Kroger : First Quarter 2024 Transcript

Corrected Transcript

20-Jun-2024

The Kroger Co. (KR)

Q1 2024 Earnings Call

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The Kroger Co. (KR)	Corrected Transcript
Q1 2024 Earnings Call	20-Jun-2024

CORPORATE PARTICIPANTS

Rob Quast	Todd A. Foley
Senior Director-Investor Relations, The Kroger Co.	Interim Chief Financial Officer, The Kroger Co.
W. Rodney McMullen
Chairman & Chief Executive Officer, The Kroger Co.

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OTHER PARTICIPANTS

Rupesh Parikh	Michael David Montani
Analyst, Oppenheimer & Co., Inc.	Analyst, Evercore ISI
Robert F. Ohmes	Edward Kelly
Analyst, BofA Securities, Inc.	Analyst, Wells Fargo Securities LLC
Zachary Abraham	Kelly Bania
Analyst, Morgan Stanley & Co. LLC	Analyst, BMO Capital Markets Corp.
Ken Goldman	Krisztina Katai
Analyst, JPMorgan Securities LLC	Analyst, Deutsche Bank Securities, Inc.
John Heinbockel	Chuck Cerankosky
Analyst, Guggenheim Securities LLC	Analyst, Northcoast Research Partners LLC
Michael Lasser
Analyst, UBS Securities LLC

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The Kroger Co. (KR)	Corrected Transcript
Q1 2024 Earnings Call	20-Jun-2024

MANAGEMENT DISCUSSION SECTION

Operator: Good morning, and welcome to the Kroger Co First Quarter 2024 Earnings Conference Call. My name is Carla, and I will be coordinating the call today. [Operator Instructions] Please note that this event is being recorded.

I would like now to turn the conference call over to Rob Quast, Senior Director, Investor Relations, to begin. Please go ahead.

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Rob Quast

Senior Director-Investor Relations, The Kroger Co.

Good morning. Thank you for joining us for Kroger's first quarter 2024 earnings call. I am joined today by Kroger's Chairman and Chief Executive Officer; Rodney McMullen and Interim Chief Financial Officer, Todd Foley.

Before we begin, I want to remind you that today's discussions will include forward-looking statements. We want to caution you that such statements are predictions, and actual events or results can differ materially. A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filings.

The Kroger Company assumes no obligation to update that information. After our prepared remarks, we look forward to taking your questions. In order to cover a broad range of topics from as many of you as we can, we ask that you please limit yourself to one question and one follow-up question, if necessary.

I will now turn the call over to Rodney.

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W. Rodney McMullen

Chairman & Chief Executive Officer, The Kroger Co.

Thank you, Rob. Good morning, everyone, and thank you for joining us today. Before we begin, I'd like to provide an outline of our discussion topics this morning. I will start by sharing a recap of our first quarter performance and highlight how we continue to advance our go-to-market strategy.

Which powers our value creation model and drives long-term sustainable growth for our shareholders. Then Todd will cover our financial results for the first quarter. Finally, I will provide a few comments on our proposed merger with Albertsons before we open it up for questions. We're off to a solid start in 2024, reflecting the strength and diversity of our model.

As better-than-expected performance from our grocery business helped us manage fuel and health and illness results that were behind expectations, Kroger is providing exceptional value and a unique omnichannel experience, which combined with strong store execution led to growth in households and an increase in customer visits.

As inflation moderates, we expect customer sentiment to continue improving. But near term, many customers are managing economic uncertainty. While we expect health and Modis profitability pressures to continue into the second quarter, our recent improvement on store execution metrics and strong customer trends give us

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The Kroger Co. (KR)	Corrected Transcript
Q1 2024 Earnings Call	20-Jun-2024

confidence that we are building momentum for a strong back half of the year, and we are well positioned to deliver on our full year guidance.

As we've seen over recent quarters, customers continue to seek value and are shopping with us differently based on their financial situations. Spending from premium and mainstream customers continue to be strong. Mainstream households drove our overall household growth. And we improved our share of wallet with premium customers who are deepening their loyalty, spending more in our fresh departments and enjoying more premium products such as private selection. Within our most budget-conscious households, we are starting to see positive momentum.

And we grew households in this segment after experiencing declines last year. Historic multiyear inflation across the economy, high interest rates and reduced government benefits disproportionately affect these customers and are influencing their spending behaviors.

