Q3 2019 Earnings Call
Good morning, and welcome to the Kroger Company third quarter 2019 earnings Conference call.
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I would now like to turn the conference over to Rebecca Managing Director Investor Relations. Please go ahead.
Thank you Gary Good morning, and thank you for joining at people. We began I want to remind you got today's discussion will include forward looking statement.
I caution you that statement, our predictions and actual events or results can differ materially.
A detailed discussion of the many factors that we believe they had a material effect on the business on an ongoing basis is contained in our SVP filings. The Kroger assumes no obligation to update that information.
Both our third quarter press release in our prepared remarks for this conference will be available on our website at <unk> IR Dot Kroger dotcom.
After our prepared remarks, we look forward to taking your question.
In order to cover a broad range of topics and then you asked me Ken we ask that you. Please limit yourself to one question and one follow up question if necessary I will now turn the call over to Kroger's, Chairman and Chief Executive Officer Rodney Mcmullen.
Thank you Rebecca good morning, everyone and thank you for joining us today.
With me to review Kroger's third quarter 2019 results is Chief Financial Officer, Gary Miller Chip.
We'd like to thank those of you who were able to attend our Investor Conference last month, where we shared our progress on restart Kroger.
We believe that restart Kroger is the right framework to reposition our business to create value for all of our stakeholders.
It provides us with a clear purpose at our vision to serve America through food inspiration and uplift.
It focuses us on redefining the customer experience identifying the partners, who will help us deliver customer value today and in the future and putting the right talent and teams in place to focus on growth in our supermarket business and our alternatives or profit businesses.
We are proud of the progress we've made and we've learned from the challenges we've experienced.
We are on track with a stable and growing supermarket business as a result over customer obsession.
Renewed intensity around operational excellence and continued investment in seamless.
We are growing our supermarket business by focusing on three levers to drive identical cells fresh our brands and data and personalization.
And we continue to be old build a seamless eco system that is available relevant and accessible for our customers.
All of US combined to generate positive results in the third quarter.
We continue to grow identical sales reduce cost and deliver strong free cash flow.
We had a broad based identical sales improvement.
15 of our divisions had increasing supermarket identical cells without fuel compared to the second quarter.
We delivered a slightly improved FIFO gross margin excluding fuel in pharmacy.
Headwinds in pharmacy were offset by strong fuel performance during the quarter.
We're on track to deliver 100 million, an incremental operating profit through alternative profit stream growth.
Kroger continues to invest in digital as we build a seamless ecosystem for our customers.
We know our customers value greater convenience. This provides and our data shows it's an essential component of growing overall loyalty.
Digitally engaged customers not only drive growth through our digital modalities.
They also helped drive brick and mortar sales growth as well and share of wallet.
So seamless is a both.
Not an either or.
Our data clearly shows that over time and after initial investments.
The profitability of a digital customer is the saying as an in store customer.
We continue to see and improving operating profit trend and digital and therefore investments are maturing as expected and consistent with the graph we shared at Investor day.
Our digital sales grew 21% in the third quarter.
As we shared previously.
We expect our digital sales growth to moderate year over year, primarily due to the cyclean of home chefs and as a result of our disciplined focus on growing the ship customer.
We've expanded our digital coverage to reach 96% of our customers.
This means that 96% of our customers, who shop Kroger in a brick and mortar store can also shop with us for pick up or delivery.
We continue to invest in digital platforms. As this is where the customer are increasingly going to meet many of their needs.
Providing our customers with the ability to have anything anytime anywhere from Kroger sets us apart from a large segment of our competitors.
And we'll drive loyalty as well as our long term growth and margin expansion.
We continue the rollout of Ocado facilities.
In November Kroger announced plans for a new high tech customer fulfillment center and west constant.
The automated warehouse will serve customers in west constant, Northern Illinois, and northwest Indiana.
What's so exciting about ocado is their model to deliver to the customer.
Significantly less costly than our existing model and any of the other models, we've examined as well.
Not only will lease facilities accelerate our ability to provide customers with a seamless experience.
They will also help us to do it at a much more cost effective way.
We know a car those value is not just its current capabilities.
But also how quickly the company is able to innovate to serve a rapidly developing online consumer market.
One of the comments, we made at IR day is that caught ocado keeps learning and improving their model.
Kardos recent announcement of a micro fulfillment center in Bristol is a good example of this.
We believe that the food industry a special.
It is huge a one of the half trillion dollar market.
And not only do people need to eat they loved to eat.
Food isn't a commodity but it's the center of our lives.
Customers deserve a partner like Kroger, who can provide inspiration and fulfill their passion for food.
And then <unk>, unlike our national competitors Kroger is food first.
We believe that no matter, who you are where you're from how you shop or what you like to eat everyone deserves to have affordable easy to enjoy fresh food that tastes amazing.
As we shared in November fresh is an important driver of sales for Kroger.
Our fresh departments drive trips loyalty and gross margin.
Our product standards selection criteria and supply chain, our core strengths and are built to deliver first to market and best of season fresh products across the United States.
Our produce department led the way in cells for the quarter, demonstrating how our store teams are focused on improving everyday execution.
And ways that are highly relevant to our customers.
In addition, we launched our fresh for everyone brand transformation campaign and the initial feedback from both our customers and our associates is very positive.
One of the many ways, we demonstrate our passion for food is through Kroger's best in class our brands portfolio.
While many grocers offer private label products, our brands is a real differentiator for Kroger.
Because our customers tell us through blind taste tests that are brands quality is better than not only the competitors private label products, but also many leading national brands as well.
Krogers, our brands grew 3.4% this quarter.
We also introduced 231, new our brand items during the third quarter.
Kroger's third differentiating lever to drive it cynical sales growth this personalization.
Data is a differentiator for Kroger.
Many retailers have transactional data, but none have the customer data and the insights to make meaningful suggestions to their customers like Kroger.
We continue to see incredible effectiveness and efficiency from a focus on loyal customers and investing in their satisfaction.
One specific area I'd like to highlight is our strong fuel points program.
