Image Source: Kroger Co – Third Quarter of Fiscal 2021 IR Earnings Presentation
By Callum Turcan
Kroger Co (KR) recently reported third quarter earnings for fiscal 2021 (period ended November 6, 2021) that beat both consensus top- and bottom-line estimates, and the retailer also once again boosted its full-year guidance for fiscal 2021. Kroger’s operations include retail store brands such as City Market, Food 4 Less, Fred Meyers, Metro Market, and more, along with its private label brands of consumer staples offerings. Shares of KR have shifted meaningful higher since its latest earnings update as of this writing.
Earnings Update
In fiscal 2020 (period ended January 30, 2021), Kroger put up banner performance due in large part to the “panic” shopping spree brought on by the early phases of the coronavirus (‘COVID-19’) pandemic and sharp increases in at-home cooking activities. Kroger’s identical sales excluding fuel sales (which are inherently volatile) grew 14.1% on an annual basis while its digital sales surged by 116% in fiscal 2020.
For this reason, Kroger stressed its two-year stack performance as compared to its year-over-year performance within its latest earnings press release, a common theme in the retail industry. Kroger noted that its two-year stack identical sales (excluding fuel sales) grew by 14.0% last fiscal quarter and was up 3.1% on a year-over-year basis. Additionally, Kroger noted that its digital sales advanced 103% on a two-stack basis in the fiscal third quarter.
Kroger posted 7% year-over-year growth in its GAAP revenues in the third quarter of fiscal 2021 as the company was able to keep its shelves stocked during a period of robust consumer demand. According to Kroger’s earnings press release, its FIFO gross margin excluding fuel fell ~40 basis points year-over-year last fiscal quarter to ~21.7%, with the decline due primarily to “higher supply chain costs and continued price investments partially offset by sourcing benefits.” By price investments, Kroger is referring to discounts to maintain its market share in the incredibly competitive retail space.
The company’s GAAP operating margin climbed modestly higher year-over-year in the fiscal third quarter (up roughly six basis points), hitting just over 2.7%. Economies of scale were key here as its ‘operating, general & administrative’ expenses as a percent of revenue fell sharply year-over-year last fiscal quarter, offsetting its ex-fuel FIFO gross margin decline. Kroger’s GAAP diluted EPS fell to $0.64 last fiscal quarter versus $0.80 in the same quarter in fiscal 2020, primarily due to unfavorable swings in its pension plan benefit/costs and investment gains/losses.
During the first three quarters of fiscal 2021, Kroger remained a cash flow cow. It generated $4.8 billion in net cash from operating activities while spending $2.0 billion on capital expenditures, allowing for $2.8 billion in free cash flow. Kroger spent $0.4 billion covering its dividend obligations during this period along with another $1.0 billion buying back its stock.
The company exited the third quarter of fiscal 2021 with an $11.4 billion net debt position (inclusive of short-term debt and finance lease obligations, exclusive of store deposits in-transit) or $11.8 billion when excluding its ‘cash’ line-item, given the need to maintain a level of cash at its physical store operations (including in its cash registers). Kroger’s $2.0 billion in ‘temporary cash investments’ line-item at the end of its fiscal third quarter better reflects the cash pile that it can use to pay down debt, expand its business, and repurchase its stock, along with other corporate purposes.
Kroger noted in its latest earnings press release that it generated $7.0 billion in non-GAAP adjusted EBITDA during the four quarter period that ended last fiscal quarter, allowing the firm to exit the fiscal third quarter with a net debt to adjusted EBITDA ratio of 1.68x (down from 1.74x in the same period last fiscal year). Please note that while Kroger included its ‘temporary cash investments’ line-item in this calculation, it did not include its ‘cash’ line-item as it concerns the calculation of its net debt to adjusted EBITDA ratio.
Over the long haul, Kroger is targeting a net debt to adjusted EBITDA ratio of 2.30x-2.50x. As its leverage ratio was well below that target last fiscal quarter, Kroger sees itself retaining ample financial firepower. However, we caution that the company’s net debt load, relatively to its free cash flows, remains rather high. Share buybacks and dividend growth are core capital allocation priorities for Kroger.
