Kroger Results Indicate Little Economic Impact

JON SPRINGER

CINCINNATI — It's not the economy, stupid. At least not primarily so.

That was the message from Kroger Co., which, other than noting slightly higher inventory levels from forward buying and a relatively modest 2008 outlook, reported little effect of a worsening economy on sales or earnings during its fiscal fourth quarter. The theme of cost controls and price and service investments that drove results when the economy was roaring has continued to provide benefits now that inflation and fears of a recession have gripped much of the country, David Dillon, chief executive officer, said in a conference call with analysts last week. (Some food retailers are increasingly concerned about escalating inflation and economic pressures. See the results of an exclusive SN survey, beginning on Page 12.)

Food cost inflation during the quarter ended Feb. 2 was, by Kroger's estimation, 3.8% compared with the same period last year, Dillon said. He characterized that as “higher than what we've seen for many years, but still moderate in long traditional terms.”

While Dillon acknowledged that inflation has caused slowdowns in sales of items like jewelry and home furnishings, he agreed it has provided a tailwind for food sales. Identical-store sales increased 8.2% overall, and 5.3% excluding fuel, compared with the same 12-week period last year (the 2006 fiscal year included a 53-week year and 13-week fourth quarter).

John Heinbockel, an analyst for Goldman Sachs, in a research note called the sales performance “heroic in this [macroeconomic] market.” Kroger officials said identical-store sales have continued at about 5% thus far in the first quarter — the high end of its 3% to 5% estimate for the 2008 fiscal year.

“They're showing that the macro backdrop, in good times or bad, doesn't really move the needle. It's just that they're doing a good job as a retailer,” Jay Whitmer, an analyst for Cleveland Research, told SN.

Kroger's sacrifice to the slowing economy was a larger-than-expected buildup of inventories that officials attributed to buying ahead of rising inflation. Kroger took a charge of about $54 million, or 5 cents per share, in the quarter to account for it. Strong sales helped earnings come in a penny ahead of analyst estimates, however.

“We've been fairly deliberate, as we see costs go up, of making sure we have made a conscious choice of how to buy products best to reduce the cost for our customers,” Dillon explained.

The company also released market share figures illustrating that its strategies have been effective, particularly in markets where Kroger competes with supercenters. Dillon said Kroger increased market share by 65 basis points overall in markets where it operates nine or more stores. Of the 44 market areas meeting that definition, market share increased in 37, declined in six and remained unchanged in one, according to Kroger's figures.

In the 36 markets in which Kroger competes with a supercenter that is at least No. 3 in market share, Kroger's market share improved by 95 basis points. When the supercenter is Wal-Mart, Kroger's gain was 80 basis points. This, Dillon said, indicates Kroger wasn't battling Wal-Mart, necessarily, but rather was absorbing a steady flow of business from other food retailers.

Dillon acknowledged inflation was a concern for customers, but “We really do not see clear signs of the customer pulling back,” he added. He said Kroger was able to pass along most of its price increases, and he was cautious not to attribute private-label sales increases solely to concerns over the economy.

“We do see improved sales in Kroger brand, but we've been seeing improved sales in Kroger brand for a number of years now. So, it's not just a result of the economy, it's also the result of what we have done in improved packaging and in quality on Kroger brand,” he said. “We think Kroger is well positioned as a value proposition and better positioned even than in the past. Our strategy, our pricing, our approach, the work our associates do, really position us well to weather this economy, in our opinion.”

Concern for the economy was perhaps best illustrated by a sales and earnings forecast that analysts found conservative, but understandable considering economic uncertainty. The company set low goals last year but twice raised estimates as the year progressed.

Kroger said it expects identical-store sales for the year of 3% to 5%, and earnings per share to range between $1.83 and $1.90. The high-side 5% sales estimate assumes that economic conditions remain as they are currently, said Rodney McMullen, Kroger's vice chairman. The $1.90 earnings figure — the high end of the range — meets analyst consensus estimates.

“The outlook was probably more conservative than investors wanted to hear,” Whitmer said. “But they've set the bar low the last two years as well.”

Karen Short, an analyst with Friedman Billings Ramsey, New York, tempered her expectations of Kroger's share price, saying that although Kroger had “the most sustainable business model” of its supermarket peers, a contracting market and investor uncertainty would likely limit the stock's price ceiling.