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The Kroger Co. (NYSE:KR) Q4 2022 Earnings Call Transcript
The Kroger Co. (NYSE: KR ) Q4 2022 Earnings Call Transcript March 2, 2023
Operator: Good morning, and welcome to The Kroger Co. Fourth Quarter and Full Year 2022 Earnings Conference Call. I would now like to turn the conference over to Rob Quast, Senior Director of Investor Relations. Please go ahead.
Robinson Quast: Good morning. Thank you for joining us for Kroger's Fourth Quarter and Full Year 2022 Earnings Call. I am joined today by Kroger's Chairman and Chief Executive Officer, Rodney McMullen and Chief Financial Officer, Gary Millerchip. 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. This morning, we released a presentation to accompany our call today, which can be found on our Investor Relations web page at ir.kroger.com.
We encourage you to refer to these materials as Rodney and Gary will make references to the presentation throughout the call. During our prepared remarks, we will share our fourth quarter and full year results. We will update you on the progress our team has made since our Investor Day last year on our Leading With Fresh and Accelerating With Digital strategy. We look forward to returning to a full Investor Day in 2024, where we expect to share detailed plans for how we will achieve synergies and maximize shareholder value from our merger with Albertsons. 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 1 question and 1 follow-up question, if necessary.
I will now turn the call over to Rodney.
William McMullen: Thank you, Rob. Good morning, everyone, and thank you for joining us today. I'd like to start by sharing how incredibly optimistic I am about Kroger's future. Our performance last year demonstrates how Kroger is consistently delivering for our customers, our associates and our communities and by doing so, creating value for our shareholders. Since announcing our Leading With Fresh and Accelerating With Digital strategy at our 2020 Investor Day, we have made tremendous progress against our commitments. As you will see from the chart on Slide 6 of the presentation deck Rob mentioned, we are delivering a fresh, affordable and seamless shopping experience for our customers with 0 compromise on value, quality, selection or convenience.
We are advancing our purpose to feed the human spirit by significantly increasing associate wages and uplifting our communities. And we are delivering on our financial commitments through our strong resilient value creation model. With this strategy, we exceeded our financial goals and delivered attractive total shareholder returns during the past 2 years. In 2022, customer preferences shifted in response to inflation and macroeconomic uncertainty. Our customers were looking for more ways to stretch their budget. The gap between food at home and food away from home spending grew in the fourth quarter as more customers gravitated toward affordable meal solutions that restaurants simply can't provide. Our research shows that cooking at home is 3 to 4x less expensive than dining out.
And as Kroger was there for our customers, innovating quickly to meet their needs and wants, our nimble and customer-focused approach helped us deliver strong results in 2022, leading to total household growth and enhanced customer loyalty. We saw an especially strong response in our higher income households as this segment grew by 1.1 million households, further illustrating the resiliency in our model and strong value proposition we offer customers across all segments. Gary will get into the specific details of our 2022 financial results and outlook for 2023 a little later. Before doing so, I'd like to spend some time reviewing how each pillar of our go-to-market strategy provided meaningful and measurable customer benefits last year and how we will accelerate those benefits in 2023.
The foundation of our go-to-market strategy is fresh, our brands, personalization and seamless. By delivering on these 4 pillars, our customers win and Kroger attracts new and more loyal customers. At the center of our go-to-market strategy is a superior customer experience. We deliver that by consistently providing customers a full, fresh and friendly experience. Kroger continued to demonstrate operational excellence in 2022 as we saw improvements in all 3 metrics. We believe our go-to-market strategy is creating a unique value -- customer value proposition designed to perform in many economic environments. We will continue to invest in our pillars and the customer experience to differentiate the value we offer. First, leading with fresh. As an important influence on where customers shop, we are constantly improving how we bring even fresher food to our stores and e-commerce experience.
Our end-to-end fresh initiative is changing the way our teams deliver on our commitment to freshness and we are incredibly pleased with this success. In 2022, more than 1,400 stores implemented the end-to-end produce solution, driving measurable increases in both fresh and total store sales. In 2023, we will continue innovating the fresh experience to drive customer satisfaction and improve our product mix. We continue to improve inventory management tools, strengthen our supply chain to deliver additional days of freshness and enhance our offerings to meet customer demand. As a reminder, our merger with Home Chef brought significant capabilities in in-store and restaurant quality meal solutions. We will be expanding our home chef production facilities to meet this growing customer need.
