The Street Reacts To Kroger's Q2 With Mixed Takeaways

Kroger Co KR reported second-quarter results that came in better than expected. The earnings beat may have been overshadowed by management's decision to remove its prior guidance of $400 million in incremental EBIT by fiscal 2021.

Q2 A Mix Of Positives And Negatives

Kroger's headline numbers "looked fine" as identical store (ID) sales excluding fuel of 2.2% was the best seen since early 2016, Morgan Stanley analyst Simeon Gutman wrote in a note. Gross margins (ex-fuel) improved from down 40 basis points in the first quarter to down 30 basis points while EBIT margins (ex-fuel) contracted just 20 basis points versus a 55 basis point contraction in the first quarter.

Gutman said Kroger's improving metrics comes at a time when industry-wide sales and peer comps both improved and management acknowledged it didn't gain any market share in the quarter.

Similarly, UBS analyst Michael Lasser said Kroger's report includes a combination of "puts and takes." On the positive side, the company's ID growth came from a combination of store renovations, private label, higher than expected inflation, and digital. These headwinds appear to have carried over into the third quarter.

On the other hand, the pharmacy business continues to see "intense" pressures and the segment's gross margins likely fell by up to 200 basis points. Kroger's headwinds in the pharmacy segment could continue through the end of the year.

Related Link: Kroger's Q1 Draws Tepid Reaction From Analysts, Investors Pull Back

No Debating At Credit Suisse

Kroger reported its "most compelling" earnings print in a while as ID sales came in north of 2% for the first time since 2016, Credit Suisse analyst Judah Frommer wrote in a note. Other key takeaways include 31% growth in digital sales and online buying is available to 95% of Kroger households. Also, private label sales rose 3.1% which is a record second quarter high.

"Continued confidence in robust free cash flow generation and a return to consistent share repurchase activity could lay the groundwork for improved own-ability of KR stock at peer-low valuation," Frommer wrote in a note.

2020 And 2021 Outlook

Kroger kept its 2020 EPS guidance range unchanged at $2.15 to $2.25, Bank of America analyst Robert Ohmes wrote in a note. This suggests EPS growth will be flat in the third quarter from a combination of ongoing pharmacy related gross margin headwinds and lapping strong expense controls last year. The fourth quarter could see a double-digit EPS growth as last year's quarter was dominated by accelerated investments in supply chain and warehouses.

Management also removed its prior guidance of $400 million of incremental EBIT by in 2021, which Ohmes said would have implied a target of $3.5 billion in EBIT. Management noted that benefits from its Restock initiative are taking longer to progress, but the company remains focused on delivering FIFO EBIT growth in 2021 and more details are expected at the November Investor Day presentation.

Related Link: Bernstein: How Kroger Could See Activist Involvement

Ratings And Price Targets

Morgan Stanley maintains at Equal-Weight, unchanged $26 price target.

UBS maintains at Neutral, price target lifted from $25 to $26.

Credit Suisse maintains at Outperform, price target lifted from $27 to $29.

Bank of America maintains at Buy, $28 price target.

Price Action

Kroger's stock traded around $26 per share at time of publication.

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