Hurricane Damages Kroger Q3

Industry analysts were generally upbeat last week about the long-range prospects for Kroger Co., despite a drop in third-quarter earnings resulting primarily from the impact of Hurricane Ike. Net income for the quarter fell 6.3% to $237.7 million, including an after-tax charge of $15.9 million, or 3 cents a share, related to the chain's $25 million deductible for disruption and damage

CINCINNATI — Industry analysts were generally upbeat last week about the long-range prospects for Kroger Co. here, despite a drop in third-quarter earnings resulting primarily from the impact of Hurricane Ike.

Net income for the quarter fell 6.3% to $237.7 million, including an after-tax charge of $15.9 million, or 3 cents a share, related to the chain's $25 million deductible for disruption and damage caused by Hurricane Ike in September, which affected stores from Texas through the Upper Midwest. Excluding the charge, net income for the quarter was virtually flat.

Sales for the quarter jumped 9% to $17.8 billion, and identical-supermarket sales, excluding fuel, rose 5.6%.

For the year to date, net income increased 5% to $900.2 million, while sales climbed 10.9% to $58.7 billion. Identical-store sales, excluding fuel, were up 5.4%.

David Dillon, chairman and chief executive officer, said ID sales during the first four weeks of the fourth quarter were running “just a tick below 5% without fuel,” acknowledging some slowness in sales of discretionary general merchandise and jewelry “that continues to get worse.”

Dillon said Kroger was raising earnings guidance for the year to a range of $1.88 to $1.91 per share, compared with its earlier guidance of $1.85 to $1.90, with a forecast of 49 cents to 52 cents per share in the fourth quarter — slightly below consensus expectations of $1.91 and 53 cents, respectively, analysts pointed out.

The company also confirmed ID sales guidance for the year in the range of 4.5% to 5.5%, excluding fuel — suggesting fourth-quarter ID sales in the range of 2% to 5%, they said.

Dillon said Kroger expects ID sales for 2009 to fall in a range of 3% to 5% and product cost inflation next year to end up in the range of 2% to 3%.

Rodney McMullen, vice chairman, said Kroger intends to pass through all cost reductions as supplier prices drop. “We do not view lower product costs as a margin-expansion opportunity, in line with our overall customer-focused strategy,” he explained.

John Heinbockel, an analyst with Goldman Sachs, New York, said Kroger may be overly cautious in its guidance.

“Third-quarter operating momentum was strong and in line with expectations, and fourth-quarter guidance was conservative, given the economy and perhaps uncertainty with respect to [inventory valuation],” he said. “We would place more weight on the business' healthy momentum, especially the top line, than forward guidance, particularly from a habitually cautious company in the midst of the most substantial consumer slowdown in decades.”

Karen Short, a New York-based analyst with FBR Capital Markets, Arlington, Va., was also positive in her outlook. “While third-quarter [cost controls] were not as solid as we would have hoped and some headwinds will likely surface next year, Kroger remains better positioned than the conventional peers to weather the storm in a turbulent economic environment,” she said.

Andrew Wolf, an analyst with BB&T Capital, Richmond, Va., was a bit more pessimistic.

“The reality of the economy is hurting Kroger a little,” he told SN. “Although they raised guidance, the numbers are actually slowing a little.”

Among other topics discussed in the conference call:

  • Capital spending: Dillon said Kroger is on track to spend $2 billion to $2.2 billion on capital projects this year, and the chain expects to spend a similar amount in fiscal 2009, he said. “We think that kind of spending level is appropriate, given the remodel activity we have planned as well as some of the infrastructure spend that we anticipate,” he said, though he was not specific

  • The LIFO (last-in, first-out) inventory charge nearly tripled to $68.8 million, compared with $23.8 million a year ago, primarily reflecting the effect of rising food inflation on the company's merchandise inventory valuation, McMullen said.

    He said Kroger is estimating a LIFO expense for the year of close to $200 million — up from its earlier estimate of $160 million — “which may seem counter-intuitive when certain commodity prices have declined from historical highs,” he noted.

    “But while prices of some commodities have leveled off or dropped, we continue to receive cost increases from several product suppliers. During the third quarter, our estimated product cost inflation was roughly 6%, with levels of over 7% in many Center Store grocery categories.”

    Kroger continues to use the LIFO method of accounting for product inventories, McMullen explained, because even though the non-cash charge hurts earnings, “it ultimately helps cash flow, and we believe that's a wise trade-off. To maximize this benefit, Kroger carries over 95% of its inventory balance on LIFO, which is higher than nearly all our supermarket peers.”

  • Accelerated sales of corporate brands: Private label rose to almost 27% of all grocery sales and 34% of grocery units during the quarter, Dillon said. “We see solid growth in this area, even after the economy recovers,” he added.

  • Accelerated sales of prepared foods “as people choose to dine out less often and eat at home — a continuation of a trend we've seen for some time,” Dillon pointed out, noting that the third quarter was the 11th consecutive quarter in which ID sales in the chain's deli departments were running above 6%.

  • The impact of lower gas prices: “We've seen customer traffic increase, and our transaction size has increased, but there is quite a bit of inflation in that number,” Dillon explained. “We've actually had a stronger increase in the number of transactions than we have in the average sale, and though the average sale is strong, it's due in part to the inflation.”

Q3 RESULTS
Qtr Ended 11/8/08 11/10/07
Sales $17.6B $16.1B
Change +9%
Comp-store* +5.6%
Net Income $237.7M $253.8M
Change -6.3%
Inc/Share 36 cents 37 cents
Year to Date 2008 2007
Sales $58.7B $53.0B
Change +10.9%
Comp-store* +5.7%
Net Income (Loss) $900.2M $857.6M
Change +5%
Inc/Share $1.36 $1.22
* ID SALES, EXCLUDING FUEL