KROGER CO Q2 2026 earnings call

Good morning. Thank you for joining us for Kroger's second quarter 2025 earnings call. I am joined today by Kroger's Chairman and Chief Executive Officer, Ron Sargent, and Chief Financial Officer, David Kennerley. Before we begin, I want to remind you that today's discussions will include forward-looking statements. We want to caution you that such statements are predictions, and actual events or results can differ materially. A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filings. The Kroger Company assumes no obligation to update that information. After our prepared remarks, we look forward to taking your questions. In order to cover a broad range of topics from as many of you as we can, we ask that you please limit yourself to one question and one follow-up question if necessary.

I will now turn the call over to Ron.

Thank you, Rob. Good morning, everyone. Thank you for joining our call today. We're happy to report another quarter of strong results, which demonstrates the clear and measurable progress we're making on our key priorities: to simplify the organization, to improve the customer experience, and to focus on work that creates the most value. Today, I want to talk about what we've accomplished, the proof points we see in our quarterly results, and how our priorities are positioning Kroger for sustained long-term growth. Over the last several months, we've made good progress to position the company for future success. A key part of that success is a strong leadership team, and during the quarter, we continue to upgrade our team. We promoted a top division president to lead our brands, one of our key growth initiatives.

We hired a new head of product sourcing who will help cost of goods sold and close the gap with the industry's best in class. We welcomed a new general counsel, and we continue to elevate strong retail leaders across the company, including several new division presidents. As we continue to build our leadership team, we're also looking at our costs, especially those expenses that don't directly support our priorities or deliver value to our shareholders. As we shared last quarter, we've begun closing approximately 60 unprofitable stores. Last month, we also reduced our corporate administrative team by nearly 1,000 associates. While these decisions are difficult, they're also necessary for the company's long-term success. Additionally, in order to create greater focus and simplify our business, we're reviewing all non-core assets to determine their ongoing contribution and role within the company.

And finally, we recently put an issue behind us by reaching a legal settlement with C&S Wholesale Grocers. We are pleased to resolve the claim so that we can remain focused on serving our customers and running great stores. Our efforts to create greater focus are showing up in today's second quarter results. Identical Sales Without Fuel grew 3.4%, which was ahead of our expectations. This is our sixth consecutive quarter of Identical Sales Without Fuel improvement. Sales growth was led by pharmacy, e-commerce, and fresh categories. We know that fresh products are important to our customers, specifically in meat and produce. These categories continue to outpace center store sales and reflect the growing demand for healthier options. Our sales growth in fresh categories shows that we're making strong progress in the categories our customers care most about. Improving grocery volume is also important to us.

We're making strategic price investments, which led to another quarter of sequential improvement. In fact, since the beginning of the year, we've lowered prices on more than 3,500 incremental products across our stores, which is improving our price spreads against our major competitors. As we lower prices for our customers, we're committed to doing so in a way that keeps our gross margins stable. We're making our promotions simpler and have continued to reduce complex promotional offers. Additionally, we are making it easier for non-digital customers to take advantage of all the value Kroger offers by reintroducing paper coupons in every store. Our customers are recognizing these changes, and they're giving us credit for them. We know this because customer price perception improved in nearly every division this quarter, and we saw another quarter of sequential improvement in share.

Beyond the price at the shelf, families are also looking for quality and value. Our brand's products had another strong quarter with sales growth again outpacing national brands. Our brands offer unique products with high quality and represent a point of differentiation for Kroger. Simple Truth and Private Selection brands again led our growth. Looking ahead, we see our brands as a critical strategic asset, helping us grow sales and build loyalty with customers. E-commerce. E-commerce also continues to be an important and growing part of our business. Sales were strong in the second quarter with 16% growth, led by good performance and delivery. We continue to make progress on improving profitability, and we saw improvements in both pickup and delivery profitability on a quarter-over-quarter basis. E-com remains a top priority for us.

Running great stores is also critical to our future, and our store teams are delivering on the basics: being in stock, showing clean and uncluttered aisles, and making shopping easier for our customers. Our internal composite scores, which track key metrics like in-stock levels, fresh product quality, and customer service, are showing consistent quarter-over-quarter improvement. And as we are improving our store and e-commerce shopping experiences, we're also taking meaningful steps to reduce our cost structure. In the second quarter, we were pleased with our OG&A rate improvement and will continue to aggressively look for ways to reduce costs throughout the company. We believe that many opportunity costs remain. So, to summarize, we've made strong progress so far this year, and we also know that we have a lot more work to do. Looking ahead, we're focused on investments that will grow our core business.

The first of these is new stores. We're on track to deliver 30 major store projects in 2025, and we're accelerating new store projects with more efficient layouts and faster construction timelines. In 2026, we expect to increase store openings by 30%, helping us grow both in-store and online sales faster. While we are growing our physical footprint, we're also modernizing our business to operate more efficiently and serve customers better. Artificial intelligence is one of the key tools to help us get there. Accelerating our AI efforts is a natural step for Kroger, given our long history of leadership in data and machine learning. Where we've implemented AI in different parts of the organization, we're seeing results with more competitive pricing, shrink improvements, and faster fulfillment, which enables two-hour pickup for customers.

