Kroger stock plunges amid food deflation and price war

Kroger's stock plunged 19 percent on Thursday as it battled food deflation and a growing price war with competitors.

The grocer's shares were the second-worst-performing on the New York Stock Exchange for the day, closing at $24.56, a nearly three-year low. 

During trading, stock in the nation's largest supermarket chain dropped as low as $24.54, down $5.74, after it reported stronger sales and a $303 million profit that slightly beat Wall Street forecasts.

But Kroger also cut its annual profit outlook by 10 percent in the early Thursday earnings release. It lowered its adjusted net earnings guidance range to $2 to $2.05 per diluted share, down from a range of $2.21 to $2.25 per diluted share.

The Cincinnati-based grocer blamed a higher-than-expected inventory charge as well as increased competition, which affects its pricing power.

"We are making the investments necessary to continue being the best food retailer in the country," Kroger CEO Rodney McMullen told analysts on a conference call. "We are confident that we will continue winning with our people, our food, and the customer experience, and we will not lose on price."

Kroger has methodically lowered its prices and gross profit margins for years to stay competitive. Its strategy is not to sell the cheapest groceries, but to lower prices enough to be competitive, while also providing a wider variety of goods and better service.

Wall Street analysts fretted over Kroger's thinning profit margins.

Kroger's first-quarter profit was down 56.5 percent from last year and its operating profit margin was cut in half, from 3.5 percent to 1.7 percent.

Importantly, the grocer revised its guidance on its gross operating margin, saying it would decline 0.2 to 0.3 percent versus a previous 0.1 percent estimate. That indicates Kroger will invest $115 million to $230 million in lower prices.

"It’s becoming clearer that the deflationary headwinds are fundamentally impacted by competitive pricing pressures at this stage of the cycle," Pivotal Research analyst Ajay Jain wrote to investors Thursday. "Those investors that are buying into the so-called re-inflation trade are likely to be disappointed."

Jain noted Walmart recently reported its best sales results in three years. He also noted Kroger has lowered prices in eastern markets ahead of Germany's Lidl opening stores in Virginia and the Carolinas. 

Total sales rose 4.9 percent to $36.3 billion. Identical-store sales excluding fuel slipped 0.2 percent during the fiscal quarter ended May 20.

The company also expects to incur an $80 million LIFO charge, compared to a previously estimated $25 million. Though it's a noncash charge that hits the bottom line, the accounting charge also signals an end to its months-long battle with food deflation.

LIFO charges are an accounting method to strip inflation costs out of inventory. If they increase, that means food inflation is increasing. Kroger's LIFO charge was $19 million in 2016, $28 million in 2015 and $147 million in 2014.  

Kroger CEO: Food price deflation is 'not fun'

Kroger considers identical-store sales without fuel a critical performance measure because it strips out increases in sales from newly built or expanded stores. Supermarkets that fall into the "identical" category have been open without major changes for at least five full quarters.

While identical stores slipped for the latest quarter, McMullen said they began to turn positive at the end.

Earnings per diluted share were 32 cents. First-quarter results included $243 million in charges for adjustments to a voluntary retirement plan offering and pension plan withdrawal liabilities.

Kroger's 58 cents of earnings per diluted share before one-time items and total sales beat Wall Street expectations. Analysts expected Kroger to report a $546 million profit before one-time items on sales of $35.5 billion, according to Zacks.