Sluggish Quarter Doesn't Change Our Outlook for Kroger

Our $31 fair value estimate for narrow-moat

In the quarter, revenue rose 1.0% on 1.6% identical-supermarket sales growth (without fuel). For the first half, sales increased 2.4% against 35 basis points of operating margin expansion (to 2.4%), with top-line results ahead of our 0.5% estimated full-year decline but profitability short of our 60-basis-point targeted uptick. Management maintained its fiscal 2018 EPS target at $2.00-$2.15 against our $2.10 expectation.

We attribute the profitability shortfall to transitory and timing-related factors. We concur with management's indications that price cuts and space optimization efforts that were pulled forward likely weighed on earnings, but we expect such initiatives to boost future results. With customers increasingly demanding an omnichannel experience including a high-quality in-store environment and numerous order-fulfillment options, we applaud management's focus on bolstering its delivery, click-and-collect, and ship-to-home offerings. Still, we believe competitive dynamics will limit Kroger's long-term operating margins to the low single digits even after the investments bear fruit.

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