CINCINNATI — Gaining sales in the current environment is turning out to be more costly than Kroger anticipated, but the retailer isn't apologizing for it.
A combination of rapidly escalating deflation and increasing price competition pressured Kroger to invest more in margins to spark sales in the fiscal second quarter, officials said last week. As a result, Kroger fell short of quarterly earnings expectations and lowered its profit forecast for the fiscal year, while eking out 2.6% same-store sales gains.
“Most of us, maybe none of us, have seen a selling environment quite like what we're experiencing right now,” David Dillon, Kroger's chief executive officer, told analysts in a conference call last week. “And we're intent on making sure that it turns into a good opportunity for us.
“We realize that our gross [margin] investment was deeper than most of you [financial analysts] had expected, and it was deeper than what we had planned for originally,” Dillon added. “But we made it through the quarter. We made intentional choices to go down this path, because we believed it was the best long-term path for shareholders, associates and our customers.”
The investment in lower prices shaved 88 basis points off Kroger's gross margin percentage for the quarter, which ended Aug. 15. Due mainly to lower input costs, Kroger's overall sales dipped 2% to $17.7 billion, while net earnings decreased by 8% to $254.4 million, or 39 cents a share. Analysts had expected earnings of 44 cents per share.
Earnings expectations for the full year were adjusted downward to between $1.90 and $2 per share, vs. earlier forecasts of $2 to $2.05 a share. This, officials said, reflects an uncertain operating environment and caution on the part of consumers.
Analysts contacted by SN said Kroger was sparked to action by competitors, including Safeway and Supervalu, which in recent months have begun aggressive pricing programs in reaction to the slowing economy. In the meantime, price deflation — sparked in part by lower demand but also by rapid price drops in products like milk and produce — has pressured gross margins.
“The big issue is deflation, and the second biggest issue the competitive activity,” Simeon Gutman, an analyst for CanAccord Adams, New York, told SN. “Kroger has always had a reputation for not managing short-term earnings but for sticking to its long-term strategy, and it's been steadfast about that. And the cornerstone of that strategy has been protecting its price advantage. But when you have a period where every competitor is unleashing some kind of new structural pricing investment, coupled with deflation, you're bound to get overinvestment.”
Kroger's shoppers, according to Dillon, are experiencing “trauma” that is changing their shopping patterns. Stores are seeing a steady increase in food stamps and patterns of decreased shopping at the end of the month. Consumers are shopping more often, he added, but buying less per trip.
“Consumer behavior seems to have gotten even more pecuniary, especially with regard to the paycheck cycle,” Andrew Wolf, an analyst at BB&T Capital Markets, Richmond, Va., told SN. “That's something the dollar stores and Wal-Mart have already seen, but it seems that it's trickled up to supermarkets. That's caused price competition to increase.”
Dillon said the changing patterns had some upside for Kroger in the quarter. Although consumers have cut back on their purchases, they are also consolidating their shopping at Kroger. Overall tonnage was up. The effectiveness of its margin investments would become clearer down the road, but, he noted, the strategy has historically served Kroger well.
Michael Schlotman, Kroger's chief financial officer, said the company has spent more than $115 million so far this fiscal year purchasing leased properties, including one of its warehouses, from landlords. “We expect additional real estate opportunities to come our way,” he said.
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