending is based on what people feel or perceive about the economy.”

As a result of these developments, management realizes the importance of cutting costs while keeping prices low to remain competitive in the eyes of cash strapped consumers: “The customer is going through a lot of change right now, and we are doing everything we can to minimize the impact on them of higher food costs (product cost inflation was 5.2% in the quarter, expected to be 3-4% for the year)… Associates are working hard to cut cost and we are finding ways to help customers save even as product cost increases are passed on. We estimate we have lowered our customer's shopping bill by $2.1 billion per year” (roughly 2.5% based on last year’s sales number).

One way they have managed to do this is by driving low priced private label alternatives. In the quarter, corporate brands (compared to national brands) represented approximately 27% of grocery department sales in dollars and 34% of the grocery department volume, both of which were up more than 100 basis points compared to Q1 of this year. “Our multibillion dollar corporate brand portfolio is a competitive advantage because it gives our customers more choices and variety and value to complement the broad assortment of national brand products we offer. This is particularly important today as many shoppers continue to watch expenses and look for quality items at affordable prices.”

One area where Kroger continues to face issues is in labor negotiations; here is what management had to say on the issue: “We have a number of unsettled labor contracts currently past their original expiration dates, including negotiations in Southern California and Southeastern Ohio and with the Teamsters at our distribution center in Washington [state]. These negotiations are challenging because of our efforts to manage the increase of healthcare and other costs, a sluggish economy and our need to compete against non-union retailers with lower cost structures are contributing factors as well.”

While management had relatively little to say beyond these prepared remarks, a look at the 10-K shows the scope of the labor issue. The company is involved in more than 300 separate collective bargaining agreements throughout the country, covering a majority of the company’s estimated 340,000 employees. Union workers in Southern California (where contracts are past expiration) and West Virginia (which expires during Q3) both went on strike in 2003 in a move that forced the company to close dozens of supermarkets overnight and cost them millions of dollars; as they proved to be in 2003, these negotiations will prove to be a critical part of Kroger’s operations in 2011 and beyond.

As the overall market sank lower on Friday, Kroger fell further than most, dropping 5.7% before the day ended; the company current has a market cap of $13.3 billion and a stock price of $22 per share.

About the author:

The Science of Hitting
I'm a value investor with a long-term focus. As it relates to portfolio construction, my goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach to investing is "patience followed by pretty aggressive conduct". I run a concentrated portfolio, with a handful of equities accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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