As we shared at the Investor Day Conference last month, and amazing, 83% of our loyal customers engage with our fuel rewards program each year.
We are increasingly targeting.
Promotion and personalization of fuel rewards and fuel drove trips and cells in the third quarter.
We are using the power of kroger's stable and growing supermarket business.
Degree meaningful incremental operating profit through the alternative profit stream businesses.
Which adds up to a business built for long term growth that generates consistently attractive shareholder total shareholder returns.
Kroger continues to generate strong endurable free cash flow.
As a result reflected by the fact that the company has reduced debt by one of the half billion over the prior four quarters and continues to increase its dividend to create value for shareholders.
We are confident that we can deliver even stronger TSR and the future because of our strong free cash flow and sustainable net earnings growth.
Restock Kroger is the right framework to reposition our business degree eight value for all of our stakeholders, both today and the future.
And now I will turn it over to Gary for more details in the into the quarter financials Gary.
Thanks, Rodney and good morning, everyone.
I want to anti Rockne and thank those of you who were able to attend overview the investor day webcast last month.
As we shared in New York I'm model for a strong enjoyable retail supermarket business begins with the customer and our obsession with increasing customer loyalty.
We believe that our intensified focus on execution and continued improvements into value and experience. We can limit for our customers is driving increased identical sales across our store and digital ecosystem.
Sure drive sustainable sales growth for the long term, we will continue to invest in areas of the business that are important to the customer.
This includes ongoing investments in talent price digital I'm store experience with an even greater emphasis on fresh our brands and personalization.
We are demonstrating through the first three quarters of the here, we're being very deliberate in balancing these investments with disciplined execution of cost savings that simplify our business.
Hi, supermarket business and the traffic and data. This generates says as the foundation from which we were able to drive higher growth in our asset light margin rich alternative profit businesses that we continue to expect to accelerate our results.
We expect time model to deliver improved operating results over time and continued strong free cash flow and we expect this to translate into a consistently strong an attractive total shareholder return through EPS growth driven by sustained net earnings growth and the return of cash to shareholders via share repurchase plus a growing dividends over time.
Now I'd like to share third quarter results.
For the quarter, we delivered an adjusted EPS of 47 cents per diluted share.
As noted in this mornings press release that includes a three cents out of period charge that I will share more detail on in a moment.
But first I'll highlight a few areas not business that were particularly robust.
Our brands contributes despite a sales driver and profit leader.
The entire Kroger team brought discipline to controlling costs during the third quarter.
I feel performance mitigated retail pharmacy gross margin headwinds in the quarter.
LIFO charge for the quarter was $23 million compared to $12 million for the same period last year, driven by inflation in dry grocery pharmacy and dairy.
We now estimate life for the year to be approximately $19 million versus our original expectation of $50 million.
Our adjusted corporate tax rate for the quarter was 70 basis points higher than the same period last year due to a decrease in the benefits of federal tax credits and an increase in reserves.
I'll now provide additional detail about two specific items that affected our results in the third quarter.
First the out of period charge of $29 million that I referenced earlier.
These charges related to a provision in a single pharmacy contract that should it be recognized over the previous six quarters.
Given the complexity of the contract and the introduction of new Clawback provisions a positive to contract was misinterpreted.
The required correction was identified in our standard management review process.
This charge is not material to total company results and the financial effect in Egypt. The pry individual quarters was immaterial to net earnings per diluted share.
The cumulative effect on out performance in the third quarter reduced adjusted net earnings per diluted share by three cents on gross margin by nine basis points.
With that whole felt it was important to provide a greater level of insight into this item.
There is no effect on earnings guidance at 29 team or 2020 as a result, this contract going forward.
I'd now like to talk about looking at markets.
During our Investor Conference last month, we committed to continue to be disciplined and prioritizing capital allocation to improve return on invested capital and create sustainable shareholder return.
As part of the portfolio review, we made the decision to evaluate strategic alternatives in relation in relation to our investment in lucky's market.
As a result to this review the company has decided to divest is interesting lucky's market I'm recognize an impairment charge of $238 million in the third quarter.
Accounting rules require kroger to record the gross amount in operating profit. However, the real economic interest to Kroger is a pretax charge of $131 million.
Additional details are provided in the financial tables in our press release.
The impairment charge is a noncash charge I'm reflects the write down of our initial investment in lucky's markets as well as additional funding provided to operate and grow the business.
There is no effect on earnings guidance the 2020 as a result this decision.
Turning now to somewhat the highlights in the third quarter as underlying trends with very robust.
Kroger reporting identical sales without fuel with 2.5% during the third quarter, marking our strongest quarter since we launched restock Kroger.
Several supermarket departments outperformed the company, including produce key beverage categories pharmacy, I'm not sure foods.
Digital contributed approximately 70 basis points, two identical sales with Kroger pickup and delivery continuing to show strong momentum.
Adjusted FIFO operating profit for the third quarter was $653 million compared to $664 million in the third quarter of 2018.
Gross margin was 22.1% to sales to the third quarter.
FIFO gross margin, excluding fuel decreased 24 basis points from the same period last year, primarily driven by industry wide level gross margin rates in pharmacy and continued growth in our specialty pharmacy business.
Gross margin rate, excluding fuel in pharmacy improved slightly in the quarter as cost of goods savings and growth in alternative businesses offset continued retail price investments.
While profitability in retail pharmacy is lower than we had budgeted this year. It remains an important part of our strategy and continues to generate good returns.
We were pleased to see the declining gross margin rate compared to last year was lower in the third quarter than the first two quarters of 2019 and this trend is expected to continue in quarter four.
As a result to continued growth in pharmacy sales improved product sourcing and initiatives that lowers the cost to fill scripts. Our expectation is that pharmacy profitability will be less of a headwind and 2020 .
Our associates continues to an impressive job managing shrink which improved in the third quarter compared to last year. This represents a ninth consecutive quarter of year over year shrink rate improvement.
Oh, gionee cost as a rate of sales excluding fuel and adjustment items decreased 15 basis points. This was achieved three broad based improvement of restart kroger cost saving initiatives.