Kroger's long-standing commitment to low prices and personalized promotions creates real value for our customers at a time when many of them need it more than ever. Food at home continues to be the most affordable meal option for customers.

While food inflation has impacted every meal occasion, inflation and food away from home has been even higher than food at home inflation since 2019. We are committed to making sure our customers can enjoy a great meal experience with zero compromise on quality, selection, value and convenience.

We see a significant growth opportunity to deliver convenient restaurant-quality meals at an attractive value. And we are expanding our ready-to-heat and ready-to-eat offerings. For example, after we revamped our fried chicken recipe, we created a meal bundle, which feeds a family for $3.50 a person, a fraction of what it would cost to eat out at restaurants with quality that's difficult to be.

Every day, we strive to provide an outstanding customer experience and we are focused on sharpening our store execution to do just that. This year, we raised the bar on our full fresh and friendly customer experience metrics, and we are very proud of our store teams who are delivering an even better shopping experience with service metrics at record highs.

To continue the momentum in our grocery business, we are committed to keeping prices low for customers and delivering a consistent experience while growing our pillars of fresh, our brands, seamless and personalization, leading with fresh our store team's primary goal this year is to drive more consistent shopping experience, and that begins with fresh.

We are introducing new technology that's enabling our teams to better track...

[Technical Difficulty] (00:06:04-00:07:41)

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Operator: We have lost connection with today's speaker. Please standby as we try to reconnect with them. Thank you for your patience everyone, we now have the speaker back on the line, please continue.

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W. Rodney McMullen

Chairman & Chief Executive Officer, The Kroger Co.

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The Kroger Co. (KR)	Corrected Transcript
Q1 2024 Earnings Call	20-Jun-2024

...our ongoing work to differentiate and elevate our brands is driving higher profitability. We are identifying new supply sources using more effective promotions and improving product mix, which is contributing to further margin improvements.

Now to seamless, delivery solutions led digital results again this quarter with an increase in both households and visits. Hiccup also had solid growth and focus on delivering best-in-class fulfillment led to strong improvements in key customer experience metrics. This quarter, our teams improved fill rates to a new record high.

Reduced wait time and delivered a significant improvement in perfect orders compared to last year. Through the power of machine learning and AI, we are developing new ways to elevate the pickup experience for customers and at the same time, reduce costs.

With dynamic batching of orders, these tools are providing associates the most effective pick routes which is enabling us to dramatically reduce pick lead time in our highest volume stores. Our customers love the Kroger delivery experience with refrigerated products delivered directly to their doorstep.

As a result, the Kroger delivery network has experienced remarkable growth with sales nearly doubling this quarter versus last year. As we focus on providing an incredible customer experience we are learning and adjusting the delivery network.

A good example of this is our decision in the first quarter to close three spoke locations to reallocate capacity closer to our automated fulfillment centers where we have higher customer density and better order level profitability.

This decision does not impact Kroger's automated FCs or other spoke locations. We remain confident that our Kroger delivery network provides a differentiated customer experience and will continue to be a key pillar of our digital growth strategy.

Turning to personalization, the combination of seamless and our personalization capabilities generated another quarter of digital engagement growth, up 9% compared to the same quarter last year. Personalization enables us to balance the depth and breadth of our promotions more effectively and encourages customers to engage more with us by focusing on promotions that matter most to them. This led to an 18% increase in digital coupon clips compared to last year.

Capturing more digital households is a key to our long-term growth model as these households are more loyal, spend nearly 3 times as much with us, and drive our alternative profit businesses.

By executing our go-to-market strategy, we create momentum in our grocery business. In turn, this creates the data and traffic to accelerate growth in areas like health & wellness and our alternative profit businesses.

Alternative profit businesses had a strong quarter, led by growth in Kroger Precision Marketing. KPM results were in line with what we expected and keep us on track to meet our full year expectations of more than 20% media growth.

Yesterday, KPM continued to broaden its reach by offering its custom audiences an ad measurement capabilities to advertisers on the Meta - social media platforms. This is another important step in KPM's growth, creating more opportunities for clients to reach relevant audiences in more places and providing better transparency to ad effectiveness.

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The Kroger Co. (KR)	Corrected Transcript
Q1 2024 Earnings Call	20-Jun-2024

Health & wellness grew its top line this quarter, however, profitability results were below expectations. We are optimistic about the potential of this area of our business. Our script adherence initiatives are on track and our teams are providing excellent care, which helps patients live healthier lives.

