Post-pandemic stagflation and the policy responses to it, including higher rates of interest, are having complex impacts on different parts of the economy, from putting the brakes on latest housing starts (down 22% 12 months over 12 months in April) to drying up West Coast import container volumes (down 15% 12 months over 12 months in May).
Meanwhile, GDP growth is slowing: Within the third quarter of 2022, year-over-year (y/y) growth got here in at 3.2%; within the fourth quarter of 2022, it was 2.6%; and in the primary quarter of 2023, it was 1.3%. Real wages have been falling for 2 years and are actually flat with 2019 levels.
It’s a fancy environment for manufacturers, suppliers and retailers, where each costs and costs are higher and demand is evolving in multiple directions.
Some retailers have been capable of thread the needle: Kroger is certainly one of them, emphasizing operating margin and profitability ahead of its merger with Albertsons. First, it raised prices to match rising costs and protect its margins, then it promoted its own more profitable private-label brands to customers trying to stretch their dollars further. Now, as its national brand CPG vendors have grow to be more focused on maintaining volumes, Kroger gets them to finance additional promotions while the grocery store welcomes a brand new cohort of higher-income customers who’ve migrated to Kroger from specialty retailers.
In line with Kroger’s management team on the grocery store’s Q1 earnings call on Thursday, Kroger was capable of use price to drive a few of its customers into higher-margin private-label items after which backfill the demand for premium brands with latest higher-income customers.
Kroger Chairman and CEO Rodney McMullen cut right to the chase in his prepared remarks, almost immediately acknowledging the difficulties presented by current economic conditions.
“We’re off to a terrific start in 2023 with results that reflect the strength of our go-to-market strategy,” McMullen began. “Kroger is constant to navigate a challenged environment as our customers manage the consequences of high inflation, fewer SNAP dollars and micro-macroeconomic uncertainty.”
What did McMullen mean by “a terrific start”? There are a pair of the way of taking a look at Kroger’s top-line revenue numbers: Overall sales increased by 1.2% y/y to $45.1 billion, but similar same-store sales grew 3.5% excluding fuel sales. If same-store sales grew faster than overall revenue, presumably, Kroger operated fewer stores in the primary quarter of 2023 than in the primary quarter of 2022. But the corporate’s concentrate on margin has made it more profitable: Net earnings were up 44.4% y/y to $962 million within the quarter. Net debt was $1.5 billion lower than the identical period last 12 months.
“These results were underpinned by key elements of our go-to-market strategy,” McMullen explained. “Our Brands sales grew 4.9%. Our Brands proceed to be a very important source of savings for our customers who’re drawn to the unequalled quality and value they supply. At the identical time, Our Brands helps drive stronger profitability, typically providing 600 basis points to 800 basis points higher margin in comparison with national brands.”
Prospects for the remaining of the 12 months, McMullen cautioned, look more dim: “Looking toward the balance of the 12 months, we’d expect similar sales without fuel to be on the low end of our guidance range of 1% to 2% for the remaining three quarters of 2023, reflecting continued slowing inflation, partially offset by underlying improvement in unit growth.”
Kroger’s barely more pessimistic outlook — it’s still technically reaffirming the revenue projections it issued last 12 months — is available in a 12 months when freight markets, even the refrigerated trucking markets heavily exposed to food, are starved of volume. Refrigerated trucking carriers are only rejecting 4.8% of the hundreds tendered to them by shippers, a far cry from rejection rates around 40% in the beginning of 2022. And volumes have settled back all the way down to pre-pandemic levels, sharply down on a y/y basis.
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There wasn’t a big seasonal bump in refrigerated trucking spot rates in April and May, which suggests that the incremental volumes coming out of Florida, California and Arizona weren’t enough to meaningfully tighten capability. Rates will stay lower for longer until more carriers exit the market.
A technique that Kroger is supporting sales volumes within the face of a cash-strapped consumer environment is with promotions. Retailers deploy euphemisms like “investing in price” to explain putting items on sale after they sacrifice margin for volume, but in Kroger’s case, a lot of these sales are being paid for by the food and beverage corporations themselves. The national CPG brands have gotten increasingly concerned with absolute levels of product flows and are financing Kroger’s discounts.
Equity analyst Chuck Cerankosky from Northcoast Research asked McMullen concerning the promotions in the course of the Q&A portion of the earnings call.
“You mentioned the increased amount of promotional activity that Kroger was in in the course of the quarter,” Cerankosky noted. “To what degree are the CPGs involved in that and the way much of … it’s Kroger spending its own, call it, gross profit dollars to advertise your personal brands?”
In his response, McMullen differentiated between the nationally branded products in Kroger stores and Our Brands, the shop’s private-label goods.
“[The CPGs] are extremely engaged in that process,” McMullen said. “If you happen to take a look at items which can be national brand items, it might be heavily financed by CPGs. We might see CPGs, as supply chains have gotten much fuller, products are beginning to flow. We now have began seeing CPGs more beginning to worry about tonnage and supporting that. Obviously, with targeted promotions on our products, those are funded … by Kroger, and it might be a pure economics by way of the rise in tonnage within the investments we’re making.”
The CPG corporations are bearing their share of the burden of supporting Kroger’s sales, and they’ll face the identical pressures to cut back costs of their supply chains and elsewhere to keep up margins. It’s an uncertain outlook for transportation providers and other supply chain participants, which can have customers determined to ship the identical volume of freight, but only in the event that they can do it at a lower cost.
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