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Kroger (KR) Earnings Miss Estimates in Q3, Decline Y/Y

Zacks Equity Research

After registering two straight quarters of positive earnings surprises, The Kroger Co. KR reported a miss in the third quarter of fiscal 2019. The company posted adjusted earnings of 47 cents a share that fell short of the Zacks Consensus Estimate by a penny and declined 2.1% from the prior-year quarter.

This Cincinnati, OH-based company envisions fiscal 2019 adjusted earnings in the band of $2.15-$2.25 per share, which indicates an improvement over adjusted earnings of $2.11 per share reported in fiscal 2018. For fiscal 2020, management estimates earnings between $2.30 and $2.40 per share. The Zacks Consensus Estimate for earnings for fiscal 2019 and 2020 currently stands at $2.20 and $2.33, respectively.

Total sales of $27,974 million came below the Zacks Consensus Estimate of $28,067 million. This was the second straight quarter when sales missed the consensus mark. However, the metric improved marginally by 0.5% from the prior-year quarter. Excluding fuel and dispositions, top line improved 2.7% from the year-ago period. The company’s digital sales surged 21%, while identical sales, excluding fuel, grew 2.5%. Management forecast identical sales growth of 2-2.25% for fiscal 2019. It envisions identical sales, excluding fuel, to be above 2.25% in fiscal 2020.

We note that gross margin increased 30 basis points to 22.1%. FIFO gross margin, excluding fuel, shrunk 24 basis points from the year-ago period, mainly due to industry-wide lower gross margin rates in pharmacy. Adjusted FIFO operating profit fell 1.7% to $653 million. Kroger anticipates adjusted operating profit in the band of $2.9-$3 billion and $3-$3.1 billion for fiscal 2019 and 2020, respectively.

The Kroger Co. Price, Consensus and EPS Surprise

Strategic Endeavors

The grocery industry has been undergoing a fundamental change, with technology playing a major role and the focus shifting to online shopping. Kroger, which faces stiff competition from bellwethers such as Walmart WMT and Amazon AMZN, has taken stock of the situation and is in the process of giving itself a complete makeover.

The company’s “Restock Kroger” program involving investments in omnichannel platform, identifying margin-rich alternative profit streams, merchandise optimization, and lowering of expenses has been gaining traction. The company is expanding store base, introducing new items, digital coupons, and order online, pick up in store initiative.

Management informed that “Our Brands” sales grew 3.4%. The company also introduced 231 new Our Brands items. Pickup or Delivery reached 96% of Kroger households (expanded to 1,915 Pickup locations and 2,326 Delivery locations). Management is also targeting “margin-rich alternative profit streams” which are likely to contribute an estimated incremental $100 million in operating profit this fiscal year versus the prior. Alternative profit streams are anticipated to contribute an incremental $125-$150 million in operating profit in fiscal 2020.

Other Financial Aspects

Kroger ended the quarter with cash of $417 million, total debt of $13,644 million, and shareowners’ equity of $8,728 million. Total debt decreased $1,374 million from the prior-year period. Management anticipates capital expenditures of $3-$3.2 billion in fiscal 2019 and between $3.2-$3.4 billion in fiscal 2020. The company forecast free cash flow generation of $1.6-$1.8 billion in fiscal 2020. The company expects to make share repurchases of $500-$1,000 million in fiscal 2020.

Wrapping Up

We believe that Kroger’s customer-centric business model provides a strong value proposition. However, intensifying price war among grocery stores to lure budget-constrained consumers poses concern.

Kroger carries a Zacks Rank #3 (Hold). We note that the stock has advanced 12% outpacing the industry’s rise of 4% in the past three months. A better-ranked stock is Beyond Meat BYND. This Zacks Rank #2 (Buy) company posted positive earnings surprise of 20% in the last reported quarter. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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