KROGER HIT BY RISING COSTS, COMPETITION

Elliot Zwiebach

CINCINNATI -- Kroger here said last week it is committed to continuing to invest gross profit margin to maintain its sales base, even if that investment results in diminishing returns during the current economic downturn.

The company said gross profit margin will decline 10 to 25 basis points this year, compared with projected increases of 20 to 30 basis points, Joseph A. Pichler, chairman, explained. "Competitive conditions thus far have prevented us from increasing gross profit margin as anticipated, and we are taking the actions necessary to protect our market share," he said.

Because of the ongoing decline in gross margin, Pichler said Kroger is lowering its earnings guidance for the year from the $1.63 per share it projected in March to a range of $1.55 to $1.63 per share.

Speaking with financial analysts last week, Pichler said Kroger had anticipated that competitors would react "pretty swiftly" to the increases in health care, pension and energy costs that affect everyone, "but in some cases, the market has not reacted, which we accept as part of competition, and in those markets we are making the investment necessary to keep pricing competitive."

Kroger's strategic growth plan, initiated 19 months ago, involved lowering gross profit margins in all divisions. "What we've tried to do," Pichler said, "is to target markets where we believe we have the best opportunity to increase market share and to target categories that will move the business. The game is not to win market share at any cost, but to not give up what we have.

"We have the No. 1 or No. 2 share in 41 of the 48 major markets in which we operate, and we're not going to give that up."

When one analyst challenged the company's strategic plan -- noting the company has not seen any lift in identical-store sales after 18 months of margin reductions -- Pichler defended Kroger's strategy. "Our identical-store sales are better than [that of] our peers," he pointed out, "and that's come in an economy that's miserable. Once the economy turns, things will get better."

The strategic growth plan is not cyclical but part of the chain's fundamental strategy, he added, "and it will have the same effect on increasing market share when the economy is on the upswing as it is having in this difficult part of the cycle."

In response to another analyst's question, Pichler said Kroger does not measure market share by quarter, "but we're pleased with our sales in many, many markets."

The conference call followed the release of Kroger's financial results for the first quarter ended May 24, which showed sales up 3.8% to $16.3 billion -- with total food sales climbing 3.5% -- and net income up 15.2% to $351.5 million, or 46 cents per share. Comparable food-store sales, including relocations and expansions and excluding fuel, declined 0.5%, and identical food-store sales, excluding fuel, fell 1.1%.

Pichler said the company was pleased with its performance, "especially in light of continued economic uncertainty, high unemployment and intense competition, and we think our strategic growth plan is the appropriate response to this economic and competitive environment."

He said Kroger is ahead of its goal of achieving cost savings of $500 million by the end of 2003, with savings through the first quarter totalling $377 million. "We believe the continued enhancement of the strategic growth plan will improve our competitive price position in selected categories and markets," Pichler said.

In other comments during the conference call:

Rodney McMullen, executive vice president, said Kroger would consider paying a dividend if its directors determine that will maximize shareholder value. "At recent [stock] prices, we believe that goal can best be achieved by repurchasing stock [rather than paying a dividend]," he pointed out.

David Dillon, president and chief operating officer, said consumer spending habits are unpredictable. "Customers are saving in areas that are personal and specific to them, so it's hard to get an overall view because patterns have been so different. But I can say customers continue to be cautious."

Kroger is "pleased with results and is on target" at its first three Food 4 Less stores that opened in Chicago earlier this year, and three more units are scheduled to open there by year's end, Dillon said. He also said the company is using elements from its Fry's Marketplace stores in Phoenix at other formats. "Instead of moving formats, we try to consolidate our learning and move ideas," he said.