The Kroger Co. held its first quarter 2023 earnings conference call, with Chairman and Chief Executive Officer Rodney McMullen and Chief Financial Officer Gary Millerchip in attendance. Rob Quast, Senior Director of Investor Relations, reminded those in attendance of the forward-looking statements that were made and cautioned that actual events or results could differ materially. Despite the challenging environment, customers continue to prioritize spending on food and the company's value proposition is resonating. Kroger's investments and productivity improvements have strengthened the business, allowing them to invest in price for customers while maintaining margins.

Kroger is delivering great value and strategic initiatives to customers, providing them with savings opportunities such as loyalty discounts, weekly specials, yellow tag promotions, and digital coupons. This is leading to increased customer trips and household growth, especially among mainstream and higher-income shoppers. These shoppers are buying more premium, Our Brands lines, fresh items, and larger pack sizes, leading to increased profitability.

This paragraph discusses how budget-conscious households are buying fewer items and switching to lower-priced products due to declining SNAP benefits. It also notes that value and quality remain in focus for customers and that the company has an attractive value proposition to meet this need. In order to differentiate itself from everyday low-price providers, the company is investing in its strategic priorities of fresh, Our Brands, personalization, and seamless. The company is also improving its supply chain to increase in-stock rates and streamline its end-to-end fresh initiative.

Kroger is investing in its store network and Our Brands to provide customers with more freshness and options while reducing expenses. Home Chef is innovating and expanding its offerings to provide more convenience and healthy choices. Kroger is using data and AI-based personalization to better understand customers' needs and provide targeted experiences. They are constantly evaluating potential use cases for AI while ensuring privacy and responsible implementation.

Kroger is leveraging AI and data science to improve the customer and associate experience. They are utilizing search algorithms and generative AI to improve substitution accuracy and search results. They are also piloting large language models to summarize customer database sets and applying AI to customer surveys and customer service logs to react to customer feedback more quickly and accurately. Additionally, they are using advanced algorithms to optimize activities such as store orders which helps reduce out of stocks, improve inventory management, and reduce expenses. Finally, they are focusing on associate training to improve the customer experience for pickup, resulting in increased net promoter scores and reduced customer wait times.

Kroger is committed to providing its customers with a great experience, whether it is through Kroger Delivery Now, customer fulfillment centers, or in-store. This has led to a 13% increase in digitally engaged households, who are more loyal and spend more. Kroger is also investing in training its future leaders, with 445,000 leadership development courses already taken in the first quarter and recognition from the SEAL Business Sustainability Awards for its environmental initiatives.

Kroger received an award for their efforts in creating communities free from hunger and waste. Their first quarter results demonstrate the success of their value creation model and investments, resulting in identical sales without fuel of 3.5%. The termination of their agreement with Express Scripts had both a positive effect on their FIFO gross margin rate and a negative effect on their OG&A rate, resulting in a slightly positive overall effect on their operating profit.

This paragraph discusses the company's go-to-market strategy, which includes brand sales growth, digital sales growth, and improved cost efficiency. The company's Net Promoter Scores have been increasing, and they are expecting double-digit sales increases for the remainder of 2023. Gross margin was 22.3% of sales.

Kroger's FIFO gross margin rate, excluding fuel, increased 21 basis points compared to the same quarter last year, due to strong Our Brands performance, sourcing benefits, lower supply chain costs, and the effect of their terminated agreement with Express Scripts. This increase was partially offset by higher shrink and increased promotional price investments. OG&A rate increased 14 basis points, excluding fuel and adjustment items, reflecting planned investments in associates and the terminated agreement with Express Scripts. Adjusted FIFO operating profit was up 4% and adjusted EPS was $1.51, both compared to the same period last year.

The quarter saw positive ID sales growth from the Health and Wellness team, despite the termination of the Express Scripts agreement. Fuel rewards engagement increased by 19%, and the average fuel price was lower than the same quarter the year prior. KPM announced a collaboration with Disney for Connected TV, which is expected to double in ad spend by 2027. KPM is also rolling out cooler screens in stores with digital overlays to offer customers information and advertisements.

Kroger continues to invest in its associates and has ratified new labor agreements with the UFCW and United Industrial Workers. The company's net total debt to adjusted EBITDA ratio is a record low and it expects its free cash flow to be in the range of $2.5-$2.7 billion for the fiscal year 2023. Kroger has paused its share repurchase program to prioritize deleveraging following the proposed merger with Albertsons.

Inflation has been decreasing throughout the quarter, and Kroger expects it to continue to decline. In light of this, Kroger has reaffirmed their full year guidance for identical sales without fuel and adjusted EPS, expecting identical sales without fuel to be at the low end of the range and adjusted EPS to grow within the range of 2-5%. Despite macro uncertainties, Kroger is operating from a position of strength and is able to continue to deliver value for customers, invest in associates and create returns for shareholders.

Rodney McMullen provided an update on the pending merger between Kroger and Albertsons Companies, stating that they are on track to close the transaction in early 2024. The companies are working with regulators and have received a lot of interest from potential buyers for the stores that need to be divested. They have also committed to not laying off any frontline workers, closing any stores, distribution centers or manufacturing facilities as a result of the merger. They are confident that stakeholders will understand the benefits this will have for customers, associates and communities.

Kroger is engaging in promotional activity, with CPGs heavily involved in promoting national brands and Kroger funding promotions for their own products. This is helping customers on a budget stretch their money further.