These are just a few examples of what AI is doing to help us better serve our customers with more and bigger opportunities ahead to both support our associates and improve the customer experience. E-commerce will also continue to have a meaningful and growing impact on our financial results, which is why we announced a thorough strategic review last quarter. We are progressing with two key objectives in mind. First, we will improve the customer experience by using our stores to deliver groceries faster. Stores are our most important asset, and when we use our stores to fulfill online orders, the inventory is closer to customers and the last-mile delivery costs are lower.

As demand for convenience grows, we can leverage our store footprint to reach new customer segments and expand rapid delivery capabilities without significant capital investments, which leads to our second objective: improving profitability and reducing our cost to serve. We're examining all aspects of our business to drive greater efficiency, including a full site-by-site analysis of our Kroger automated fulfillment network. Where we have seen strong demand in high-density areas, these facilities deliver better results than those facilities where density is lower and customer adoption has been slower. We continue to evaluate all options across all facilities to improve profitability while continuing to provide a great customer experience. We expect to share an update on our strategic review during the third quarter. We're confident that the outcome of our work will lead to both stronger e-com capabilities and a clear path toward profitability.

Finally, we're starting the foundational work to refresh our go-to-market strategy. This involves a deep dive into customer data and a rigorous assessment of our competitive positioning. This important work will set us up for even stronger performance in the future. Now I'll turn it over to David, who will review our financial results in more detail. David?

Thank you, Ron, and good morning, everyone. This quarter, Kroger delivered strong results, which reflect continued progress in our core grocery business and robust growth in e-commerce and pharmacy. Momentum in our core grocery business is being driven by improved execution as well as a disciplined approach to price investments. By reducing the complexity of our promotions and investing more in everyday prices, we are sharpening our price perception with customers and driving volume improvements while responsibly managing our margins. I'll now walk through our financial results for the second quarter. We achieved Identical Sales Without Fuel growth of 3.4%, as sales growth was led by strong pharmacy, e-commerce, and fresh results. We are encouraged by the continued improvement in grocery volumes, particularly in the perimeter of the store.

Food inflation was slightly lower in the second quarter compared to the first quarter, but continues to trend in line with our original expectations from the beginning of the year. Our pharmacy business delivered another strong quarter, driven by core pharmacy scripts and growth in GLP-1s. Although strong growth in pharmacy sales impacts our margin rate, it drives positive gross profit dollar growth and improves our overall operating profit. This quarter, we've been pleased to welcome more ESI customers back into our stores. We continue to expect that the full return of the business will take time, and in Q2, ESI had a roughly 15 basis points positive impact on our ID sales. We continue to keep a close watch on the changing tariff environment. As a domestic food retailer, we expect a smaller impact than some of our competitors.

We continue to be proactive to address exposure where we do have it, and our approach remains to raise prices as a last resort to ensure that we keep prices as low as possible for our customers. Tariffs have not had a material impact on our business thus far, and as of now, do not expect them to going forward. Our FIFO gross margin rate, excluding rent, depreciation, and amortization, fuel, and adjustment items, increased 39 basis points in the second quarter compared to the same period last year. The improvement in rate was primarily attributable to the sale of Kroger Specialty Pharmacy, lower supply chain costs, and lower shrink, partially offset by the mix effect from growth in pharmacy sales, which has lower margins and price investments.

After excluding the effect from the sale of Kroger Specialty Pharmacy, our FIFO gross margin rate decreased 9 basis points, largely in line with our expectations to remain margin neutral. The slight reduction in our FIFO gross margin rate was primarily due to pharmacy mix with good progress on rate in the rest of the business. We have many levers to improve our gross margin rate over time, and we will continue to use those to balance incremental price investments that improve our value perception with customers. We expect our gross margin rate for the full year on an underlying basis to be relatively flat as we balance the impact of pharmacy mix, margin enhancement initiatives, and price investments. The operating general and administrative rate, excluding fuel and adjustment items, decreased 5 basis points in the second quarter compared to the same period last year.

The decrease in rate was primarily attributable to improved productivity and a favorable comparison to prior year, which included certain non-recurring charges, partially offset by the sale of Kroger Specialty Pharmacy. After adjusting for the effect from the sale of Kroger Specialty Pharmacy, our adjusted OG&A rate significantly improved, decreasing 41 basis points on an underlying basis. Cost optimization is one of our top priorities, and driving productivity has long been a core competency of this company. We will continue to build on that strong track record by identifying new and innovative ways to deliver cost savings across our business, and our teams are actively pursuing opportunities across multiple areas. One of the areas we're prioritizing is sourcing. We see significant opportunities to optimize our both cost of goods sold and goods not for resale.

