Kroger Co Executive Insights: Slow Tonnage Recovery, Customer Focus

On Thursday, Kroger Co (NYSE:KR) reported its first quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Slow Tonnage Recovery:

John Heinbockel – Guggenheim Securities: So a couple of things guys. When you look at your expectation for comps through the remainder of the year, what do you think happens to tonnage from where we are right now? Do you think we see any improvement? It looks like the work we’ve done that competitive rationality continues to prevail. People aren’t doing anything done at this point. Do you see the same thing? And would you expect that to continue?

David B. Dillon – Chairman and CEO: On the tonnage for the year, we’ve said I think all along that as inflation comes down, which is what we expect to have happen, that – while that’s not negative that doesn’t mean prices are going to go down. It just means the rate of growth (would slow). But we do think that that will, in the long run, be positive for tonnage. However, tonnage will be slower to recover then the rate of inflation will come down, I believe that’s a personal opinion. We don’t have a way to prove that till we actually go through it. And the reason I think that is because the economy, from a shopper’s point of view, is not in all that greater shape. So, it’s not going to cause customers to jump back on the wagon unless they’ve got more money to spent. But we do expect it to positively affect, it just at a slower rate, that’s all. As for competition, we would agree with you. It’s been a rational market. I think everyone realizes it’s a tough market out there for customers, and I don’t see a lot of overreacting going on. Rodney, do you want to add any color to that?

W. Rodney McMullen – President and COO: No.

John Heinbockel – Guggenheim Securities: All right. Secondly then if you think about deployment of your cash flow, arguably you’re in the best position you’ve been in a very long time competitively, stock has been cheap as it has been in 10 years. So, how do you think about two things; one, being more aggressive with your buyback effort to the point of possibly levering up a little bit to do that. Secondly, how do you think about the dividend payout ratio, I know, you have a target in terms of yield, but where do you think you ought to be in terms of pay out?

David B. Dillon – Chairman and CEO: I’ll have Mike answer both of those in detail here in a second, but I will tell you that part of the answer you can find in the fact that our Board authorized stock repurchase to start back up again as we finished that earlier this week, and that was intentional because we agree with our stock prices is cheap. Mike?

J. Michael Schlotman – SVP and CFO: Yeah, relative to the buyback we finished the quarter at 1.91 times net total debt to adjusted EBITDA. We think being in the 2 to 2.2 times range is something that the rating agencies will be comfortable with and allow us to continue to be at BBB flat credit which is important to us. I’m not saying I want to be at 2.2 because you do like to have a little cushion – operating cushion, and not live life on the edge necessarily. Over the last four quarters we’ve returned $1.6 billion between buybacks and dividends. I think that’s a pretty healthy return back to our shareholders. And relative to the dividend payout ratio, this will be our seventh year of paying the dividend since we reinstituted it and we’ve increased it every year. We said at the outset and we continue to say our plan would be to – once you start a dividend you want to maintain it and not have to stop it and continue to grow it over time.

Customer Focus:

Deborah Weinswig – Citi: Congratulations on a great quarter. In terms of categories I thought it was interesting you talked about every supermarket had positive identical sales led by growth in natural foods, pharmacy, bakery and deli. I was wondering if you can provide some more color around those particular categories.

W. Rodney McMullen – President and COO: Well, obviously the pharmacy department, as Mike has mentioned, was benefitted from Express Scripts, but even without Express Scripts pharmacy had a very strong identical sales growth. The team – when they put together a plan on addressing – getting the additional Express Scripts business did a nice job of making a broader than just trying to get that business and they have done a very nice job. Obviously, in natural foods, it’s a trend change – a continued trend of people eating more organic and natural foods and that – as we do a better and better job in that area, we’re able to – for a customer to eliminate one extra shop and they can get those items from us at a price point that’s very at reasonable. On produce, deli, bakery, we’ve had strong results there for a while. Produce is kind of interesting, they had fabulous tonnage growth, identical sales weren’t so – it was positive but not so much, but the tonnage was just outstanding.

Deborah Weinswig – Citi: Then Dave, you talked about this idea of creating a new industry and I know that when your peers talk about your performance, I mean they really do stand in awe. As you look into the future, and I know that Kroger is always on the cutting-edge of technology, what do you think continues to differentiate Kroger from the pack?

David B. Dillon – Chairman and CEO: I really think is the way in which we’ve looked at the business. And that was the point of the opening comments that I had is that in the past, if you go back 15 years ago, we kept thinking like a traditional grocer and we kept thinking that our competitors were traditional grocers and we kept thinking about where you get customers is by competing with traditional grocers. The difference for us has been by focusing on customers, we’re defining the industry we’re in by how the customers think of it, not how we previously thought about it. So, as an example, we used to think about it as people who buy food in supermarkets, but today they buy food everywhere. They go to the club stores, the dollar stores, the mass retailers. They go to lot of places that are not supermarkets and in fact, if you were to list our top competitors based on market share and the markets we operate in, the top two or three would not be traditional supermarkets, aside from us. And as a result we don’t really see that to be the universe that we’re operating in. We see it as totally different and we’ve had to approach it differently and I think that that’s the reason we’ve had better results because we’re swimming in a pool that’s bigger. We were thinking about it as bigger than simply what the market was for traditional retailers. It’s almost a classic business school case study to show how you define your market and how you think of yourself will often determine who you become, and I think that’s very true for us.

W. Rodney McMullen – President and COO: The only other thing I would add Deborah to your question, one of things that we’ve really been working on hard and this has really been over the last several years is not having a strategy that’s only dependent on one competitive advantage. And if you look behind the strategy there’s really 10 or 12 different critical pieces. We often obviously talk about dunnhumby and that would be one of the piece, but that isn’t the only piece. And we believe over time that creates a bigger and bigger competitive advantage because the competitor can try to get as good on one particular part but to do all the pieces is a lot harder and that’s really, when Dave talks about creating a new industry, that’s one of the things that we don’t know quite what words to use other than we know it’s a new industry because there’s really not anybody else competing on such a broad level of experiences. Obviously technology is one piece of that too.

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