Kroger Predicts Profit Challenges Ahead in 2018

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Market share isn't easy to defend, nor cheap to acquire, in the brutally competitive grocery industry. That's one big takeaway from Kroger's (NYSE: KR) recently released fourth-quarter results.

The supermarket giant managed quicker sales growth over the holidays but paired those gains with aggressive spending on price cuts that reduced profitability. Executives' first official outlook for 2018 predicts more of the same combination of modest revenue growth and elevated spending.

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More on that forecast in a moment. First, here's how the latest results compare with the prior-year holiday period:

What happened this quarter?

Kroger's sales gains improved for the fourth straight quarter, giving the company solid momentum after over a year of decelerating comparable-store sales.

Here are some of the key highlights from the quarter:

  • A 1.5% comps uptick delivered slight market-share gains and marked its best growth performance since mid-2016. The increase helped produce Kroger's 13th consecutive year of market-share growth, mainly against chief rival Walmart.
  • Kroger had to cut prices to stay competitive against its retailing peers, and so gross profit margin slipped to 21.9% of sales from 22.3% a year ago.
  • Expenses rose as the company poured resources into areas including wages, store remodels, and support of its in-store brands like the Simple Truth organic franchise.
  • Several major, but unusual, factors impacted bottom-line profitability. On the plus side, Kroger benefited from a lower tax burden. That boost was offset by payments to its pension fund. Adjusting for all these events showed a modest decrease in earnings power as operating profit fell to $6.6 billion for the full year from $6.8 billion in 2016.
  • Return on invested capital over the prior 12 months fell to 12% from 13%.

What management had to say

CEO Rodney McMullen focused his comments on the positive sales momentum and management's optimistic reading on their recently launched rebound plan. "Customers are letting us know that they see, feel and appreciate our efforts to redefine the customer experience," McMullen said in a press release, "and they are rewarding us with growing loyalty. This is the cycle that creates long-term value for shareholders."

Executives explained that the cash bounty provided by recent tax law changes will fund even greater spending on the business while helping each of the retailer's stakeholders. "We are taking a balanced approach to ensure tax reform benefits our associates, customers and shareholders," McMullen said.

Looking forward

Kroger's 2018 forecast calls for sales growth to continue speeding up, with comps improving by between 1.5% and 2% compared to last year's 0.7% uptick. Elevated spending should pinch earnings results, though.

In fact, profit is expected to come in between $1.95 and $2.15 per share in 2018. At the midpoint of guidance, that prediction translates into flat earnings. The supermarket chain had been targeting annual gains of between 8% and 11% as recently as mid-2017, but management's new outlook reflects a tougher selling environment. The key question going forward is whether Kroger's strategic shifts will power a return to healthy earnings growth starting in 2019 at the earliest.

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Demitrios Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool is short shares of Kroger. The Motley Fool has a disclosure policy.