Additionally, our marketing plans and in-store activations, designed to raise awareness and attract new patients, are launching now to help drive growth in the back half of the year.

Turning now to associates. Our associates are doing an excellent job elevating the customer experience and improving our full fresh and friendly metrics this quarter. Team consistency leads to better execution and retention improved again this quarter. We are retaining more associates through a holistic approach, which includes wage and benefit investments and also a focus on associates' well-being.

And this work is being recognized. This quarter, Kroger received the 2024 Platinum Bell Seal for Workplace Mental Health. This is the third consecutive year that we've been recognized with the certification and for the first time, we received the top distinction.

This program recognizes Kroger as an employer who creates a mentally healthy workplace for our associates through culture, benefits, compliance, and wellness programs. We'll continue to invest in our associates. When our associates have a better experience, they provide a better experience to our customers.

With that, I'll turn it over to Todd to take you through our first quarter financial results. Todd?

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Todd A. Foley

Interim Chief Financial Officer, The Kroger Co.

Thanks Rodney and good morning everyone. Kroger's first quarter performance reflects the resiliency of our model, which enables us to manage a variety of economic cycles. The strength of our model, combined with a momentum in our grocery business, gives us confidence to reaffirm our full year guidance, even as we continue to navigate an environment of economic uncertainty.

I'll now take you through our first quarter financial results. We achieved identical sales without fuel growth of 0.5%. As Rodney mentioned earlier, our identical sales were driven by several positive customer metric trends, including increases in total and loyal households and increased customer visits. We continue to see sequential unit improvement, and our teams remain focused on returning to positive units later this year.

Inflation continues to moderate, which is consistent with our expectations at the start of the year. And towards the end of the first quarter, we began cycling the headwinds from the reduction in SNAP benefits.

Digital sales grew by more than 8%, which was led by 17% growth in Delivery Solutions. Gross margin was 22.4% of sales, and our FIFO gross margin rate, excluding fuel, decreased seven basis points.

The decrease in rate was primarily attributable to lower pharmacy margins and increased price investments, partially offset by favorable product mix, reflecting our brand's margin performance.

The slight decline in our FIFO gross margin rate was in line with our expectations. We expect our FIFO gross margin rate to improve beyond our first quarter results, driven by the core components of our margin expansion initiatives.

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The Kroger Co. (KR)	Corrected Transcript
Q1 2024 Earnings Call	20-Jun-2024

During the first quarter, we recorded a LIFO charge of $41 million, compared to a charge of $99 million for the same quarter last year. The decreased charge for the quarter was due to lower inflation expectations for the current year, compared to last year.

The OG&A rate, excluding fuel and adjustment items, increased 22 basis points, driven by planned investments in associate wages and increased incentive plan costs. Partially offset by continued execution of cost savings initiatives.

In the second quarter, we expect the factors identified in the first quarter to continue, leading to a similar to slightly higher OG&A rate. We expect our OG&A rate to improve in the second half of 2024.

We continue to make progress on our digital profitability, delivering another quarter of improvement in our pickup cost to serve. It remains a long-term margin opportunity with runway to improve to increase volume and process enhancements.

Our store associates played a key role in the cost to serve improvements and as Rodney mentioned earlier, did so while they improved key customer experience metrics. Adjusted FIFO operating profit was $1.499 billion. Our adjusted EPS was $1.43 per diluted share, a decline of $0.05 compared to last year.

Fuel continues to be our strategy to build loyalty by providing compelling fewer rewards to customers. We continue to see more reward activity with 8% more redemptions contributing to gallon sales, which outpaced the industry this quarter.

However, our fuel profitability was below expectations this quarter, with our cents per gallon fuel margin down low-single digits, compared to last year. I'd now like to provide a brief update on associates and labor relations.

We continue to invest in our associates, as part of our long-term strategy, resulting in an average hourly rate of $19 an hour, at a rate of nearly $25 with comprehensive benefits factored in.

During the first quarter, we ratified new labor agreements for our Houston Clarks and Meat, Mid-Atlantic division stores in West Virginia, South Carolina stores in Colombia and Myrtle Beach and Portland distribution center and drivers covering more than 21,000 associates.

