CINCINNATI -- Kroger Co. here said last week it expects strong sales gains to continue through the balance of the year -- an expectation echoed by industry analysts, who said Kroger's prospects appear even brighter with the possible sale of Albertsons, Boise, Idaho.
Kroger said increases in customer counts and transaction sizes drove sales increases for the second quarter and first half ended Aug. 13, with sales rising 6.8% to $13.9 billion for the quarter and 6.5% to $31.8 billion for the half, while identical-supermarket sales for the quarter jumped 5.1% including fuel and 3.4% excluding fuel -- by either measure, the highest supermarket IDs since the company's 1999 merger with Fred Meyer Inc., and the eighth consecutive quarter of positive IDs, excluding fuel. Kroger said it expects ID sales for the year, excluding fuel, to exceed 3%.
Noting that Kroger was able to achieve strong growth "without a punishing gross margin investment," Perry Caicco, an analyst with CIBC World Markets, Toronto, said, "The company is benefiting from its painfully established price leadership, the consistency of its operations and, no doubt, from the 44% of its stores that share markets with the faltering Albertsons. [Kroger] should continue to benefit from a steady bleeding of sales and demoralized culture at Albertsons, which could persist deep into 2006."
John Heinbockel, an analyst with Goldman Sachs, New York, said Kroger's comp sales are at nearly the same level as those of Wal-Mart Stores, Bentonville, Ark., although he noted that Wal-Mart's comp-store food sales are better at 5% with a less-mature store base. "That strength reflects the maturation of Kroger's pricing and merchandising initiatives and ongoing fallout of weak competitors. With Winn-Dixie having just closed over 200 stores, not all in Kroger markets, and Albertsons likely to exit Texas, Arizona and Colorado -- markets in which Kroger will be one of many piecemeal buyers -- good sales momentum should continue."
Chuck Cerankosky, an analyst with KeyBanc Capital Markets, Cleveland, told SN he was impressed with Kroger's second-quarter results. "Even without fuel, the comps were very strong because Kroger is priced right and merchandised right, and it's taking full advantage of competitors that may not be as well-merchandised or that have distinct operating problems."
Andrew Wolf, an analyst with BB&T Capital Markets, Richmond, Va., said Kroger's financial results are the culmination of investments made in previous quarters. "Kroger didn't achieve those numbers overnight," he told SN. "They are the result of better pricing and promotional programs over the last couple of years. And getting customer counts up is very impressive -- something we haven't seen any of the big three able to do for years."
Although improving results in Southern California were significant contributors to Kroger's second-quarter gains, more than half the improvements came from outside that area, David B. Dillon, chairman and chief executive officer, Kroger, said during a conference call with analysts. "Our commitment to place the customer first helped drive growth in customer traffic and average transaction size," he explained, with about two-thirds of the gains coming from increased transaction size and one-third from increased customer counts.
Net income rose 38% to $196.5 million for the quarter and 21.1% to $490.7 million for the first half, while sales rose 6.8% to $13.9 billion for the quarter and 6.5% to $31.8 billion for the half.
Operating, general and administrative expenses, exclusive of fuel, declined 22 basis points in the second quarter to 18.23%. Kroger explained that expense reductions were limited as it is investing in store labor to provide better service at the same time it's investing in price.
"We invest some in price and some in service," Michael Schlotman, senior vice president and chief financial officer, said. "As we save dollars, we turn around and invest some of those dollars in additional hours in the stores to provide a better shopping experience to our customers, so we aren't taking all the leverage and all the savings to the bottom line."
"That's a good point," Dillon added. "Some of that spending is in the form of additional service -- at the front end, in our delis and other places in the store. So looking at the total numbers will have the effect of increasing some of our costs as well."
Kroger's recovery from the 141-day labor dispute in Southern California that ended in February 2004 "remains on track," Dillon said, with the chain's Ralphs and Food 4 Less stores there combining for increased identical-store sales of 2.9% -- though he acknowledged IDs at Ralphs are still negative while those at Food 4 Less are positive.
However, total sales in Southern California have not returned to pre-strike levels, he noted, because the company has closed "a couple of handfuls" of stores there, "and that would cause our total sales actually to be less than what we had at that time," Dillon said.
MUM ON ACQUISITIONS
Analysts appeared to be trying to prod Kroger executives into revealing whether they might be interested in acquiring any divisions of Albertsons that might become available in the wake of Albertsons' announcement that it contemplates a sale of the entire company. However, Dillon did not take the bait.
In response to one question, Dillon said he wasn't aware of any changes in the government's approach to antitrust.
When another analyst asked if Kroger might consider an acquisition that's larger than a fill-in, given the overall improvement in its performance, Dillon replied, "I don't think we're going to talk about acquisitions going forward."
Dillon said Kroger remains most interested in fill-in acquisitions in existing markets "[because] we think we've had the best results in those markets."
He noted Kroger entered the Chicago market with nine Food 4 Less stores to date, "[but] we want to be careful when we go into a new market like that [because] you are an unknown quantity and it's a lot harder to get started, so we want to be cautious about not trying to bite off more than we can chew. But we evaluate things as they come up."
In response to a question, Dillon said Kroger doesn't have enough data yet to determine whether higher gas prices are affecting shopping habits. "From what I've read, there could be some trip consolidation that is causing some of our sales to improve, mostly because people are staying closer to home and keeping the drives shorter."
Regarding the impact of Hurricane Katrina on the company, Dillon said Kroger has three stores in the Gulfport, Miss., area that it no longer operates -- one is vacant and two are subleased -- "and we could have some liability there, though it's too early to tell," he said.
However, he anticipates costs will go up as a result of the hurricane because of increased diesel costs, disruptions of products and packaging, and the need to re-route some products.