Rodney McMullen responds to Chuck Cerankosky's question about the dollar amount of the 30% increase in delivered digital orders by stating that the majority of the increase is coming through Ocado's sheds. He does not have the specific dollar amount but he is aware of the total increase. McMullen then adds that Ocado has a great partnership with them and they are making progress in ramping up the Monroe facility. Simeon Gutman then asks if the price investments and promotions are a response to the competitive environment and if it is a sustainable change. McMullen responds that it should be read differently than the way it was asked.

Walmart is using their own algorithms and AI to offer targeted promotions that are more attractive to customers. This increased engagement is partially funded by CPGs and is also due to the economic environment. They are focusing their marketing efforts to ensure that they are personalizing offers to resonate with customers who are on a constrained budget due to lower SNAP dollars in the market. Additionally, Walmart is seeing some prices come down in order to help customers manage their budgets more effectively.

Rodney McMullen of Kroger explains that historically, as inflation goes down, there is an increase in tonnage. He notes that there is a bifurcation in customer behavior, with some customers behaving as if the economy has always been the same, while others are making modifications such as buying less per trip. McMullen predicts that as inflation continues to decline over the course of the year, tonnage will improve.

Gary Millerchip clarified that the updated expectation for identical sales (IDs) to be at the lower end of the full year comp guidance only applies to the last three quarters of the year and does not indicate that the full year would be at the bottom end of the range. He also expects each of the final three quarters to be positive, assuming that inflation continues to decline and ends the year at low single-digit inflation.

Kroger is seeing a decline in their grocery department, but they are still seeing an improvement in their unit trajectory. In order to combat any potential market share losses to other price-leading players, Kroger is willing to use their own P&L to fund further investments. Kroger has done an analysis of their total go-to market value, which includes their prices, promotional activities, rewards programs, and personalized offers. Their total value equation is close to what EDLP merchants offer, just with a different approach. Kroger is mainly focused on their price-sensitive shoppers on a budget.

Gary Millerchip does not give specific guidance for the P&L, but suggests that quarter one can be used as a proxy for the rest of the year. Investments will be made to remain competitive and manage inflation and interest rates. Shrink will continue to be a headwind, especially in the center of the store.

The team is doing a great job in managing Fresh shrink, but there are structural challenges in center store shrink. The tailwinds for the rest of the year include sales growth from Our Brands, benefits from Express Scripts, strong performance from supply chain, and double-digit growth from alternative profits. These impacts and drivers should be similar in the rest of the year for gross margin rate.

Gary Millerchip and Rodney McMullen answer a question from Robert Ohmes on the penetration of their brand and the margin benefit of it. They explain that their brand has a margin of 600-800 basis points higher than national brands and that Private Selection has grown faster, with customers loving the quality and uniqueness of it. They also mention that Smart Way has a lower margin, but the mix of products still makes it margin accretive for the rest of the year. They don't target specific growth for their brand, but use a customer-led approach with data to drive growth.

Rodney McMullen reported that customers tend to engage with Our Brands products more during a challenged economic environment and that the penetration level often stays high even after the economic challenges have passed. In response to a follow-up question about the benefit of the GLP-1 drugs to the ID, McMullen reported that it was material and that the impact of Express Scripts exiting was minimal due to the pharmacy team's efforts to help customers find alternative ways of getting prescriptions filled.

Kroger has seen positive growth in their customer households overall, with the mainstream and upscale customers being more profitable than the value customer. They have done surveys to find out if customers understand and perceive the value proposition versus EDLP.

Rodney McMullen answered a question about how customers perceive fuel rewards offers. He explained that customers who have the money to stock up on items understand the way the company goes to market, while customers on a budget may understand the offers but not have the money to stock up. Kenneth Goldman then asked what was different this time that would allow the company to maintain profitability and margins during disinflation, to which McMullen responded that the competitive environment is not as intense as it was before.

Rodney McMullen explains that competition in the grocery industry is intense, but it ultimately benefits the customer by providing a better experience and value. He also discusses the importance of investing in wages, creating value for shareholders, and finding ways to reduce costs. He believes that the total ecosystem is improving and that customers and associates will continue to benefit from that in the future.

Gary Millerchip and Rodney McMullen discussed the impact of COVID on the ability to personalize value to customers through online shopping. Kenneth Goldman asked about the magnitude of the health and wellness outside of Express Scripts and its impact on the total comp and transactions for the quarter. Rodney McMullen responded that the impact on sales is more than margin, and the margin on that product is very marginal. He also mentioned that there is a plan for the momentum of health and wellness to continue throughout the rest of the year.

Rodney McMullen and Gary Millerchip discussed how Express Scripts had a positive impact on sales and a narrow impact on profitability. They also discussed how budget-conscious consumers prioritize shelf prices and how the company had to modify their strategy to connect with them. They introduced Smart Way, which focuses on everyday prices, and also have entry price point items for these customers.

Rodney McMullen of Kroger explains that the promotional environment is largely driven by supply chain issues and access to supply, rather than competition. He states that the majority of promotional offers are back to the way they were before COVID-19 and that quarter-to-date, IDs are in the middle range of what was previously discussed.

Kroger celebrated Mary Tennant, their longest serving associate, who has worked at their Moundsville, West Virginia store for 65 years. Mary, at 85 years old, still loves her fellow associates and customers and plans to keep working. Rodney McMullen thanked everyone for their questions and shared Mary's story as a great example of coming to Kroger for a job and discovering a career. He wished everyone a fantastic summer and concluded the call.

This summary was generated with AI and may contain some inaccuracies.