Turning to cash flow, Kroger continues to generate adjusted free cash flow, strong adjusted free cash flow through consistent operating results, which is enabling us to continue deleveraging in anticipation of our merger with Albertsons. At the end of the quarter, Kroger's net debt to adjusted EBITDA ratio was 1.25, compared to our target range of $2.3 million to $2.5 million.

Our strengthened balance sheet provides ample opportunities for Kroger to pursue growth and enhance shareholder value. We continue to take a disciplined approach to deploying capital, with a focus on projects which drive long-term sustainable net earnings growth.

While remaining committed to our investment-grade debt rating, increasing our dividend over time subject to Board approval and returning excess capital to shareholders when we are able to do so. As part of our capital investment plans for 2024, we shared last quarter our plans for approximately 30 major storing projects focused on higher growth geographies, where we have traditionally achieved a strong ROIC and operating profit growth.

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The Kroger Co. (KR)	Corrected Transcript
Q1 2024 Earnings Call	20-Jun-2024

We've made good progress on our projects so far and remain on track with our plans. While early, we're happy with the results from projects completed in the first quarter. We are confident these new storing projects will help advance our omnichannel strategy and be an important component to our sales growth and TSR model going forward.

During the first quarter, we announced we had entered an agreement for the sale of our Kroger Specialty Pharmacy business. As part of our regular and ongoing review of our portfolio, we determined that Specialty Pharmacy was not part of our core strategy going forward and the sale will enable us to focus on our health and wellness strategies that revolve around our retail pharmacies.

Due to the sale, a non-recurringheld-for-sale tax adjustment of $31 million was recognized in the quarter, and it has been reflected as an adjustment item in our results. The sale of KSP is not expected to have an impact on our 2024 guidance.

I'd now like to provide some additional color on our outlook for the rest of the year. Today, we reaffirmed our annual guidance, reflecting both positive momentum we are seeing in our business, along with a more cautious customer environment in the near-term. In terms of quarterly cadence, we now expect a decline in adjusted EPS for the second quarter, similar to the rate we observed in the first quarter as we expect pharmacy business profitability pressures to carry over into the second quarter. This reaffirms where we expected to be through both the first half of the year as well as the full fiscal 2024.

In closing, our first quarter performance reflects the strength and resiliency of our model. We are strengthening our grocery business, which drives the data and traffic to accelerate growth in our alternative profit businesses and we remain confident in our ability to drive attractive and sustainable returns for our shareholders.

I'll now turn the call back to Rodney.

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W. Rodney McMullen

Chairman & Chief Executive Officer, The Kroger Co.

Thanks, Todd. As you've heard from both of us, our grocery business is performing well, and we are building momentum across our business. Kroger is operating from a position of strength. We have the right strategy, which is resonating with customers, and we have the financial strength to pursue growth and enhance shareholder value.

As we continue to prepare for our merger with Albertsons, I'd like to thank our associates for their incredible commitment. Since we announced the proposed merger back in October of 2022, our associates have done an exceptional job preparing for the integration with Albertsons, while never once taking their eye off the ball of serving our customers, advancing our strategy, operating our business and driving results. Because of their efforts, we will be prepared to hit the ground running as a combined company, ready to serve more customers from day one.

As a more general merger update, in April, we announced an expanded divestiture plan with C&S, which directly responds to the concerns raised by federal and state antitrust regulators regarding the original agreement. We believe the package, which includes a modified and expanded store set and more non-store assets, bolsters Kroger's position and regulatory challenges to the proposed merger, including our upcoming court proceedings. It also positions C&S to be a strong and successful competitor. We are prepared to defend our merger because it will produce meaningful and measurable benefits for customers, for associates, and for communities across the country. Customers will benefit from lower prices and more choices following the merger close.

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The Kroger Co. (KR)	Corrected Transcript
Q1 2024 Earnings Call	20-Jun-2024

We have committed to investing $500 million to begin lowering prices day one following close, along with an additional $1.3 billion to improve Albertsons stores. Employees will benefit from Kroger's commitment to invest $1 billion to raise wages and comprehensive benefits, further building on our $2.4 billion in incremental investments since 2018. As union membership continues to decline nationwide, this merger will secure union jobs and communities will benefit from the strength and the ability of the combined company to accelerate Kroger's commitment to ending hunger. As a combined company, Kroger has committed to donating 10 billion meals to families across the US by 2030.

