The Kroger Co.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

The Kroger Co. is one of the largest retailers in the U.S. with a vast network of grocery stores, pharmacies, and fuel centers.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Kroger is a complex business due to the combination of different types of operations. In this report we will analyze how Kroger is able to compete, what problems they have been facing, and how good it is as an investment.

Business Description

Kroger, founded in 1883, is an American retailing company, operating across a multitude of sectors in the retail industry. It has a strong presence in grocery and food retailing along with an emerging healthcare and digital presence.

Revenue Distribution

Kroger’s revenues can be broadly divided into:

  • Supermarkets: These represent the vast majority of Kroger’s revenue. The grocery business sells food items, household products, and other common retail goods.
  • Fuel Centers: Kroger’s large network of fuel stations, primarily located at stores, provide a significant source of revenue. The price of fuel however, depends a lot on outside factors and is often volatile.
  • Pharmacies and Health: Operating pharmacies inside stores gives the business some edge and better control over its customers. It also operates a specialty pharmaceutical business, which has a slightly different and more complicated business dynamic compared to the typical retail pharmacy.

The food and grocery retail industry is facing several transformative trends:

  • Inflationary Pressures: Significant inflation increases costs, which the customers may not accept as a higher price tag at the store, causing pressure on profits.
  • Digitalization: E-commerce has become a significant part of the industry now with most players trying to capitalize on it and having a robust infrastructure for online orders and delivery systems are now essential.
  • Supply Chain Issues: It’s often seen that supply chain disruptions and disruptions in sourcing of materials have caused price increases, which in turn affect the profitability of retail firms.
  • Competition from discounters: Companies like Aldi and Lidl often steal market share from grocers by offering cheaper options.
  • Personalized offerings: There’s growing demand for more customized solutions, better store experiences, and for programs that help customers save more and plan better.

Financial Analysis

Kroger’s recent financials reveal a very complicated and challenging situation, and to understand its moat we need to understand how it is performing and how they are handling all the challenges they face.

Profitability & Efficiency

  • Kroger has experienced quite significant challenges in recent times with earnings and profit margins.
  • In 2022, the adjusted FIFO gross margin, which excludes fuel, was 22.5%, which is pretty low in the grand scheme of retail businesses. This, along with inflation and high costs, is causing problems with profits.
  • Their operating profit margin has also declined year-over-year, a sign of increasing difficulties in operations.
  • They did a little better in Q1 2023 and Q2 2023 and started to see increase in their fuel margin.
  • In the most recent quarterly report, the revenue growth and digital sales have been flat or have only seen marginal growth. However, this has been attributed to them facing a difficult environment.

While the company’s margins have been low, their revenue growth has been impressive. A company that produces stable revenue is always better at handling adverse situations than a company that has wild fluctuations in its income.

Balance Sheet Health

Kroger’s balance sheet has seen its share of ups and downs:

  • The company’s current assets to current liabilities is around 0.97, meaning they have slightly more liabilities compared to assets.
  • The quick ratio is around 0.42, a result of high inventory. It shows an inability to cover their obligations without using assets that aren’t cash.

The balance sheet is neither excellent, not terrible. However, it’s not in the best shape for a large retailer, which must face economic uncertainties, and this means the business is particularly vulnerable.

Financial Data (Latest Reported Quarter, Q2 2023)

  • Total Sales: $34.41 billion (+0.9% YoY)
  • Identical Sales Excluding Fuel: +0.2%
  • Digital Sales: +10.8% YoY
  • Gross Margin: 22.8% (+70 basis points from Q1 2023)
  • Operating Profit: $1.07 billion
  • Net Earnings per Diluted Share: $0.92
  • Net sales : 33.9 billion
  • Adjusted FIFO gross margin 22.5%, (excluding fuel sales)
  • EPS: $0.96
  • Operating Cash Flow:$ 2.4 billion
  • Net increase or decrease in cash and short-term investments: -$1.2 billion

Recent Concerns / Controversies and Problems

  • Inflation-related issues: The biggest challenge is inflation, as it affects prices and profitability. Consumers have become more price-sensitive and less eager to purchase from high-end brands.
  • Supply chain issues: Disruptions in sourcing materials have been a problem and have caused unexpected price changes which affects the companies profitability.
  • Pressure from Discounters: Retailers like Aldi have been eating into the market share of giants like Kroger, as they tend to offer lower prices.
  • Labor: Kroger is a huge employer and they are having increased unionization and employee related pressures. They have recently been involved in a couple of litigations regarding these problems which have negatively affected the company.
  • Merger with Albertsons: The ongoing merger with Albertsons is another major source of uncertainty because of the large scale of the transaction and how it is handled and how will it affect the financials in the upcoming years.

Kroger’s management is well aware of these problems. They are trying to improve through various methods like cost cuts, and innovation in digital businesses and supply chains.

Moat Analysis

Kroger’s moat assessment is quite complex:

  • Brand Power (Narrow Moat): Though Kroger has a recognizable brand name, its moat due to branding is not so wide. The company is quite popular among customers in various parts of the US, especially through its fuel business. However, this is not unique to Kroger and almost all other big retailers have well established brand recognition.
  • Switching Costs (Low Moat): Switching costs to another grocer is typically low. The customer does not face a big barrier in switching their brand preference. However, the data in their online ordering systems may create slight customer stickiness. In addition, since the location and proximity are a very important factor in retail businesses, many customers may simply choose the closest store.
  • Network Effects (Low Moat): Kroger does not really create network effects, however, it’s possible that the company’s loyalty programs create somewhat a local network effect in a given area and make it hard for competitors to come up in that region, but these are mostly restricted to local market areas.
  • Cost Advantages (Narrow Moat): The company’s large scale and distribution network enables some cost advantages, and it also has some production capabilities for their product brands like bakery, grocery, and more. However, many other competitors also have this kind of scale as it is a commodity.

All in all, we will rate Kroger a 2/5 on the moat because it lacks a durable competitive advantage that will help the company remain profitable for a longer time period.

Understandability

Kroger’s business is rather complex and difficult to analyze due to the size and scale of its operations. Its different business lines (fuel, retail, pharmacy), different financial structures, and multiple different ways of acquiring growth adds to the complexity.

  • It’s easy to understand what Kroger does. They sell groceries, gasoline, and other retail items. Everyone has probably at least once gone shopping there.
  • Understanding how exactly the company makes a profit requires some knowledge in various forms of accounting.
  • The company’s growth strategies and M&A activity is very complicated, as it often involves complicated financials and new structures.
  • Finally, predicting where the grocery industry will be in a few years with all the ongoing technological transformations and the supply-chain issues.

We would give the business a 2/5 in terms of understandability. While the overall retail side is easy to understand the overall business is quite complex

Balance Sheet Health

Kroger’s balance sheet is in okay condition, with room for improvement:

  • They have more liabilities than assets, but not excessively so.
  • Their debt levels are also quite high and they are having some trouble with decreasing profitability due to all that.
  • The company is however doing a lot of work on improving profitability.

With all these reasons we will give the company a 3/5 rating for its balance sheet. It’s neither extremely strong not terrible, but they have a lot of problems to deal with.

Summary

The Kroger Co. is currently undergoing a major transformation and is adapting to the new and ever-changing conditions of the retail industry. They are facing headwinds of inflation and also the increased competition from discounters. All this makes the business slightly more complex to navigate through and requires constant and detailed analysis. While they have some inherent strengths that have helped them stay afloat, their future is completely dependent on how they tackle the challenges at hand.