The Restock Kroger transformation plan is yielding results, but bruising competition is pressuring profits and clouding the short-term outlook.
Although the specter of the Amazon and Whole Foods combination and competition with Walmart continues to hang over Kroger, the nation’s largest supermarket operator delivered on key metrics in the fourth quarter, fell short on others and offered a concerning profit outlook for 2018.
Kroger grew identical store sales 1.5% in its fourth quarter, gained market share for the 13th consecutive year according to IRI data and increased profits by 19% as it pursued a wide range of initiatives that are part of the Restock Kroger transformation program launched last fall. Click and collect service expanded to nearly 1,100 locations and private label sales increased to $20.9 billion and now account for 26% of Kroger sales excluding fuel and pharmacy. Within private label, the company’s Simple Truth brand topped sales of $2 billion just five years after launching.
“We launched Restock Kroger in the fall of 2017 and finished the year with positive momentum in our sales and overall business,” Kroger Chairman and CEO Rodney McMullen said. “Customers are letting us know that they see, feel and appreciate our efforts to redefine the customer experience – and they are rewarding us with growing loyalty. This is the cycle that creates long-term value for shareholders.”
The long-term is something Kroger executives remind analysts about often, cautioning against reading too much into 30 basis points of margin compression in the quarter and whether that is a signal of future erosion. That’s why, despite the company’s many notable accomplishments in the fourth quarter and full year, it was a 2018 outlook that caused concern among investors. Kroger shares declined more than 12% to levels not seen since last summer when Amazon announced its acquisition of Whole Foods and investors grew worried about the prospects for traditional supermarkets.
Kroger this year said it expects identical supermarket sales growth, excluding fuel, to range from 1.5% to 2.0%, a respectable number for a retailer whose selling space is highly productive. However, to drive those top line gains the company’s profit guidance implied margin pressure resulting from investments in price. Earnings per share were forecast in the range of $1.95 to $2.15 means Kroger could experience a profit decline from 2017 adjusted earnings per share of $2.04.
“As I've said before, we're not going to lose on price, but we're not out there trying to lead the market down,” McMullen said during the company’s earnings call. “And as you know, as part of Restock Kroger, we committed to improving operating margin dollars by $400 million over the next three years.”
To deliver on that expectation, McMullen said the company would continue to take costs out of the business through reducing its cost of goods and process improvements. While it does so the company, like many other retailers, expects to benefit from the Tax Cuts and Jobs Act and said the reforms would allow for an acceleration of the Restock Kroger plan.
“We are taking a balanced approach to ensure tax reform benefits our associates, customers and shareholders. What we’ve previously said is that sharing the benefits with our associates and customers will create a more sustainable and stronger business model for the future. This balanced approach is also consistent with our values and Kroger’s purpose, to feed the human spirit,” McMullen said.
Kroger’s definition of balance means that shareholders will benefit from approximately a third of the tax savings flowing through to net earnings and customers will benefit from strategic investments to continue redefining the grocery customer experience through a combination of improved services, reduce prices and increased convenience. As for employees, Kroger said it is forgoing the one-time bonus approach seen from other retailers, a move that generated favorable but fleeting publicity, to develop a plan to invest in long-term benefits including education, wages and retirement.