We remain on track to achieve over $1 billion of cost savings in 2019 on top of the $1 billion savings achieved last year.
We also have clear line of sight to the 1 billion dollar of incremental savings in 2020 that we shantytown Investor Conference.
These savings are being achieved through improved productivity and automation elimination of waste improved sourcing of goods not for resale and administrative efficiencies.
Like many industries grocery retailers navigating through disruptive change.
As part of the company's ongoing evolution store operating divisions recently evaluated and reduced middle management roles to ensure they have the right talent in the right roles closest to our customers in store leadership positions.
As a result, kroger incurred severance charges in the third quarter totaling $18 million.
Fuel is an important part of our strategy to drive customer engagement and our loyal customers continue to receive hundreds of millions of dollars in fuel rewards each year in the form of price discounts at the pump.
As Rodney mentioned fuel is driving low customer trips Ams sales and the amount of fuel rewards pay to loyal customers increased by 8% in the third quarter.
The average retail price of fuel was $2.62 this quarter versus 2081 cents in the same quarter last year.
Cents per gallon fuel margin in the third quarter was 30 cents compared to 26 cents in the same quarter last year.
Joel is a great example of Kroger sourcing teams continuing to improve buying practices. This allowed us to achieve improvement in fuel cost of goods in the third quarter.
Alternative profit streams are on track to contribute an incremental $100 million in operating profit in 2019.
Media and credit a personal finance continue to be the primary drivers of growth this year.
Kroger precision marketing continues to build momentum increasing engagement toys, a 1000 brands with a 90% retention rate and significantly higher spend.
We have relationships with all major agency holding companies supporting their media Activations as they deploy brand building programs.
Our media business continues to release, new inventory and create new publisher relationships to support the demand and advertisers.
And now to update on Labor relations athletes as we have previously shared we are proud that average hourly rate is over $20 with comprehensive benefits factored in.
Benefits that many of our competitors don't alpha.
As a result of credit investments in our associates, we are improving employee retention in one of the tightest labor markets in years.
We continue to invest in our associates as part of restart Kroger in a variety of ways, including investments in wages training and development.
We ratified new labor agreements with the U.S. CW covering associates in Southern California, Portland, Seattle, and Michigan joined the quarter.
We are currently negotiating the U.S. CW for contracts covering store associates in Las Vegas and Memphis.
Our objectives in every negotiation is to find a fair and reasonable balance between competitive costs and compensation packages that provide solid wages good quality affordable health care I'm retirement benefits for our associates.
We strive to make our overall benefit package relevant to today's associates.
Our financial results continue to be pressured by inefficient health care and pension costs, which some of that competitors do not face.
We continue to communicate with our local unions and the international unions, which represent many of our associates on the importance of growing our business in a profitable way, which will help us create more jobs and career opportunities and enhanced job security for our associates.
A key element of our capital allocation strategy is to use our free cash flow to invest in the business and drive profitable growth.
While also maintaining our current investment grade debt rating braking and returning capital to shareholders.
We actively balanced the use of cash flow to achieve these goals.
We committed to prioritize free cash flow in 2019 to reduce the company's net total debt to adjusted EBITDA ratio to within our target range of 2.3 to 2.5.
Over the last 12 months net total debt was reduced by $1.5 billion and credit. This net debt to adjusted EBITDA ratio is 2.5 for the third quarter of 2019 compared to 2.72 a year ago.
We remain committed to at target net total debt to adjusted EBITDA range.
Now that we are operating within our target range and as we expect to generate strong free cash flow, we anticipate starting to buy back shares in the fourth quarter under $1 billion Board authorization.
This is not expected to have a material impact on fourth quarter EPS.
Turning now to guidance for 2019, we continue to expect identical sales growth excluding fuel to range from 2% to 2.25% in 2019.
We continue to expect adjusted net earnings to range from 2015 cents to $2.25 per diluted share an adjusted FIFO operating profit to range from 2.9 billion to $3 billion for 2019.
We expect underlying identical sales growth in the fourth quarter will be similar to third quarter. However, incremental snapped dollars that were in the market in January 2019 represent about a 50% 50 basis points excuse me 50 basis point headwind in the quarter, we therefore anticipated reported I'd sales.
Yes, well be towards the lower end about 2019 guidance range for the quarter full as we cycle the effect of snap.
We continue to expect the fourth quarter filling a double digit EPS growth on an adjusted basis.
Where we land with our adjusted EPS annual guidance range will be heavily influenced by fuel margins in the fourth quarter, which were at record highs in quarter four last year.
How customers shopping behavior is affected by the lower snap dollars in markets in January will also influence the outcome.
As you know, we typically shall annual guidance when we report our fourth quarter results in March but this year, we provided guidance to 2020 several months early.
We remain confident in the 2020 guidance that we shared last month at our Investor Day in New York.
Now I'll turn it back to Rodney.
Thanks, Gary as I shared when we first began the call.
We believe that restock Kroger is the right framework to reposition our business and create value for all of our stakeholders.
We are on track with a stable and growing grocery business as a result of our customer obsession.
Renewed it intensity around operational excellence and continued development of our seamless ecosystem.
Our focus on the fundamentals generated positive results and our supermarket business in the third quarter, which gives us strong momentum heading into the holiday season.
Now we look forward to your questions.
We will now begin the question and answer session.
To ask a question you May Press Star then one on your Touchtone phone.
If you are using a speakerphone. Please pick up your handset before pressing the keys to withdraw your question. Please press Star then to at this time, we will pause momentarily to assemble a roster.
[noise].
The first question is from Edward Kelly with Wells Fargo. Please go ahead.
Hi, guys good morning.
I I just wanted to start with a with a question on the Q4 outlook. So you have a fairly wide range that I guess implies you know earnings growth anywhere from sort of like you know mid singles to all the way up over 20%. One question I think than to have related to this is you know what are the put.
And takes around that range and I know you mentioned fuel, but you know second question related to that is that you know to get to these numbers sort of either way unique or grocery earnings to improve.
