In a financial landscape marked by economic uncertainties and shifting consumer preferences, Kroger (KR) recently announced its Q3 (October) results, surprising investors with better-than-expected numbers. This performance provided the impetus needed to propel Kroger shares out of an initial slump, almost returning them to breakeven for the year. In addition to the positive earnings report, Kroger also raised the lower end of its FY24 (January) earnings outlook by $0.05. However, the company did adjust its FY24 identical sales without fuel forecast, acknowledging some ongoing macroeconomic uncertainties.
Kroger’s Q3 Highlights
Despite the economic pressures facing the grocery industry, Kroger managed to deliver impressive headline figures during the third quarter. Adjusted earnings per shareEarnings per share (EPS) is a fundamental financial metric that provides valuable insights into a company's profitability. This widely used indicator helps investors and analysts g... (EPS) saw an 8% year-over-year increase to $0.95. Moreover, the company witnessed a notable improvement in year-over-year revenues, with a mere 0.7% drop to $33.96 billion, in contrast to a more substantial 2.3% decline the previous quarter.
One key factor impacting Kroger’s performance is inflation, which appears to be decelerating. Over the quarter, inflation rates were approximately 270 basis points lower compared to the previous quarter. This situation presents a double-edged sword for Kroger. On one hand, slower price increases provide some relief to consumers, easing their financial burden. On the other hand, the deceleration in price growth translates to lower overall revenue for Kroger.
Continued Growth in Digital Business
Kroger’s ability to adapt to changing consumer habits and embrace digital solutions has been a significant driver of its success. During Q3, the company achieved its tenth consecutive quarter of total household growth. An 11% increase in sales in its digital business played a crucial role in this achievement. Furthermore, the expansion of digital offerings led to a 13% spike in digitally-engaged households, a vital component of Kroger’s business model since these households tend to spend nearly three times more than the average household.
Consumer Behavior Shifts and the GLP-1 Trend
In the broader context of the consumer packaged goods industry, Kroger’s performance stands out. Rival Walmart (WMT) has been taking note of shifts in consumer buying behavior, particularly with the surging popularity of weight-loss medications known as GLP-1 drugs. This trend has prompted cautious investor sentiment toward grocers and other consumer packaged goods companies like PepsiCo (PEP). However, while Kroger has seen rapid growth in GLP-1 drugs across its retail pharmacies, it has not observed any major macro shifts. The company’s management also remains relatively unconcerned about long-term impacts on its business, highlighting its ability to adapt to shifts in consumer preferences.
Notably, the rise in GLP-1 drugs presents opportunities for consumer packaged goods organizations to explore smaller snack pack sizes, which often command higher prices. This avenue could prove to be a net benefit in the evolving landscape.
Addressing Challenges: Shrink and Margin Outlook
One persistent challenge Kroger faces is shrink, which has been a headwind during Q3 and has put pressure on gross margins. The company is actively investing in initiatives to mitigate shrink, but it anticipates a similar margin outcome in the near term.
In retail, the unaccounted loss of inventory is known as shrink, and at Kroger, the largest U.S. grocery store by revenue, shrink has grown.
Despite these challenges, Kroger remains optimistic about its ability to navigate the competitive landscape.
Looking Ahead: FY24 Outlook and Merger with Albertsons
Kroger’s FY24 outlook shows promise, with a target adjusted EPS range of $4.50 to $4.60, an increase from the previous range of $4.45 to $4.60. The company is also on track to achieve its sixth consecutive year of $1.0 billion in cost savings. However, comp sales without fuel are expected to be in the range of +0.6% to +1.0%, down from the previous guidance of +1.0% to +2.0%. This reduction in guidance is partially attributed to Kroger’s divestment of its Express Scripts business, which is projected to clip around 150 basis points off identical sales growth for the year.
Kroger’s Strong Q3 and Future Prospects
Bottom-line: Kroger’s robust Q3 performance is a testament to its ability to weather economic challenges and adapt to changing consumer preferences. While disinflation may impact overall sales, it can also lead to volume improvements. Kroger’s continued focus on its digital business and its ability to address challenges such as shrink and margin pressures are key strengths. Moreover, the impending merger with Albertsons in early 2024 is expected to remove a long-standing overhang, potentially providing additional momentum for Kroger in the months and years ahead.
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