After reporting a positive earnings surprise of 15.9% in the first quarter of fiscal 2018, The Kroger Co. (KR - Free Report) again delivered better-than-expected second-quarter bottom-line results. The top line also came ahead of the Zacks Consensus Estimate for eighth straight quarter.
However, identical sales, without fuel, fell short of analysts’ expectation. Moreover, gross margin continues to contract. Further, in spite of reporting better-than-expected results, management maintained its full-year adjusted earnings per share view. These were not well perceived by investors and consequently, shares of this grocery retailer fell as much as 9% during the pre-market trading hours.
The company delivered adjusted earnings of 41 cents a share that beat the Zacks Consensus Estimate of 38 cents and increased 5.1% from the prior-year quarter. This Cincinnati, OH-based company continues to envision adjusted earnings in the range of $2.00-$2.15 per share. The current Zacks Consensus Estimate for fiscal 2018 stands at $2.12.
However, the company revised its GAAP net earnings view to $3.88-$4.03 per share from its previous range of $3.64-$3.79 owing to the unrealized gain in Ocado shares, recorded in the quarter under review.
Total sales grew 1% to $27,869 million from the prior-year quarter and came marginally ahead of the Zacks Consensus Estimate of $27,823 million. Excluding fuel, the convenience store business unit divestiture and the merger with Home Chef total sales jumped 1.8%. Digital sales surged more than 50% during the quarter under review.
The company’s identical sales, excluding fuel center sales, grew 1.6%. Kroger projects fiscal 2018 identical sales growth, excluding fuel, to be in the range of 2-2.5%.
We note that gross margin contracted 40 basis points to 21.3%, after shrinking 30 basis points in the preceding quarter. Meanwhile, excluding fuel and the LIFO charge, gross margin fell 36 basis points during the quarter under review, after declining 13 basis points in the first quarter. Management hinted that gross margin rate reflected price investments, higher transportation costs and growth of the specialty pharmacy business.
Kroger Ups the Grocery Retail Game
The grocery industry has been undergoing a fundamental change, with technology playing a major role and the focus shifting to online shopping. Kroger, which faces stiff competition from bellwethers such as Walmart (WMT - Free Report) and Amazon (AMZN - Free Report) , has taken the stock of the situation and is in the process of giving itself a complete makeover. The company is expanding store base, introducing new items, digital coupons, and order online, pick up in store initiative. The company’s “Restock Kroger” program is also gaining traction.
In order to bolster its omni-channel capabilities, Kroger acquired meal kit provider, Home Chef. The company also partnered with British online grocery delivery company, Ocado that reinforces its position in the online ordering, automated fulfillment and home delivery space. The company’s latest deal with Nuro — the maker of driverless road vehicle — to deliver groceries at customers’ door steps using autonomous vehicles is just another game plan to take on rivals.
Kroger launched “Our Brands” internationally, making Simple Truth products such as nuts, dietary supplements etc. available in China by joining forces with Alibaba's Tmall platform. Taking forward its partnership with Instacart, the company plans to enhance its customer delivery coverage area to 75 more markets by the end of the October. The company also launched a grocery delivery service “Kroger Ship”.
Moreover, after the sale of its convenience store business earlier this year, the company has now started searching strategic alternatives for its Turkey Hill Dairy business, including a potential sale. Clearly, the company has been narrowing its non-grocery footprint and making investments to expand its grocery offerings as well as e-commerce presence.
These endeavors have helped the shares of Kroger to surge 21% in the past three months compared with the industry’s growth of 15%. We believe that the company's operational strategies present enormous opportunities to augment identical sales and enhance return on invested capital.
Other Financial Aspects
Kroger ended the quarter with cash of $316 million, total debt of $14,532 million, and shareholders’ equity of $7,338 million. Total debt increased $484 million from the prior-year period. The company's net total debt to adjusted EBITDA ratio jumped to 2.59 compared with 2.37 in the year-ago period. In the trailing four quarters, the company bought back $2.6 billion of shares and paid $435 million in dividends.
Management continues to project capital expenditures — excluding mergers, acquisitions and purchases of leased facilities — to be approximately $3 billion for fiscal 2018.
We believe that Kroger’s dominant position enables it to expand store base and boost market share. The company’s customer-centric business model provides a strong value proposition to consumers. However, intensifying price war among grocery stores to lure budget-constrained consumers poses concern.
Kroger carries a Zacks Rank #3 (Hold). A better-ranked stock includes The Chefs' Warehouse, Inc. (CHEF - Free Report) having a long-term earnings growth rate of 22% and a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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