And that's despite you know what is a harder comparison on on snap and.
Quite frankly recent pressure in grocery so can you just kind of walk us through those puts and takes and then what.
Do you think will drive core grocery earnings to inflect positively in Q4.
Yes, Thanks for question and I'll I'll kind of that.
So you're correct, we expect time as I mentioned in the prepared comments we are expecting.
<unk> adjusted EPS growth to be and a double digits in the fourth quarter, obviously as I mentioned, a moment ago were assuming on expecting identical sales growth to be in the range in the quarter continuing that sort of trend that we saw in Q3, but there will be some snap headwinds that will bring it down towards the at the lower end of the range. So that's the kind of course.
Assumption around I'd sales for the quarter, we do cycle. Some investments in Q4 last year, if you recall that Sam where setup costs around some facilities in DC. So from a a gross margin perspective, we do have some tailwinds that will help the quarter. We also expect to continue to see the cost saving improvements that we've been.
Accelerating throughout the year as we continue to execute on the 1 billion dollar cost saving plan on of course, I think we shed on previous quarters that alternative profit streams tends to be skewed more towards the fourth quarter predominantly because both kps has a heavy fourth quarter influence on the results and then media continues to accelerate and Q4.
There's always a high on media quarter as well, so you combine and accelerating rate and the fact that.
Media is higher in the fourth quarter helps the alternative profit posit business to continue to grow.
In terms of the sort of puts and takes in the quarter that could influence where we finish in the range on the headwinds side. Obviously, we have been investing in a new brand launch and we obviously spending dollars there in continuing to improve the the messaging and translating that into a connection with not customers. We also launched the promotion on free pickup for the quarter as well and see.
We have not plays out in terms of I'm customer behavior, and then of course, we also have the fuel headwind in the fourth quarter, where IRA I rate was 34 cents, which was a record high last year. So those would be the the the headwinds that were pushing against versus the m. The assumption I mentioned earlier the unknown is around the range really.
With fuel being you know a record high in the fourth quarter last year, if a fuel deforms inline with where it's been on average for the the year to date position. It would obviously be at a certain level. If it was which is a 29 to 30 cents range. If it was at the same levels last year at 34 cents that makes a meaningful difference too high.
The quarter ends and then of course seeing how customers behave as a result to the snap that was not being in marketing January's. A is a further factoring in you know really causing us to leave the range is why did the days, but we do feel confident in the way we see the model in the fourth quarter, which is why we still believe double digit growth in the.
Earnings per share is what we'd expect to achieve.
And just a just a follow up it seems like what's what's what's new in terms of what we're learning into guidance. This quarter is it I guess it seems like Theres a three cents pharmacy charge. That's that's in the guidance given everything your 47 cents.
Your LIFO charges going up by four cents.
They say that seems to be something that's a bit more unexpected what's offsetting that.
To allow you to maintain guidance.
At Bad this is right and just a couple of comments and I'll, let Gary Philbin. Obviously are identical has continued to improve and us in a strong there.
If you look at gross margin without the fuel and pharmacy, a slight improvement there we had great balance between cost improvements in gross investment and it's the continuation of those pieces coming together.
So it's really the core business continuing to improve and move into right direction.
Thats, providing that tailwind to offset the three cents on the pharmacy that that was out of the a quarter adjustment and the LIFO as well I don't know Gary anything I would completely agree with your Rodney I think the key thing for us that is that to your point that those headwinds even with those headwinds if you if you strip.
I was back in the quarter look at Q3 underlying EPS and operating profit would have been positive excluding the out of period adjustment as Robin you mentioned, obviously I'd sales was was very positive during the quarter, but we mentioned on the call. We didn't include it in the press release, but the impact to the out of period on gross margin rate was nine basis points, so actually in the quarter.
Our gross margin rate, even with the pharmacy headwinds that we called out I would have been balance with Oh DNA improvements over 15. So we were 24 basis points reported gross margin decline excluding fuel taken out those nine basis points you get to the 15 basis points of of underlying if you like at gross margin investment.
After the <unk>, excluding the onetime sorry, the active period adjustment.
So when we look at 15 basis points investment, including pharmacy headwinds that we faced and we achieved 15 basis points of urging improvement we actually feel like the progress that we're seeing in the model has been mask quite a bit in the quarter and we feel very public about the underlying trends that we're seeing in the business.
Great. Thank you.
He said.
Your next question is from Judah Frommer with credit Suisse. Please go ahead.
Hi, good morning, and thanks for taking my questions. Maybe first just following up on fuel can you help us with the benefit you're getting from improved sourcing and the sustainability of that relative to just kind of a general step higher in industry profitability and how that's playing out.
It's a combination of really some technology investments that we've made in terms of.
But how how to buy fuel and making sure from a market standpoint.
How we're pricing on a daily basis, and reacting and to what our competitors are doing so it's the benefit of or the way fuel is being bought plus in much more discipline relative to the market. So it's really the combination of those oh in terms of expectations going forward.
From a procurement standpoint, we don't believe that's something that we'll continue to incrementally get better we do believe that something that we'll be able to maintain and it's something that we've reflected in our guidance going forward.
Okay. That's helpful. And then and then maybe just following up on on the Lucky's write down I don't think it was that as long as though that you guys were side and you know double digit ideas that lucky's and great trend and produce maybe just a little bit more on the decision to exit the investment the write down of the investment and is there.
Any commentary on that Kinda, you know sub channel of food retail kinda specialized fresh led food retailers and the smaller boxes, that's causing you to say you know maybe the traditional larger store fresh led format.
Is the way to go.
Yeah. It it really gets back to Gary's comments in the prepared remarks is.
And we talked about at Investor day, It's really a reviewing our whole portfolio of things that we are involved with and working on.
And it really the amount of investment that it would take for lucky is to be a meaningful contributor to Kroger overall in the efforts that it would take we just didn't think it created a good a return for the investments that we needed to be made our.
Relative to that so it was really driven by narrowing our focus and the additional requirements to make its something that.