Next, Our Brands. The Our Brands portfolio allows us to offer exciting products at great value while driving incremental sales and improving margins. Our Brand's quality and value proposition is especially important when inflation is affecting so many of our customers' lives. To meet the needs of customers on a budget, we launched a new opening price point product line called Smart Way. By consolidating and simplifying several brands into one, we are making it easier for customers while creating a point of differentiation across the full portfolio. We will continue expanding Our Brands to more categories with innovative product offerings. Our goal is to help every customer find high-quality, affordable products they love from pantry staples to fresh food to ready-to-heat restaurant quality meals.
Now I'll move to personalization. Our data science teams are using predictive science to serve customers the right products at the right time and at the best value. Because we know our customers so well, we were able to provide recommendations to start their baskets and deliver personalized offers on the products most important to them, saving them time and money and making their lives easier. In return, our customers reward us with their trust and loyalty, consistently ranking us among the best at being able to offer personalized savings and solutions that meet their needs. In 2022, we grew loyalty as our customers more deeply engaged with personalized coupons and fuel rewards. As customers look for more ways to save, digital coupon engagement hit an all-time high during the year.
Our combined paper and digital coupons helped save our customers more than $1.4 billion on products they need and want. That's on top of our everyday promotions and all the other value we offer. To provide even more value, we launched Boost, the industry's most affordable membership nationwide in July. Early results are exceeding our expectations with incremental engagement and overall household spend. We are evolving Boost with new benefits to further broaden its appeal and create additional customer value. In 2023, we will make significant investments to build out our personalization capabilities, including increasing the use of real-time data to predict customer needs, which will support sales growth during the next 3 years. Finally, turning to Seamless.
Seamless is growing in importance among our customers, and we expect it will be a significant growth driver over the next several years. We have built a digital platform that offers a seamless shopping experience with 0 compromise, allowing customers to shift effortlessly between store, pickup and delivery solutions. As you'll see on Slide 12, our combination of stores and dedicated fulfillment centers positions Kroger to serve all customer trips from in-stock shopping to rapid delivery on needed now items to large stock up orders. Despite the easing of pandemic-related shopping behaviors that led to a significant increase in online shopping, more and more customers are incorporating e-commerce into their daily permanent routines, recognizing the value and convenience online shopping offers.
We expect digital sales will continue to grow at a faster pace than overall food at home sales and believe Kroger is well positioned to deliver double-digit growth in over the next 3 years. As we work to become the most trusted online grocery destination, we are focused on 4 key areas that will position us to deliver that growth. We start by providing a compelling Kroger owned digital destination, where we offer customers exceptional value, personalization and freshness in a single, easy-to-use online experience. Second, we are focused on delivering best-in-class fulfillment, driving trust and loyalty by exceeding expectations for quality and freshness. Our delivery approach is unique in the fact that we have a large store network conveniently located close to our customers and large dedicated fulfillment centers designed efficiently to pick large orders.
Our dedicated fulfillment centers provide the most reliable experience, the highest in-stock levels, best on-time delivery and one-of-a-kind white glove experience with industry-leading Net Promoter Scores. Kroger delivery customers are more engaged across our entire ecosystem, spending more and shopping with us more often. Looking ahead, we will continue to learn through our customer fulfillment network with a focus on driving profitability and efficiencies to ensure that we are well positioned to deliver sustainable, profitable growth while delighting our customers. Next, we are focused on reaching new customers and adding more shopping occasions. Our delivery network allows us to offer enhanced service to new customers, and we will also grow our share of wallet by increasing the number of orders customers place with us.
Solutions like Kroger Delivery Now enabled by our vast network of conveniently located stores can connect customers to fresh groceries and household essentials in as little as 30 minutes. This seamless ecosystem makes any shopping experience simple for our customers. Finally, we are driving our profit flywheel and improving margins by reducing our digital cost to serve and growing our alternative profit streams. To accomplish this goal, we are lowering fulfillment costs, building the density of demand and last mile routing, engaging directly with our third-party vendors and growing digital retail media. Now let me share how we are accelerating growth in our model through alternative profits. During the last several years, we invested heavily in technology to transform our business and enter new high-growth and high-return businesses.
These businesses contribute meaningfully to our results with alternative profit businesses achieving $1.2 billion in operating profit in 2022. Kroger Precision Marketing is one of our fastest-growing businesses and is well positioned to win within the U.S. retail media landscape, which is projected to be a $55 billion industry by 2024. What makes our retail media business special is our ability to help brands achieve a greater return on their media investment. For the fifth year in a row, KPM was recognized as a leader in the retail media space by the Path to Purchase Institute, which collects feedback from those closest to the retail media networks and accessing their effectiveness. KPM was recognized as a leader for many of its capabilities, including maintaining its leadership in targeting and measurement capabilities, a testament to the strength of our unique product offerings and the insights we bring to this emerging landscape.