Guidance Update
In the upcoming graphic down below, Kroger lays out its improved guidance for fiscal 2021 (provided in conjunction with its latest earnings report) versus its previous expectations laid out in September 2021. Please note Kroger also raised its full-year guidance when reporting its first and second fiscal quarter earnings updates. We appreciate that Kroger now expects to generate $2.4-$2.6 billion in free cash flow (as defined by the company) this fiscal year, up from previous guidance.
Image Shown: Kroger raised its full-year guidance for fiscal 2021 in conjunction with its third quarter of fiscal 2021 earnings update. Image Source: Kroger – Third Quarter of Fiscal 2021 IR Earnings Presentation
The retailer exited the fiscal third quarter with $7.5 billion in inventory, up marginally year-over-year, and appears well-positioned to meet robust consumer demand during this current holiday shopping season.
Digital Update
In September 2021, Kroger launched its ‘Kroger Delivery Now’ offering in a partnership with privately-held Instacart to provide quick home delivery services. Kroger also recently launched an annual membership program, Boost by Kroger Plus, that offers free delivery services and enhanced fuel points for customers. The firm is supporting its e-commerce growth initiatives by expanding and upgrading its fulfillment operations.
Kroger and Bed Bath & Beyond Inc (BBBY) announced a strategic partnership in November 2021 that involves starting off with relatively small pilot projects at some of Kroger’s retail locations as well as an e-commerce collaboration component focused on home and baby products. During Kroger’s fiscal third quarter earnings call, management had this to say on the retailer’s digital operations (emphasis added, moderately edited):
“We launched three new offerings during the quarter that support the plan to double digital sales and digital profitability by 2023. First, Boost by Kroger [Plus] builds on our industry leading loyalty program to deliver additional savings and personalized offers to our members. We are encouraged by the initial engagement in the program, which is ahead of internal expectations.
Second, we launched Kroger Delivery Now in partnership with Instacart. This unique convenience and immediacy offering positions us to win more trips with current customers and to bring new customers to the Kroger ecosystem by offering the largest selection of quality fresh products at affordable prices in 30 minutes. Here’s what’s so special about this offering. It was profitable on day one, contributing to our goal to double digital profitability [by] 2023 that was announced during our 2021 Investor Day.
And third, we announced a strategic collaboration with Bed Bath & Beyond… that will expand our current marketplace offering and provide Kroger shoppers easy access to essential home and baby products. This exclusive offering will be available through both Kroger.com and on a small scale physical store pilot and select stores beginning in 2022.” — Rodney McMullen, CEO of Kroger
In March 2021, Kroger hosted a big investor day event and laid out how it would aggressively grow its digital sales and profitability levels going forward. Management appears comfortable with Kroger’s performance on this front so far, though competition in this industry remains fierce.
Concluding Thoughts
Kroger has been performing well of late, though as of this writing, shares of KR are trading above the top end of our fair value estimate range (which sits at $43 per share). Shares of KR yield ~1.9% as of this writing, though its large net debt load weighs negatively on its dividend strength. We see better opportunities out there.
For investors interested in the consumer staples sector, we include the Vanguard Consumer Staples Index Fund ETF (VDC) in the High Yield Dividend Newsletter portfolio (more on that here) to gain diversified exposure to many of the best companies in this sector. The VDC ETF had modest exposure to Kroger at the end of October 2021. Many of these companies have ample pricing power and are great cash flow generators. However, we caution that many of these firms also have relatively large net debt loads and are contending with longer term headwinds regarding their revenue growth potential, dynamics that should not be overlooked by investors when analyzing this sector given the valuations many of these firms are currently trading at.
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Callum Turcan does not own shares in any of the securities mentioned above. Philip Morris International Inc (PM) and Vanguard Consumer Staples ETF (VDC) are both included in Valuentum’s simulated High Yield Dividend Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.