That would be meaningful to Kroger I don't know Gary you've been more on a day to day basis involved anything you want to add.
I I think you characterize the well Rodney I think the anything maybe to to build in the second part of the question I. We do believe that as we get better it connecting on a fresh and continue to evolve the strategy around natural and organic obviously, we have put providing a far more comprehensive level of experienced for that customer than ever before and continue to do more of that as we.
Continue to build out the strategy around freshness and connecting with Aloe customers Oh, we do believe that there's still a role for the small format store I think it we were 70 per even I think.
It's still probably to be proven in the industry about what is the right model for a smaller format store and how do you make that economic model work and how do you connect with the customer and away that drives the right value on those smaller shopping trips as well. So we still believe and continue to look for opportunities and obviously I Walgreens pilot continues to provide an opportunity to learn how to continue to.
To build a strategy that has a small format presence in that but I I do think it also demonstrates show comment that it's hard to figure out about small format modeling to make it work effectively.
Great. Thanks. Thanks.
The next question is from Chuck Cerankosky with Northcoast Research. Please go ahead.
Good morning, everyone.
In looking at the Thanksgiving sales and how customers were spending trading up can you talk about what that might mean for the.
Christmas selling season.
Yeah it.
Yeah. Thanks, Chuck if you look at a quarter to date are done of course would be pretty similar to where we were in the third quarter.
The bounciness of it is.
Significantly different than the last few years, because obviously, there's one less week between Christmas and Thanksgiving and Christmas.
If you look at the way our customer spend their money a we continue to see obviously strong on people trading up.
Strong performance in wine cheese, or all of those types of categories and we would certainly expect that to continue to do I stay consistent through Christmas as well. So we really expect business to continue where it is through Christmas obviously.
If you look at January of next year, it's really the snaps us cycling the snap.
Impact would effective kind of the numbers that we provided for guidance.
Yeah related to customers trading up is that.
What you're trying to do when you invest in the customer experience.
Prepared foods strikes me, you're making investments there well, but are there other things we should think about.
Yeah. It it's.
Fascinating because their customers trading up both in terms of buying bigger package size. So what we find us when people are tied on that budgets. They go to smaller package size. So we see people trading up there. We still are we see people trading up to.
Products, that's better for you natural organic category prepared foods would be an area that we see people continuing to trade up for it and it's an area where.
Weve focused a lot of attention on how do we get better we view it as a huge opportunity to improve from where we are a lot and it's one of those things where.
We were just up at the beginning part of that journey, but certainly see customers very willing.
Two.
Pickup debtor at Kroger, but do it at a with a home chef meal or something already prepared.
Right. Thank you thanks Chuck.
Your next question is from Michael Montani with Evercore ISI. Please go ahead.
Good morning, guys. This Antonio tabby, taking over for Mike Montani I, just wanted to ask something on the Fourq you comp outlook.
You guys, obviously cycling snap in January but I'm curious as to what you're seeing so far now with the whole rebrand going on and another follow up to that is with the option of a free pickup promotion going on right now until January 1st is there a possibility that that days or what do you have seen from that so far from.
The reception of Christmas Thanks.
If you look at the outlook for the fourth quarter, so far in the quarter, we're tracking pretty similar to where we were in the third quarter.
So it's really a end up until the snap period, we really don't see changes there in terms of or the pick up a free pick up option.
We really are to the point yet of deciding whether to continue it or not.
As you know we've done it L in several markets.
And we're still early on the analysis with the customer adoption has been stronger a little bit stronger than what we were expecting.
But it's us to us so we're still at a point, where we don't need to decide that yeah in terms of whether we extended or not.
Just to add Rodneys I hate is literally a few weeks obviously into since we announced that promotion. It's interesting we're seeing a combination of new custom is starting to use the service as well as existing well Craig a shop is using the service more frequently as well so I will be using all about eight years, you might expect to really analyze and evaluate and that certainly.
Factors that could also influenced how the quota plays out in terms of sales, which is another reason why we were trying to be I'm clear about sharing the different moving parts that could still affect the quarter.
Okay. That's helpful and just a quick follow up on the digital side you guys grew digital sales, 21% this quarter and just the way we're thinking about it for the full you were thinking somewhere in the range of five to 5.5 billion digital sales versus.
2018 value somewhere around the baseline of 4 billion, so that implies around 31%, 30% year over year growth is that is that's somewhat reasonable to think of who is an attainable target just wanted to get your color on that.
Yeah, if you look at our run rate basis, yes, the numbers.
But you shared would be very consistent with what we see the other thing I always think is important to remember that I mentioned.
Our digital business and you all shared it on a graph is.
The profitability of that business is maturing as we expect a and if you look at the early.
Adopters on digital the profitability that customer was the same as going in store, because we get such a higher share of their total spend and we continue to see that maturity.
Happen as well, which for US is something that makes it a sustainable model a longer term as well.
One thing to add to Rodney you said in your prepared comments and I mentioned in previous while but Tom I think we shared before that it really is that the cycling at the home chef manager that caused the the absolute percentage growth rate to show a declining trend the underlying.
Progress that we're seeing and customer engagement through Kroger pickup and delivery continues to be very strong and very consistent in the the underlying results that were seeing beyond the headline number.
Okay and does that headwind continue to Fourq you.
Now at least that Weve cycled out now so it kind of if it was partially through Q3. So you have kinda roughly half of it and Oh, sorry, obviously Q2 to roughly half of it in the second quarter and now it's fully cycled through in a in Q3 I think Yale may have shad two at the Investor Conference that we expect the growth year over year going into 2020 to be in that 20% range concern.
Certainly what we shed this quarter.
All right. Thanks.
Excellent. Thank you.
Next question is from Ken Goldman with JP Morgan. Please go ahead.
Hi, good morning, Thank you good morning.
Rodney Thank you for the update on the quarter to date comp.