Our associates enable our success, and we are committed to investing in theirs. To remain an employer of choice, we support our associates development and holistic well-being. We provide our associates with the tools they need to grow their careers that they want at all stages. In 2022, Kroger was named as a Best Place to Work in IT for the fifth consecutive year and a best place to work for disability inclusion for the third year. We also continue to support our associates through investments in wages and comprehensive benefits. In 2022, we raised our average hourly rates by more than 6% and has now invested an incremental $1.9 billion in associate wages since 2018. Our average hourly rate is now more than $18 and more than $23 when you include comprehensive benefits.
We are committed to sustainably increasing associate wages and plan to invest more than $770 million in associates in 2023. We value and respect our associates and investing in their success is just one way we demonstrate that. We take seriously our role in helping to create a healthier and thriving neighborhoods across the country. The centerpiece of our efforts is Kroger's Zero Hunger | Zero Waste social impact plan, an industry-leading commitment to build communities free from hunger and waste. Since launching Zero Hunger | Zero Waste, we have made continual progress toward our goals. We have directed more than $1.65 billion in food and funds to help end hunger, including donating more than 2.3 billion meals. We are making progress on our carbon emissions reduction plan and our brand's sustainable packaging goal.
I'm especially proud of our incredible associates who helped us reach a key milestone this year with 100% execution of our surplus food rescue programs across each and every store across the company. Looking ahead, we will continue to focus our efforts on our ambitious goal of ending hunger in our communities and eliminating waste, especially food waste throughout the company. In summary, our proven go-to-market strategy led to enhanced loyalty and household growth as we help customers manage the effect of inflation in 2022. We are well positioned to sustain our momentum into 2023. And with that, I'll turn it over to Gary to take you through our results and expectations for 2023. Gary?
Photo by Franki Chamaki on Unsplash
Gary Millerchip: Thank you, Rodney, and good morning, everyone. Before jumping into our 2022 results and sharing our outlook for 2023, I'd like to take a step back and remind you how Kroger's value creation model is enabling the company to deliver sustainable value for our shareholders. We believe our value creation model has been a key to delivering consistently strong results over the past 4 years and is positioning Kroger for growth in years to come. The go-to-market strategy that Rodney outlined earlier is the foundation of our model. Over recent years, we have invested significantly in our people, our customers and technology to create a leading omnichannel position in food retail. By executing our go-to-market strategy, we win customers in our core supermarket business, including health and fuel and drive significant customer traffic and data into our ecosystem.
This, in turn, allows us to deploy our investments in technology and 84.51Â° to deliver even greater value for customers and create new high-growth, high-margin alternative profit businesses. The value generated from these businesses enables us to reinvest back into our supermarkets and drive further store and digital traffic, creating a flywheel effect. We are evolving from a traditional food retailer into a more diverse food first business that we believe can deliver sustainable future growth and succeed in a variety of operating environments. As a reminder, since introducing this model in 2019, we have achieved consistent returns for our shareholders that have significantly exceeded our TSR commitment of 8% to 11%. As you can see in the table on Slide 19, over the past 3 years, Kroger has achieved more than 19% compounded annual growth rate in adjusted FIFO net operating profit and approximately 25% compounded annual growth rate in adjusted EPS.
Over this same time period, we generated adjusted free cash flow of approximately $9.7 billion and have returned a total of nearly $5.8 billion to investors via dividends and buybacks. Overall, we have delivered nearly 3x the expected return from our TSR model over this 3-year period. Importantly, at the same time, we continue to invest in the business to support future growth. This included improving our price position relative to key competitors since the start of the pandemic, increasing associate wages and benefits by 34% since 2018 and increasing the amount of capital investments allocated to technology and digital capabilities to enable top line growth and margin expansion. Our strong performance and progress with our model in recent years also gave us the financial flexibility and confidence to announce our proposed merger with Albertsons.
Upon closing, which is anticipated to be in early 2024, we believe the merger will significantly accelerate our go-to-market strategy and deliver TSR well above our stand-alone model during the first 4 years post close. I'll now walk through our full year 2022 financial results. Kroger delivered adjusted EPS of $4.23 per diluted share, an increase of 15%. We achieved identical sales, excluding fuel of 5.6%. The FIFO gross margin rate, excluding fuel, decreased 9 basis points. This reflects the outstanding work of our merchandising and sourcing teams who are extremely effective in managing higher product cost inflation while maintaining competitive prices and helping customers manage their budgets. The OG&A rate, excluding fuel and adjustment items, decreased 19 basis points, reflecting sales leverage and cost-saving initiatives, partially offset by planned investments in associates.
