Kroger expecting slow climb from deflation

Officials of Kroger on Thursday acknowledged they were likely experiencing the worst effects in a prolonged stretch of deflation — and expected it would come out of the rut as gradually as it went in.

As previously reported, falling prices for items like milk, eggs and cheese contributed to non-fuel identical-store sales of 0.1% during the third quarter ended Nov. 5 — Kroger’s smallest gain in that metric since posting negative comps in the second quarter of fiscal 2003.

Mike Schlotman, Kroger’s CFO, said deflation in the quarter accelerated to about 1.5% overall, from 1.3% in the second quarter. In addition, he said, comps were negatively affected by subsiding inflation in pharmacy; by an increase in relocated and expanded stores falling out of the comp base; and by more cannibalization from new stores than a year ago.

“We’re in the middle of the cycle now – and it’s not fun,” CEO Rodney McMullen remarked.

McMullen compared the current streak of deflation — now approaching a full year — to the five-month stretch of lower prices affecting grocers in 2002, saying the onset in both cases was gradual and supply-driven, as opposed to the stretch of 2009 deflation brought about by abrupt economic chaos.

That, however, portends to a gradual easing of deflationary pressures, he predicted. “The cycle coming out,” he said, “will be driven by what caused you to go in.”

Schlotman said falling prices for milk, eggs and cheese alone accounted for about a 50-basis point impact to comp sales in the quarter. And while those items, like milk, are seeing improved input costs already, they are still down as compared to the previous year.

“Milk and cheese looks like it may be bottoming, but that doesn't mean things turn around on a dime as raw material input costs change,” he said. “There's usually a lag from that bottom and a slight flip up in those costs until you start to see any effect on retail pricing.”

Kroger accentuated a few positive trends, including better tonnage results, many resulting from larger pack sizes triggered by deflation; and sales of items like sushi, wine, Starbucks coffee and natural and organic products led by its fast-growing Simple Truth brands.  “If you can drink it or snack on it, it's selling,” he remarked.

Those trends are balanced out somewhat by economic concerns among consumers. “Customers are telling us they expect the economy to get worse in the next three months,” McMullen said.

Some analysts appeared alarmed at the ID sales figure, considering Kroger guided to 0.5% to 1% range at an investor conference only weeks before the end of the quarter.

Schlotman however tried to put it in perspective, saying a miss in the low range appeared worse than the same variance would had comps been higher.

“It takes about $23 million of sales to move our IDs by 10 basis points,” he explained. “When you're plus or minus $23 million in a two- or three-day time frame — or even $40 million in a two- or three-day time frame — when you're at 4% or 4.5% [ID sales], it's a blip on the radar screen. When you're between flat and 50 basis points of identicals, it's a huge percentage move.”

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