Kroger: Shrink is down in Q2 as grocer prepares for Albertsons merger

As Cincinnati, Ohio-based Kroger nears the end of its antitrust case this week, the grocer reported better-than expected results in its Q2 earnings report, which gave its stock value a boost on Thursday morning.

Kroger reported earnings 93 cents per share on $33.91 billion in revenue for the quarter. Analyst estimates predicted 92 cents per share on $34.09 billion, according to Earnings Whispers, which provides unofficial on earnings releases. 

Identical store sales, not including fuel, were up 1.2% for the quarter year over year, and digital sales were up 11% for the quarter. 

“The reduction of excess savings built up during the pandemic, higher interest rates and the effect of inflation are pressuring customers’ ability to spend,” said Kroger CEO Rodney McMullen during the company’s quarterly earnings call. “This is especially true for our most budget conscious customers, as we’ve been seeing for a while now, but we’re now seeing other customer segments beginning to make changes as well. Customers are purchasing lower-price cuts of meat, buying less, and focusing on essentials.”

He said the company is responding to the belt-tightening by “keeping prices low through promotions, including loyalty, discounts, personalized offers and fuel rewards.”

Kroger also aims to keep prices low for customers through its multiple private-label brands, which McMullen said outpaced national brand sales growth for the quarter. 

“More than 90% of our customer households purchased our brands’ products during (Q2),” he said. “Across the portfolio of our brands, we are expanding into new categories and launching new products with almost 600 already introduced this year.”

In August 2023, Kroger’s Smart Way brand was identified by data analytics firm Numerator as the fastest-growing private-label brand in the country, outpacing Amazon Basics and Aldi’s private-label products.  

McMullen said Kroger is continuing to expand its private-label product line with the rollout of Field & Vine in August and plans to add new products later this year within its private-label product lineup. 

“As we innovate within the portfolio and expand to meet customer needs, we are improving our mix and driving better profitability,” McMullen said. “For example, our manufacturing plants allow us to make many of our own products, keeping costs lower as we pass those savings on to customers while preserving our ability to grow margins.”

He said Kroger is working to grow its digital sales, and the 11% increase year over year for the quarter was driven by both households and traffic. “This means we are moving customers from simply using our app or website to making purchases through one of these digital channels,” he said, noting that Kroger grew its ecommerce households by 14% year over year in Q2. 

Kroger CFO Todd Foley said digital sales benefited from 17% growth in the company’s pickup and delivery business. 

“Pickup is an important part of our seamless ecosystem, and demand continues to be strong, with pickup sales growing 10%,” Foley said. “This reflects our digital team's relentless focus on delivering a great customer experience, resulting in increased fill rates, a reduction in wait times and a 33% improvement in perfect orders…”

The company remains optimistic about its pharmacy business, and McMullen said Kroger’s pharmacy customers are more loyal to the business than non-pharmacy customers.

The grocery chain reported that pharmacy sales outpaced internal expectations, but profitability was similar to the same period in 2023. Profitability of its pharmacy business lagged internal expectations due in part to strong sales for GLP-1 drugs like Ozempic. 

“We expect GLP-1 to have a similar impact on our results for the remainder of the year,” McMullen said. 

Kroger also touted its progress in reducing shrink for the quarter, helping to bolster its quarterly gross margin of 22.6% of sales. That was partially offset by lower pharmacy margins. 

“The improvement in shrink reflects the significant ongoing work from our operations team as they address this challenging issue,” Foley said. “While we are pleased with the result this quarter, shrink related to theft remains high on a historical basis, and we still have work to do to further mitigate the financial impact.”

Foley said Kroger continued to generate strong adjusted free cash flow during the quarter “and is enabling us to deleverage in anticipation of our merger with Albertsons at the end of the second quarter. The company’s net total debt to adjusted EBITDA ratio was 1.24, outperforming Kroger’s target range of 2.3 to 2.5. 

“The strength of our free cash flow gives us the ability to invest in the growth of our business, we are allocating more capital to our major and minor store projects this year,” Foley said.

Foley noted that this year Kroger has finished “almost double the amount of store projects” as of the same time last year, positioning the company to grow in the second half of 2024 and into 2025. That optimistic outlook has allowed Kroger to raise its full-year guidance for capital expenditures from a range of $3.5 billion to $3.6 billion to a range of $3.6 billion to $3.8 billion. 

McMullen said the company is fortunate to generate “a tremendous amount of free cash flow.” That total share return (TSR) is typically 8-11% a year, McMullen said. 

“That long-term TSR model assumes that we continue to invest in wages, continue to invest in lower prices for our customers,” McMullen said. 

“As you know, fortunately, we generate a tremendous amount of free cash flow. We would expect over time for more of that growth to come from the business, as opposed to buying back stock. And then, once the merger happens, obviously there’s incremental accretion that will happen because of the merger for a period of time that once the merger happens we’ll give more insights into.”

McMullen spoke briefly about the company’s proposed merger with Albertsons but did not take questions on the topic during the Q&A portion of the earnings call. He said the company’s strong free cash flow positions Kroger to invest in the business and drive attractive returns for investors.

In Kroger’s earnings statement, the company said it expects to overcome the legal challenges it faces. 

“As we near the close of the FTC’s preliminary injunction hearing, we are confident in the facts and the strength of our position. The food industry has always been competitive and will continue to be after this merger. We are committed to closing this merger because bringing Kroger and Albertsons together will provide meaningful and measurable benefits — lower prices, secure jobs and expanded access to fresh, affordable food — for customers, associates, and communities across the country.”