And I'm delighted to say for the fifth consecutive year, we delivered cost savings of $1 billion in 2022. Our adjusted FIFO operating profit was $5.1 billion, an increase of 18% from last year. And the LIFO charge for the full year was $626 million compared to $197 million in 2021. Turning now to our fourth quarter results. Adjusted EPS was $0.99 for the quarter, an increase of almost 9%. We saw continued momentum in our identical sales without fuel of 6.2%. Underlying growth would have been 6.7% after adjusting for the effect of Express Scripts. Our Brands contributed another strong quarter with identical sales of 10.1%, reflecting the growing importance to customers of these exclusive to Kroger products. And digital sales also accelerated during the quarter, up 12%, led by 22% growth in Delivery Solutions.
Kroger's FIFO gross margin rate excluding fuel decreased 1 basis point and the OG&A rate excluding fuel and adjustment items decreased 56 basis points. Fuel remains an important part of our overall value proposition. Our loyalty program, which can save customers up to $1.25 per gallon has been one of the many ways we have helped customers stretch their dollars over the past year and contributed to our gallon sales outpacing the industry during the quarter. The average retail price of fuel was $3.39 compared to $3.30 in the same quarter last year. Our cents per gallon fuel margin was $0.51 compared to $0.44 in the same quarter last year. Adjusted FIFO operating profit was $1.27 billion, a year-over-year increase of 26%. And the LIFO charge was $234 million in the fourth quarter, reflecting sustained higher product cost inflation, particularly in grocery.
This compares to a charge of only $20 million in Q4 last year. Included in our fourth quarter results was a $164 million goodwill and fixed asset impairment charge related to Vitacost.com. The talent and capabilities gained through the merger with Vitacost in 2014 have been key to advancing Kroger's digital platform and growing our digital business to more than $10 billion in annual sales. As our digital strategy has evolved, our primary focus looking forward will be to effectively utilize Kroger store pickup and delivery capabilities, and this reprioritization resulted in the impairment charge. Vitacost.com will continue to operate as an online platform, providing great value, natural, organic and eco-friendly products for our customers. Adjusted free cash flow for the year came in $800 million lower than anticipated.
This was entirely due to movements in working capital towards the end of the year. The cause was a combination of factors including higher inflation affecting inventory, some forward buying to protect margins and timing of accounts payable and third-party receivable payments around the year-end. As shared last quarter, we feel comfortable with our overall level of mix of inventory, which is higher due to heightened levels of inflation and in-stocks returning to pre-pandemic levels. Looking over a 5-year time horizon and smoothing the volatility in working capital experience during the pandemic, we have seen an underlying benefit from working capital over this time period, and we would expect to see further improvement going forward. We remain confident in our ability to generate strong free cash flow.
And as shared in our guidance this morning, expect to achieve adjusted free cash flow of $2.3 billion to $2.5 billion in 2023. Turning now to financial strategy and capital allocation. We will continue to be disciplined with our capital investments, prioritizing the highest growth opportunities that strengthen our business and deliver solid returns for our shareholders. As you saw in our guidance this morning, we are anticipating capital investments of $3.4 billion to $3.6 billion this year, which is consistent with our long-range TSR model. Our priorities for 2023 are aligned with our value creation model and are expected to drive future sales growth and margin expansion. To drive sales, our focus is on enhancing our store and digital ecosystem.
We apply a data-driven approach to make decisions on a store-by-store basis, prioritizing store formats and locations with the highest growth potential. Additionally, we are continually enhancing our seamless experience including investing in technology to improve the customer proposition and augmenting personalization, which will, in turn, create additional alternative profit opportunities. We continue to invest in areas of the business that will drive operating margin expansion, including enhancements to our supply chain capabilities. These investments help improve margins and differentiate our fresh offering. And finally, an essential element of our value creation model has been our ability to take cost out of our business. We remain focused on eliminating waste in areas that did not affect the customer experience and we are making investments in technology to improve store productivity, lower digital fulfillment costs and reduce waste and shrink.
These improvements will drive an incremental $1 billion of cost savings in 2023, which would mark our sixth year in a row of delivering $1 billion of savings. In closing, I'd like to share some additional color on our expectations for 2023. While there is still uncertainty regarding the economic outlook, our go-to-market strategy is resonating with customers, and we believe our successful value creation model positions us well to navigate evolving market conditions. Before I go into the details of our 2023 guidance, there are a couple of unusual factors that I'd like to highlight. First, Kroger's decision to terminate our agreement with Express Groups in December of 2022 is expected to have a negative impact of 150 basis points on identical sales without fuel.