Can you I know you probably will soon though you've never done this before but just given some of the puts and takes for the for the fourth quarter could you give us an update on sort of where you stand on your core gross margin quarter to date and your fuel margin as well I. The reason I'm asking is there do it does seem to be a little bit of hesitation from some investors.
And your ability to sort of hit the high end of your.
Guidance range for the fourth quarter I, just wanted to get your your thoughts on that.
Yeah. The at I. I really would just go back to the comments that Gary made before if you look at the underlying.
Supermarket business it continues to be strong.
Identical continue to be strong very good balance between cost reductions and and investments in service and gross.
The biggest.
Swing would be the fuel margin.
And.
Even internally.
The swings can be so much from day to day that it's really the value of where we are quarter to date I don't think curry.
<unk>, they can change overnight and I remember the other day being in a market where in the morning margins were 40 cents in the afternoon. The margins were 15 cents is that type of swaying, but when you look at overall, it's a great returns and that creates a lot of customer loyalty. So.
And then the other pieces that so I I don't know Gary if there's any additional insight, but to me quarterly fuel margins or just kind of hard though because it swings. So much nothing that's right and just to put the number into context I mentioned to briefly earlier, but the you know the rates that we've been trending up year to date isn't that 20.
Nine ish sense a range that you know at 34 cents was the the Q4 rate last year.
That five cent range can make a $50 million difference in terms of profitability. So.
Obviously, we have a very clear strategy of how we connect with customers on fuel and and making sure that were in line with the markets and so it is one of those areas, where you know it kind of a significant impact and and hence why appreciate does leave a much wider range than we normally one to I think having place for the fourth quarter.
He certainly not a lack of confidence in what we're seeing in the underlying core business, but it's just with that level of uncertainty out there on something like rates. It's Ah. We felt it was prudent to to lead the range where it is.
Oh I get that thank you for that and then my follow up is you know obviously the government made some changes that are going to.
Take some people in America, all food stamps and sounds like there was more of that coming I'm curious to what degree does you were 2020 guidance factor that there's a risk because clearly I think that.
700000, or eventually some of the people think it'll be closer to 3 million Americans get a food stamps I can't say that as a positive for you, but I'm curious if there's any way to think about you know numerically.
How that might affect you.
Yes. Thanks for the question can obviously, it's something that we continue to watch very closely and.
Obviously, it's one of those things that we knew was a potential risk that's out there in the business and we'll continue to watch it and evaluate.
From my perspective, we really try and build the business model around being able to adapt to the circumstances and we do believe that you know the model that were creating and our ability to connect with customers and deliver an overall experience. The personalized pricing office that we can generate that obviously are what we tend to see when customers have less dollars they'll tend to gravitate.
In order to own brand products, and you'll start to see some behavior shift, but because food is a non discretionary spend you know usually the customer's going to make that adaptations that they have to be able to you know I'm still by the grocery is that a that feed the family. So from our perspective, we certainly something that we contemplated.
As a risk as we think through how we'll continue to build on modeled and drive connection with customers and it's something that well continue to adapt as we gain more and learned.
When and if the changes occur, but obviously, it's one of these things out about controlling and our focus is much more and how do we make sure we're going with the customer and continue to adapt strategy. If some of those things were too to it to us as a a headwind in 2020 . Yeah. Just a couple of additions up obviously, the overall economy continues to be strong as well which provides support.
And when you look at us snap, we would be less dependent on on snap than many of our competitors would be as well.
Thank you so much thanks again.
The next question is from Rupesh Parikh with Oppenheimer. Please go ahead.
My name is actually archive I'd say past thanks for taking your question.
I just wanted to touch on price investments I think last quarter, you caught I think it was about 12 basis points of price investments.
Yes.
The only about half price investments that right now.
Yeah, I don't think we've typically you called out specifically price investments what I, what I would say in terms of maybe a couple of thoughts when you think about gross margin and what happened in gross margin during the quarter the way that time to sort of break it down if you like and I covered a couple of these points failure, but.
If you ask me fuel from the results, we had a 24 basis point investment in gross margin a nine basis points, it's not related to the out of period charge that we shed in the press release this morning, which essentially brings it down to 15 basis points on all of that gross margin headwind was essentially in.
Health and wellness space between Craig the specialty pharmacy, and retail pharmacy, and as Rodney mentioned, a gross margin rate overall improved slightly when you exclude pharmacy app from from the core business as I never like to say that is through the cost of goods savings that we were able to execute on during the quarter I'm. The alternative profit growth that we wrap.
To achieve during the quarter, which both support improvements in gross margin, we fully offset the continued price investments that we made in the business to drive that continued improvement to 90 sales growth I. We are continuing to invest in prices. We shall I think at the Investor Day, you know a lot of our focus this year is already making sure that we're using our data to drive.
Price investment scenarios that matter, most about customers and some of those are going to be personalized offers and promotions, but some of it will also be in fuel rewards and we mentioned in the prepared comments that the while the profitability of fuel improved during the quarter that was our second the supermarket business by 8% growth and the amount of fuel rewards that we paid to customers.
To incentivize them to continue buying a cargo so it's a it's a complex model in that sense, but we are continuing to invest in price. We're pleased with the way that customers are reacting to the investments that we're making because it's a it's certainly allowing us but one component of driving the identical sales growth that we shut in the quarter, but we're being very deliberate in balancing those investments with.
Cost of goods savings and alternative profit growth and the other thing that helped gross up shrink improved for the ninth consecutive quarter and warehousing and transportation costs improved as well.
Okay. That's helpful. And then you briefly mentioned the prepared foods opportunity could you maybe.
Talk a little bit more by his vision behind on the recently announced cracks or truck partnership and you know did [laughter].
Tax and how you're thinking about Oh I'm sorry.
Oh it I'll start with the end of your question first it doesn't affect us how we look at home shaft at all.
And if you think about our overall strategy on trying to serve the customer anything they want anytime they want anywhere they want.
Hi.
As you know about half of food is food already prepared were people spend their money at our market share there is significantly less than on the traditional supermarket business.
And we really view, though it will be a combination of home chef something physical in stores in terms of meals ready to heat ready to eat.
