Kroger Sales Soar in Q3, but Investors Want More

CINCINNATI — A heavy round of pricing investment drove robust quarterly sales for Kroger, but not everyone approved.

Shares in the retailer here dipped more than 6% after Kroger said it invested much of a $40 million tax benefit in lower retail prices and service initiatives during the fiscal third quarter, which ended Nov. 10. The investments helped quarterly sales zoom up nearly 10%, but the resulting pressure on margins — combined with investors' feeling that they should have received a more direct share of the tax break — left Kroger officials defending their actions amid probing questions from analysts, some of whom sounded irritated to learn that the company had thrown off their financial predictions.

“If you look at how we spent the cash flow from a shareholder point of view, it's a good thing,” contended David Dillon, chief executive officer, after one analyst chastised the company for encountering “unusual items” like the tax break too frequently in recent quarters.

“We think calling out these unusual items is helpful to you, not hurtful to you,” Dillon added. “We could have left them all alone this quarter and you wouldn't have known the difference. Well, you would have known the difference, because our stock would have been up by $3.”

Dillon's defense also revealed that Kroger's “customer first” strategy — which involves investing cost savings in lower shelf prices and service initiatives — may call for quick strikes when the opportunity presents itself. For Kroger, the tax benefit — combined with declining margins due to rising gasoline prices — provided just such an opportunity.

“I think it's important to recognize that [the accelerated pricing investment] wasn't just some promotional strategy that we did sort of on a whim because we had money available to spend, but rather it was part of a plan where we actually have the strategies worked out in our minds over time,” he said. “We were trying to pick the best time, best circumstance and best competitive situation in which to introduce them.”

He also maintained that despite the erratic quarterly results, performance for the fiscal year would be slightly better than the range officials had been forecasting from the beginning of the year.

Quarterly earnings of $253.8 million, or 37 cents per share, came in above analyst expectations of 35 cents, but below what might have been expected if Kroger had not received the tax benefit, analysts explained.

“If you exclude the tax benefit, they missed expectations,” Neil Currie, an analyst for UBS, New York, told SN. “But what Kroger sees is a long-term opportunity to press its advantage over competitors with lower prices and better service. This [tax] windfall they received, rather than give it to shareholders, they gave it to customers. It's not different from what they've been doing, it was just unexpected.”

Dillon also tried to defuse speculation that the price investment was driven by a reaction to a slowing economy, saying the company is less likely to invest when it feels consumers won't spend.

“The time you don't want to invest is when you think putting additional money won't produce additional sales and won't have a desired effect with the customer, and there are times when that happens,” Dillon said. “If the customers are behaving in a sense that says they don't want to spend money, you can sense that. That's not a particularly good time to spend money. But we are not sensing that situation right now.”

Gross margin as a percent of sales decreased 101 basis points, to 23.4%, as gasoline sales made up a larger part of the overall sales mix while gas prices continued to climb, officials said. Dillon acknowledged this could result in erratic margin performance quarter-to-quarter.

“I really don't care if the performance is volatile, as long as returns are attractive and it adds to the business in other ways,” Meredith Adler, an analyst with Lehman Bros., New York, told SN. “And this is something they can't manage one quarter at a time.”