Highlights From KR's Q1 Conference Call: Sales Increased 4.6% ex-fuel; Guides Higher for FY

Kroger Co. (NYSE: KR) reported Q1 EPS of $0.70, $0.06 better than the analyst estimate of $0.64. Revenue for the quarter came in at $27.5 billion versus the consensus estimate of $26.48 billion. Shares are currently up 4.66%.

Highlights From KR's Q1 Conference Call:

• Raises its FY2011 EPS guidance to $1.85-$1.95, versus prior guidance of $1.80-$1.92 and the consensus of $1.92.
  
• (David B. Dillon, Chairman, CEO) Identical supermarket sales increased 4.6% without fuel during the quarter. This continues Kroger's industry-leading trend of positive identical sales growth for 30 consecutive quarters.
  
• Each of the 18 retail divisions had positive identical sales excluding fuel. We are particularly pleased with sales in our deli bakery, grocery and natural foods departments.
  
• The promising signs of the improvement we saw earlier this year seems to have stagnated. Unemployment remains high in most of our markets and food stamp and other government program use continues at high levels.
  
• Our price checks show that most competitors are passing higher costs on to customers. We expect approximately $200 million of incremental expense from rising pension and healthcare costs for the year, continued cost reduction in other areas is helping us offset these expenses so we can invest in areas that matter most to our customers.
  
• Because fuel is volatile, we should expect variability over the next few quarters, even so fuel remains a meaningful offering for our customers.
  
• (W. Rodney McMullen, President, COO) Kroger continued to see positive tonnage growth throughout the quarter, which comes on top of strong unit movement last year. Our promotional and pricing strategies are designed to deliver the sustainable results. The initiatives we implement focus on building long-term loyalty and expanding Kroger's competitive advantage.
  
• Millions of loyal households shop with us and 99.9% of them bought at least one corporate brand item per quarter. We are still working on that 0.1%.
  
• For the first quarter, corporate brands represent approximately 26% of grocery department sales dollars and 33% of grocery department units sold. These figures compare with 26% and 34% respectively for the first quarter last year.
  
• A highlight of the quarter was the launch of our new Home Essentials brands, Kroger Home Sense with. 200 reformulated or rebranded products, the collection of the smart, simple solutions helps customers get great results everywhere in their home. You will find our new brand in paper towels, facial tissue, paper housewares and more. We also introduced Heart Baked Pizzas and I can tell you at least the barbecue chicken tastes delicious.
  
• For the quarter, we estimated product cost inflation excluding fuel was approximately 3.5%. We saw inflation in all categories, including grocery.
  
• Grocery product costs inflation approached 2.1% excluding milk. Last quarter, we mentioned that rising costs for many agricultural commodities were drivinghigher retail prices for packaged goods in our grocery department.
  
• Our customers continue to seek value in this economy. With inflation and rising gas prices, customers' budgets are stretched. The value we offer them through lower everyday prices, weekly features and personalized rewards to our loyal customers continue to resonate with them. We system we are currently saving our customers 2.1 billion per year. This demonstrates that while we are passing on inflation, we continue to provide significant value to our customers, including price.
  
• Since 2009, our manufacturing division has reduced our monthly waste to landfills by more than 50%. Improved bagging techniques and increased use of reusable bags translated into saving an additional 159 million plastic bags in 2010. This buts more than -- puts us more than 35% of the way towards reaching our goal of saving a billion plastic bags by 2014.
  
• Turning now to labor relations. We completed successful contract negotiations for our associates in Fort Wayne, Indiana, and negotiations continue in Southern California and with the Teamsters who represent some of our associates in distribution and manufacturing operations in the Midwest. We will soon begin contract discussions in West Virginia, as well as the Memphis area.
  
• ( J. Michael Schlotman, Chief Financial Officer and Senior Vice President) As Dave mentioned earlier, our identical supermarket sales without fuel increased 4.6% in the first quarter.
  
• Those sales drove strong first quarter net earnings we reported earlier today, totaling $432.3 million or $0.70 per diluted share. Net earnings in the same period last year were $373.7 million or $0.58 per diluted share.
  