And clustered truck is one of those where we think it's in addition.
To that overall eco system or the obviously they have a incredibly good technology, it's made to order quickly and they will be able to leverage and we're doing it's obviously on a test basis, they'll be able to leverage some of our physical assets or to be able to scale.
As well so it's really an additional piece in terms of how do we get the customers what they want when they want it the way they want it and it's just the overall part of the overall ecosystem.
And we just see the opportunity on food that's already prepared.
As a massive opportunity.
Okay, great. Thank you so much in America.
Your next question is from Michael Lasser with using the last month. Please go ahead.
Good morning, Thanks, a lot for taking my question, Tony <unk> is too.
You say you you've been encouraged by some of the early learnings from your expansion of the freedom Digital pickup initiative can you give us a sense for how the the that initiative has impacted the piano tiles, two or is the financial performance inline with what you expected.
Okay.
Yeah. Thanks for the question as it just recall that guy he's really early days and in the journey ways that the promotion because we literally launched a few weeks ago and obviously part of the.
The modeling that you would expect us to do as we understand customer behavior is to look at that's as Craig. It does not everything that we do look at the long, but you know behavior with a customer and not just the individual transaction, but how does that change or the level of engagement with the customer and that's going to need to happen over a longer period of time as Rob you mentioned earlier I'm certainly the early encouraged.
Seeing signs ours, I mentioned, we starting to see a new customers.
Experience the service and start to engage in credit or pick up that happened before I. We're also seeing existing kroger pickup customers start to increase the frequency with which they use pickup service and so a lot of.
Financial modeling that we will do well really be looking at those metrics over a longer period of time and saying how you know how does that play out in terms of the value it creates and ER and how does it drive loyalty and then of course as we talked a little bit about at the Investor Conference well, we'll look at that into context of the investments that we make in the business and how does customer value. This part.
The experience versus other ways in which we're creating value across a price investments across our fuel discounts and obviously through the experience that we're offering and there's still a so it's a it's a pretty complex area and certainly we'll look at it over a longer period of time.
What we're seeing kind of this type of behavior would have expected to see and it's certainly been positive I, but it's really going to be a longer period of time before we could really evaluate either way in which it impacts the model with the customer.
And just to clarify Gary you have assumed that in your 2020 guidance that you've provided the test will be limited to 2019. So it will not continue into 2020 at this point and then I have a quick follow up.
We havent really gone into specifics around what App, you know what our pricing strategy will be in 2020 units, we talked about obviously I would think about it more mature as you think back for the chocolate I shared at the Investor meeting in New York and how we're balancing the investments we simply making in the cost savings in the business. So we certainly have a clear view of how much we believe.
Leave we want to invest in the business next year and how that will be supported by the billion dollars of cost savings that we're expecting so if we were going to see the value in a pick up driving more value in our model it would be because either we expect it to drive high sales and support the investment all we believe it would be a better way to invest the dollars that we think are important to drive.
Value for the customer and 2020 .
That's helpful. My follow up question is right have you seen some pretty good momentum in your idea deals there's probably a variety of factors that are contributing to that including a healthy your overall environment being further away from some of the disruptive changes that you've made and a better execution in the bay.
Business, if you had to rings, those factors and maybe any others in order of importance in magnitude that they've contributed to driving this improvement how would you do that.
Yeah the.
Great question, Michael We would really view those is pretty equal the other thing that we would add on top of that is really using personalization and data.
To be more specific for each customer individually. So like on the example, I gave on fuel rewards, but it wouldn't be true for offers more than just fuel rewards, but really personalizing it.
To each household individually and it's really all of those we would call. It to some of all parts of all of that to gather a that's creating an improving the momentum it's not just one single thing.
Thank you very much and have a good holiday makes you as well you too.
Next question is from Simeon Gutman with Morgan Stanley . Please go ahead.
Hi, This is Josh Cameron for semi thank you for taking my question. So sales trends are improving and the grocery gross margin increased slightly in the quarter. How sustainable do you think that combination is in the near Tim and then more broadly what changed in the competitive landscape would you need to see to undergo a deep around price investments over the next three years been.
It's currently embedded in your plan.
Yeah. Thanks to the question I think on that the first part of the question.
I would kind of draw back again to what we talked about at the Investor Conference. The weight. The way we think about the model going forward is certainly we're going to continue to invest in price, we're going to continue to invest in the customer experience because.
For the long term sustainable growth in low teen we think that's critical to our plan. What we're doing very deliberately is being very disciplined in how we're managing cost within the business both cost of goods savings, but also I would you in a cost efficiency, which obviously was a strong during the quarter and then alternative profit streams continues to accelerate.
I I mean, obviously offsets the gross margin investments that we're making as well. So I think we we look at it much more of an April ecosystem. If you like if how do we use food as the foundation for customer loyalty, which drives the traffic and then fuel obviously builds on that in terms of causing customers to shop more frequently.
When you think about the health and wellness business and alternative profit streams layering on together to create this overall ecosystem that drives customer loyalty and drives total profitability at the customer and the way. We think about is how do we pull those levers together in a way that allows us to continue to invest and build loyalty and we're using the different dynamics there around alternative profit in cost savings.
To be able to continue to invest I think when we look at that the markets. You know certainly obviously, there's there's a there's always a high competition. We expect that to continue we always issue not within our model and we feel very good about the plans that were implementing around driving cost averaging a teenage girl synergy profit that we can make the investments that we need to be able to.
We continue to grow customer loyalty.
The only add a couple of things one in Gary briefly mentioned that you look at continuing to learn to improve the customer experience or that provide support and ongoing support because we still a we've made good progress, but we still see opportunities to get better.
The one area that I've been pleasantly surprised as you know we've been able to dine in 2018 were able to take over $1 billion a cross sell.
We're on track to exceed that again incrementally in 2019 EM.
We have plans to do that in 2020 as well we continue to see good opportunity it would take costs out and when you look at all those both those pieces together and the free cash flow that business is what gives us.