In closing, Kroger is off to a solid start to the year, positioning us well to deliver on our commitments. We continue to invest in associates and the associate experience. Because when they have a better experience, our customers do as well. Grocery results are off to a better-than-expected start, which provides the foundation for growth in alternative profit businesses. And our model is generating strong free cash flow, which has strengthened our balance sheet and positions us for future growth.

With that, Todd and I look forward to taking your questions. Because we are in litigation, we will not be taking questions on the merger this morning.

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QUESTION AND ANSWER SECTION

Operator: [Operator instructions] And our first question comes from Rupesh Parikh from Oppenheimer.

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Rupesh Parikh

Analyst, Oppenheimer & Co., Inc.

Q

Good morning, and thanks for taking my question. So I want to dig deeper into the gross margin line. If you can maybe walk us through the puts and takes as you guys see it for the balance of the year, including how you think about the pharmacy margins in the back half of the year?

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Todd A. Foley

Interim Chief Financial Officer, The Kroger Co.

A

Yeah. Thanks, Rupesh. Great question. We talked at the beginning of the year that our expectation was to have relatively flat year-over-year gross margin, and that is still the expectation. As mentioned in my comments, we do expect results for the balance of the year to improve beyond our Q1 results. And that's really reflective of some of the gross margin expansion efforts that we have going on. They're going actually really well. We alluded to our brands' performance. Our margins and our brands continue to do very well. And as that business continues to grow, particularly in today's environment, we talked about the budget-conscious consumer. And that continues to connect with them. So the growth in that business helps drive the margins, and we expect to see that as the year goes on.

Fresh is another category where we've had meaningful growth. Fresh is doing really well. We've talked a lot about produce, our end-to-end fresh and how that business is growing. And certainly, that comes with higher margins, which has a positive effect on our mix. And then when you look at alternative profits and in particular, retail media, that business continues to grow well. And especially the second half of the year, we expect retail media to continue its momentum to achieve our growth of in excess of 20% for the year. A lot going on in that space, and we went to a new platform a year ago. And as we went and ramped up the platform a year ago, we'll be cycling that period of time with some of the momentum we have in that business.

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The Kroger Co. (KR)	Corrected Transcript
Q1 2024 Earnings Call	20-Jun-2024

So all of those are where a lot of our confidence comes from, and we talk about reaffirming our guidance for the year. And we alluded to some of the pharmacy headwinds. Even though we expect some of those to carry over into the second quarter, I think all of the results that we're seeing from our margin expansion efforts are going to continue to drive us so that we hit our expectations to improve the result relative to Q1.

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W. Rodney McMullen

Chairman & Chief Executive Officer, The Kroger Co.

A

I want to just add a couple of points on Todd's last point. We continue to have good success with value-add product. And typically, that product is something that the customer can eat almost immediately in the car or at home and that's helping on margin and then our sourcing teams continue to have - making progress in cost of goods, which helps as well.

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Rupesh Parikh

Analyst, Oppenheimer & Co., Inc.

Q

Great. And then maybe just one quick follow-up question. In light of some of the competitor announcements of reducing price on certain items. Just wondering how you guys feel about your price gaps today?

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W. Rodney McMullen

Chairman & Chief Executive Officer, The Kroger Co.

A

Yes. If you look at overall, as you know, for the last, I don't know, 15, 18 years, part of the Kroger strategy has always been to invest in pricing every year. And 2024 wouldn't have been any different than any of the previous years. And we continue to execute against that plan of helping the customer stretch their budget.

If you look at where we feel on a relative price position, we feel very good. And one of the things that we - even was glad to see is if you look at the customer that's on a budget for the first time in over a year, we actually had growth in count from that customer base. So overall, we feel good about where we are.

One of the things I always think it's important to remember too is, as a promotional merchant, people buy a lot more when things are promotion. We also have a very sophisticated rewards program that for personalized offers that publicly you wouldn't see and also our fuel rewards. So overall, we feel good about where we are, and we feel good about where we are relative to any of our competitors. Thanks, Rupesh.

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Rupesh Parikh

Analyst, Oppenheimer & Co., Inc.

Great. Thank you. I'll pass it on.

Q

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Operator: The next question comes from Robert Ohmes from Bank of America Merrill Lynch.

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Robert F. Ohmes

Analyst, BofA Securities, Inc.

Oh, hey, Rodney.

Q

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W. Rodney McMullen

Chairman & Chief Executive Officer, The Kroger Co.

Hello.

A

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