• Excluding retail fuel operations, FIFO gross margin decreased 4 basis points while this was helped by favorable shrink results it was partially offset by higher diesel fuel costs. Kroger's first quarter OG&A excluding fuel was 36 basis points lower than the same period last year.
  
• On "rolling four quarters basis, our operating margin, excluding fuel, increased by 12 basis points. With our expectations of earnings per share near the top of our guidance, we would expect fiscal year 2011 nonfuel operating margin to be slightly lower than this. It plays hand in hand with our strategy to continue to invest in gross margin as we are able to realize reductions on the OG&A line.
  
• Turning now to Kroger's retail fuel operations, in the first quarter, our supermarket fuel centers and convenience stores produced solid identical gallon growth. These outlets earned approximately $0.12.4 per gallon compared to $0.117 in the same quarter last year. As Dave noted earlier, strong fuel margins did not enhance Kroger's first quarter earnings per share on a year-over-year basis. This was primarily due to higher credit card fees which increase as retail fuel prices rise. We need the higher margins to cover this expense.
  
• We continue to expect margins of approximately $0.115 per gallon for fiscal 2011.
  
• Capital investment, excluding acquisitions and purchases of leased facilities totaled $573.1 million for the first quarter, compared with $532.2 million for the same period last year. We expect capital investment for the year to be consistent with our original guidance of $1.07 to $1.9 billion. One item that helped was higher fuel costs. We sell fuel before we have to pay for it, so it lowers our working capital. Additionally, we have implemented systemic improvement that will advance the progress during this quarter.
  
• We invested $544.3 million to repurchase 21.3 million shares of stock at an average price of $23.55 per share. At the end of the first quarter, approximately $602.7 million remained under the $1 billion stock repurchase program authorized in March.
  
• We expect to use the full billion dollars during fiscal 2011. Net total net was $7.1 billion, an increase of $47.3 million from a year ago. On a rolling four quarters basis, Kroger's net total debt to EBITDA ratio adjusted for impairment charges in 2010 and 2009 was 1.79 compared with 1.91 during the same period last year.
  
• We now expect identical supermarket sales growth, excluding fuel of 3.5% to 4.5% for the year. The previous guidance range was 3% to 4%. Kroger increased its earnings guidance for the year to $1.85 to $1.95 per diluted share. Based on the current operating environment, the company expects to achieve results near the top end of this range. The increase reflects the strength of our first quarter results and the higher estimated LIFO charge of $150 million for the full year. The original guidance was $1.80 to $1.92 per share.
  
• Additionally, we now expect product cost inflation to be in the 3 to 4% range, the previous range was 1 to 2%. Keep in mind the factors Dave mentioned that will continue to influence Kroger sales and earnings performance throughout the year.
  
• Our long-term growth model is to generate 6 to 8% annual earnings per share growth rate over a 3 to 5 year time horizon, including dividends, the total shareholder return rate is 8 to 10%.
  
• We aim to produce this with less volatility than the S&P 500 over the same timeframe. We are not opposed to a year occasionally exceeding this range which is what we now expect to deliver in 2011.
  
• (Q&A) First, I want to drill down on the consumer. If you look at the consumables part of your mix, the vast majority, it looks like we are seeing modest, very modest demand dampening and modest trading down. Is that fair? And I also want to talk about the discretionary part of the business too. Is it -- is the consumer reaction modest to date in terms of how they are trading down or -- or, you know, cutting the number of items they buy? (A) John, we are seeing some modest change. It's not really very much. We are seeing some change in mix, some trading down, perhaps, some choices being made, some of the areas that are discretionary areas, several of those are still a bit challenges compared to our overall results. But our tonnage is still solid and that tells us it's really modest changes that we are seeing. (A) The only other thing I would add on top of that, John, if a few places you can see a little bit of where people are trading down to a lower expensive item or buying more on promotion, but I would echo on what Dave said, it's very modest and very early. So whether it's a trend or just a little bump in the road it's hard to say.
  
• If you look at some of the discretionary item. It looks like across retail, there's some crowding out. People are buying food and gas, and buying less discretionary stuff. Are you seeing that in what you sell? (A) I wouldn't say it's ever been robust as we go through the recession but it's gradually improved. I would say the improvement has slowed down. The improvement is definitely slower than what it was.

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