Confidence in comfort in the comment that Gary shared at the Investor meeting of TSR of 8% to 11% per year.
That's helpful. Thank you and then in general maybe you could just quickly touch on your your price gaps versus when you get competitors, a baby and widening the narrowing and are you pretty happy with where they sit at the moment.
Yeah, but one of the things that we always think it's important I worked with work comfortable where we are but it's always important to remember that customers decide where to shop based on freshness of departments and we shared with you a that our.
Customer feedback on fresh.
That are that are a big box competitors Oh, we also have tons, a personalized offers where a customer gets value. Both in terms of individual mailings individual emails and fuel. So it's all of those pieces together and we feel good about where we are gap is.
Great. That's very helpful. Thank you.
And the last question will be from Robby Ohmes with Bank of America. Please go ahead.
Hey, guys. Thanks for fitting me in just two follow ups I you know just the first on on the LIFO increase on can you. Maybe just you you know you mentioned procuring batter life was coming in higher than expected I think in the press release, you guys called out grocery in dairy inflation is this is this all commodity driven.
For our CPG companies pushing through price increases and then also could you tell us what what the inflation component of ideas wants to the third quarter. So maybe just paint a picture what what exactly is going on between all those things.
Thanks for question Robby.
So there is an interesting question around life any inflation, because you know I without maybe answer to question slightly differently from an inflation point of view as you know we shed before we were assuming inflation in the range of zero to 1% in the year I would say, it's trending slightly above that range actually for Q3, I wouldn't say, it's materially different than it was in Q2 s.
Couple of of categories like produce when when a slightly down and meet went slightly up but nothing that would have been dramatic in terms of the overall change in inflation. So just slightly ahead of that 1% assumption that we had during the year and actually even though I LIFO charge forecasted increasing we haven't really seen a dramatic change in the overall inflow.
Patient right across the categories everything out your said now should probably Cabot excludes fueled in pharmacy, because those two obviously tend to have a a different trajectory versus most of the food categories. A interesting we'd lifetime. It is a a one data point in time at the ended the year that we follow to support the accounting rules that are in place around making that life.
Adjustment with a data point that we used in the third quarter caused us to in following that process believed that we should increase the life and based on what is telling us. That's why we called out the forecast is expected to be a.
Headwind for the yet because it's a noncash item in it it doesn't really impact the underlying performance of the business, but time it will impact the the earnings for the year based on the trend that we're seeing right now, but I wouldn't say, it's a reflection of a major change in what we're seeing in inflation and obviously, we've shared before when we when we see price increases generally speaking will be.
Pushing back on them basing basin I knowledge of iron brand products, and managing those but where we are seeing them, which everybody looking to pass them onto the customer might make sense in those markets.
Thanks, and just my other follow question just on pure reward. So you were expecting the you know the CPG profitability fuel the kind of it sounds like flatten out next year, but it sounds like you're also going to be pushing harder if I understood. It you know to kind of drive ideas more using the fuel rewards program you know just house.
Should we think about that and has there been a change in the responsiveness to fuel rewards that that Scott you you know interested in pulling that lever a little harder to to drive ideas and penetrate loyalty more.
It really is in an important part of our overall connection and or rewards on back to our customers for them shopping with US I would say part of it is just.
Just continuing to learn.
New approaches.
That connect with the customer so over the last a really really six to 12 months, we've been doing a lot of different types of test and learn just trying to identify I'd add additional approaches that connect well what the customer and it's really on some of those are working so we continue to scale that.
How much we scale will really be driven by the degree of customer connection and how much does it drive the business, but customers still love an incredible a great value for fuel and you know we have somebody convenient fuel locations. It really works out well for our customers and for our business as well.
And just Rodney how should we think about you know if you do keep growing at 8% year over year, how were how will you fund that in 2020, if you're not going to be growing the profitability of your fuel business at the same rate.
Yeah, well it when we talk about feel cents per gallon. We do not include we do not reduce that for any rewards at all of that doesn't.
Doesn't show up there in terms of our internal financials.
If you look at the overall guidance that we gave for 2020.
We would be reflecting what we expect and plan to do on fuel rewards, but it really gets back to Gary's comment on terms of yeah.
Like <unk> improving identicals by this much these type of process changes in getting cost out what type of capacity does that give us to invest in service.
Price and we would look at fuel rewards as part of that price investments because that's how our customers look at it.
Great. Thanks, so much thanks Robbie.
We really appreciate everybody joining us today and as always thank you for your questions.
Hopefully you can get to sense from Gary in my comments or was that our underlying business results continue to be strong identicals continued to move in the right direction, we had good balance on investing in.
Gross and cost improvements and the free cash flow that business continue to be strong, which positions us to get into a position of being able to buy stock back as well. So when you look at it overall in the quarter.
So very good about the underlying results and where we're headed.
As you know booked for I end todays call I always like to share a few final comments, that's directed at our associates and how we live our purpose every day.
Last week I was visiting with store associates in our Colleyville, Kroger and Memphis and customer approached me.
When I was walking into the store and you just wanted to share of Hawaii shops at Kroger and they said its first of all I gave an example, we're one of our associates just gave incredible customer service and then he said you know krogers.
You always.
Our great at donating food and funds to serve hungry families in our communities any specifically talked about is community.
And to me that reminded me of the privilege that we all have to serve our customers in communities and each other.
Whether its general sleep, giving back to our neighbors and need or by being there for more than 11 million customers that come into our stores and online every day.
Especially during this busy holiday season.
We opened our doors and welcome everyone and as gas whether they shop with US all the time or is there first time shopping with us.
Each celebration or tradition is unique and we can be there for our customers when they need us most.
Because we believe no matter, who you are how you like to shop or why do you like to eat everyone deserves to have affordable easy to enjoy a fresh food.
Each of US all 460000 associates play an incredible important role and bringing fresh to for everyone to life from stores the plants in distribution centers and our corporate and division teams.
Thank you for all you do every day and especially during this busy holiday season.
I wish all of you and your friends and family Happy holidays, Merry Christmas and a happy new year.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
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