Falling prices could take a bite out of Kroger Co. (KR) growth this year

Company warns deflation will reduce profits

CINCINNATI - The Kroger Co. reduced its earnings, sales and capital-spending guidance for 2016, citing concerns over deflation.

At the same time, it exceeded Wall Street expectations with a $383 million profit on revenue of $26.6 billion.

The results included a one-time charge against earnings for pension obligations. Excluding the charge, Kroger earned 45 cents per diluted share. That’s better than the 45 cents analysts were predicting for the company.

But revenue fell $220 million short of expectations: Analysts were predicting $26.79 billion in revenue for the quarter.

Kroger reduced its earnings outlook and sales growth projections while reducing its projected spending on new capital investments by $500 million.

The company is now expecting sales growth of up to 1.5 percent, down from a previous estimate of up to 3.5 percent growth. The company reduced its earnings guidance to a range of $2.03 to $2.18 per share, down about 7 percent from its early projection.

Kroger executives told analysts that it saw “significant deflation” in the price of milk, eggs and cheese, impacting all departments except produce and pharmacy. Customer surveys show U.S. shoppers are in a penny-pinching mood.

“Customer insights give us a big advantage in challenging environments like this one,” said CEO Rodney McMullen. “A lot of what we are seeing suggests a gradual tightening of budgets. Our customers tell us they are less confident about the economy now than they were three months ago, and they expect the economy to get worse in the next three months.”

McMullen brushed off concerns about increasing price competition by Wal-Mart and other rivals, saying it continued to gain market share in the second quarter.

Chief Financial Mike Schlotman said Kroger will continue to focus on growing the number of households shopping in its stores, growing the number units and “making sure we are delivering the right value proposition” to customers.

“We continued to do all three of these things during the second quarter,” Schlotman said. “That our team accomplished this in such a deflationary environment is no small feat and demonstrates that our associates continue to connect with customers in a personal and meaningful way.”

Kroger shares are down 17 percent since July 8, as investors worry that deflation and increased competition will chip away at the company’s 12-and-a-half year streak of identical-store sales growth.

This week, Credit Suisse lowered its price target on the stock to $29 from $34, citing an industry trend toward “intensifying deflation” and a climate of “aggressive promotions” that could erode Kroger’s profitability.

Kroger shares were up 8 cents, or 0.24 percent, in mid-morning trades.

The stock closed at $31.31 on Sept. 8.

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