Kroger Co. (KR, Financial) reported financial results for the second quarter of fiscal 2019 on Sept. 12. Revenue for the quarter increased 2.5% to $22.1 billion (adjusted for fuel and the sale of the convenience store business), with same-store sales (what Kroger calls identical or ID sales) up 2.2%. While this still lags peers like Costco (COST, Financial), Walmart (WMT, Financial) and Dollar General (DG, Financial) by a wide margin, it has been slow and steady improvement for Kroger over the past six quarters.
In the quarter, revenues for the company’s own store brands increased 3%, led by Simply Truth and Private Selection (to capitalize on consumer trends, the company recently launched Simple Truth Plant Based, a collection of fresh meatless burger patties). In addition to a tailwind from its private label brands, the company’s digital revenues increased 31%, with pick-up and delivery locations now able to serve 95% of its customer base. Importantly, as noted on the call, the profitability of the digital business is improving as well (“becoming less of a headwind”).
Moving down the income statement, gross margins contracted 30 basis points, with management pointing to industry-wide gross margin pressure in the pharmacy business (margins in the supermarket business were stable). Operating expenses decreased by 15 basis points, reflecting some benefits tied to the company’s “Restock Kroger” initiatives.
Kroger benefited from the sale of a non-core asset (an unused warehouse), with the cash flow statement showing an incremental gain of $100 million in the quarter. Based on how management reports non-GAAP earnings, adjusted diluted earnings per share increased mid-single digits to 44 cents per share. But if you account for real estate gains, which it is not clear were included in adjusted figures, diluted earnings per share declined year-over-year. Either way, as I’ve noted in recent articles about Kroger, I’m not pleased with some of the games that they seem to be playing with their reporting. They have been unnecessarily opaque -- and that’s a red flag in my book.
In the first six months of the year, Kroger generated $3.3 billion in cash flow from operations. From there, it has spent $1.6 billion on capital expenditures and $250 million on capital returns to shareholders (largely the dividend, which was increased 14% earlier this year). At the end of the second quarter, Kroger’s net debt to adjusted Ebitda ratio was at the high end of management’s target range of 2.3x to 2.5x.
Conclusion
At $25 per share, Kroger currently trades at less than 12x guidance (management reaffirmed full year earnings per share guidance of approximately $2.2 per share). As you can see below, the forward price-earnings multiple for Kroger has been quite volatile over the past decade.
Notably, management pulled its mid-term guidance of $400 million of incremental operating income from 2017 to 2021. That goal has appeared optimistic (to put it kindly) for some time. It appears that management has now accepted that this objective was a bit aggressive as well.
Despite the low multiple, I’m still not particularly interested in the stock. That partly reflects my respect for some of the company's closest competitors like Walmart. Simply put, I'm not very interested in competing with Doug McMillon and his team over the long run. And considering the lack of any meaningful insider activity at Kroger over the past few years despite a tough run for the stock price, it would appear that members of management and the board share some of that concern.
Disclosure: None.Ă‚
Thoughts on Burry's GameStop Proposal
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