This decision is not expected to have a material effect on profitability. Second, 2023 will include a 53rd week. We expect the effect of this extra week at approximately $0.15 to our adjusted net earnings per diluted share for the year. With that important context, we expect to achieve identical sales without fuel of 1% to 2% in 2023. Excluding the effect of Express Scripts, our underlying identical sales without fuel growth is expected to be between 2.5% and 3.5%. We expect to achieve adjusted FIFO operating profit of between $5 billion and $5.2 billion and adjusted net earnings per diluted share of between $4.45 and $4.60, including the expected benefit of the 53rd week. We expect to grow revenue by continuing to invest in our customers through competitive pricing and personalization and providing fresh products and a better shopping experience across our store and digital ecosystem.
We will fund investments in gross margin in 2023 by improving our product mix as we accelerate momentum with our Fresh and Our Brands initiatives and by growing our alternative profit businesses. As Rodney mentioned earlier, we will also continue to invest significantly in associate wages and this will be funded by our planned cost-saving initiatives. While we believe fuel margins will remain structurally higher than historical averages, fuel profitability is expected to be a headwind to our model in 2023 as we lap historic fuel margins from last year. Our 2023 guidance assumes a LIFO charge of between $300 million to $350 million as a result of lower product cost inflation compared to 2022. While this amount is well above historical levels, LIFO is expected to be a year-over-year tailwind and should more than offset lower fuel profitability.
In terms of quarterly cadence, we expect identical sales without fuel to be above the top end of our guidance range in the first half of the year as we continue to experience heightened levels of inflation. In the second half of the year, we expect identical sales without fuel to be at or slightly below the bottom end of our range as we expect inflation to taper later in the year. We expect adjusted earnings per diluted share in quarter 1 will be slightly negative year-over-year as we cycle 22% growth in EPS from Q1 last year. Quarter 2 and quarter 3 are expected to be within our annual guidance range and quarter 4 is expected to be above our guidance range as we cycle the higher LIFO charge in '22 and benefit from the 53rd week. As you know from Rodney and myself this morning, Kroger is operating from a position of strength and the investments that we have made in our go-to-market strategy provide exciting opportunities for future growth.
Our team is energized by these opportunities and we believe Kroger is well positioned to continue to deliver attractive and sustainable returns for our shareholders. I'll now turn the call back over to Rodney.
William McMullen: Thanks, Gary. Before we open up the floor to your questions, let me provide an update on our pending merger with Albertsons. During the past few months, we've spent time getting to know Vivek and the Albertsons leadership team. We are incredibly impressed with their talent, culture and commitment to their customers and communities. We look forward to bringing together our 2 highly complementary organizations to provide customers with lower prices and more choices while realizing the long-term value we expect this merger will deliver. We are working cooperatively with regulators responding to the Federal Trade Commission's second request and in discussions about the transaction, while also working to identify potential buyers for the stores, we expect to divest to obtain clearance for the transaction.
We are pleased with the level of interest received thus far, and we'll work towards finding a solution that benefits all stakeholders. We remain on track to close the transaction in early 2024. During the quarter, we launched our integration planning efforts with the goal of preparing for a seamless cultural and operational integration. We expect to create customer benefits beginning day 1 post close. The integration team is developing work streams with clear objectives and milestones to deliver value for our customers, associates, communities and shareholders. We are pleased with the progress we've made to date, and we'll continue to provide updates as we have them. We achieved exceptional results in 2022, building on our record years in 2020 and 2021, and we exceeded our commitments in our Leading with Fresh and Accelerating with Digital strategy.
Our folks strategy is focusing on our customers, our associates and our communities is working. Our customers are telling us that we're doing a better job serving their needs. We continue to improve our associate wages and comprehensive benefits with a 34% increase in the last 5 years. And we are helping to create healthier thriving communities through our Zero Hunger | Zero Waste work. We believe our momentum is sustainable and will only accelerate upon the completion of our pending merger with Albertsons. With that, Gary and I look forward to taking your questions.
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This morning, we released a presentation to accompany our call today, which can be found on our Investor Relations web page at ir.kroger.com.
Harris Teeter Supermarkets, Inc. has completed its merger with The Kroger Co. Harris Teeter now operates as a wholly-owned subsidiary of The Kroger Co.
The following slide deck was published by Kroger Co. ... Kroger (KR) Investor Presentation - Slideshow. Oct. 12, 2017 2:18 PM ETThe Kroger Co.