We also have a significant and continuing opportunity to modernize work across the enterprise, making us more agile and efficient and leading to a more streamlined operating model going forward. Our Adjusted FIFO Operating Profit in the quarter was $1.1 billion. Adjusted EPS was $1.04, reflecting 12% growth compared to last year and our strongest growth rate since the fourth quarter of 2023. Fuel is an important part of Kroger's strategy and offers an additional way to build loyalty with customers through the fuel rewards in our Kroger Plus program. Fuel sales were lower this quarter compared to last year, attributable to a decrease in the average retail price per gallon and fewer gallons sold. Fuel profitability was also behind the same period last year, and we expect gallons sold to remain lower on a year-over-year basis for the remainder of 2025.

Our e-commerce business delivered 16% growth this quarter, driven by an increase in both household and order frequency. This growth was led by delivery, with orders fulfilled from both our stores and centralized fulfillment centers. We are seeing a clear trend of customers opting for faster delivery times, an area where we are well-positioned based on our conveniently located store network, coupled with our delivery partner, Instacart. Today, we can offer delivery in under two hours from 97% of our stores. This capability is resonating with our customers, and we continue to see more orders placed in these short windows. This digital momentum directly fuels our retail media business, which had a strong quarter and is a key contributor to profitability. While we're encouraged by the performance in the quarter, we believe we have an opportunity to meaningfully accelerate our growth.

To support this, we're actively reviewing the operating model and how we engage with retail media clients to ensure we are strategically positioned to maximize growth in this area of our business. I'd like to take a moment to provide a brief update on Associate and Labor Relations. We made significant progress on agreements this quarter, which provides certainty for our associates and our business. In total, we ratified new labor agreements covering approximately 54,000 associates. We continue to meaningfully improve wages and benefits, and we value our strong working relationships with our unions. By working together, we're better able to support associates and improve the experience we provide customers. These collective efforts have helped us build a more stable workforce with improved retention rates, which in turn drives a better customer experience. I'd now like to turn to capital allocation and financial strategy.

Kroger delivered strong Adjusted Free Cash Flow this quarter, which reflects the strength of our operating performance. Free Cash Flow is important to our model, providing liquidity for our operations and strengthening our balance sheet. At quarter end, our net total debt to Adjusted EBITDA ratio was 1.63, which is below our target ratio range of 2.3-2.5. This provides us with significant financial flexibility to pursue growth investments and other opportunities to enhance shareholder value. We expect to return to our target leverage ratio over time. Our capital allocation priorities remain consistent and are designed to deliver total shareholder return of 8%-11% over time. We are focused on investing in projects that will maximize return on invested capital over time while remaining committed to maintaining our current investment grade rating, growing our dividend subject to board approval, and returning excess capital to shareholders.

In the second quarter, we raised our quarterly dividend by 9%, reflecting the strength of our Free Cash Flow and our commitment to returning capital to shareholders. Our quarterly dividend has grown at a compounded annual growth rate of 13% since its reinstatement in 2006, and this marked the 19th consecutive year of dividend increases. Dividend increases are just one component of our broader total shareholder return strategy, and we plan to continue returning capital to shareholders through share repurchases. We expect our $5 billion ASR program to be completed in the third fiscal quarter of 2025. The ASR is being completed under Kroger's $7.5 billion share repurchase authorization. After completion of the ASR program, we expect to resume open market share repurchases under the remaining $2.5 billion authorization.

We expect to complete these open market share repurchases by the end of the fiscal year, which is contemplated in full year guidance. A key priority for Kroger is to improve ROIC, which includes reallocating capital towards higher return projects such as new stores. We are pleased with the progress we are making on these projects and are on track to complete 30 this year. As Ron mentioned earlier, we plan to accelerate these store projects beyond 2025 and expect them to be an increasing contributor to our growth, with a 30% increase expected in 2026, positioning us for sustained expansion and market share growth. I would now like to provide some additional detail on our outlook for the rest of the year. We are pleased with our second quarter results, which reflect continued momentum in our business.

Sales have been strong, led by e-commerce, pharmacy, and fresh, and we are encouraged by the improvement in grocery volumes. As a result, we are raising our Identical Sales Without Fuel guidance to a new range of 2.7%-3.4%. For Q3, we expect Identical Sales Without Fuel to be slightly below the midpoint of our full year range. We are also raising the lower end of our Adjusted FIFO Net Operating Profit and Net Earnings Per Diluted Share guidance to new ranges of $4.8-$4.9 billion and $4.70-$4.80, respectively. I will now turn the call back to Ron.

Thanks, David. The team continues to make progress in running great stores. We are more focused on our core business and our customers. We're moving with speed, and we're simplifying the company.

We are executing better in our stores, and we are seeing it in the results, both our quarterly financial results and our customer metrics. Our customers are telling us they like lower prices and simpler promotions. They care about quality and value, and they appreciate better store conditions and better service. Our work is far from finished, but I'm proud of the team and the progress we're making. Before we move into Q&A, I'd like to comment briefly on the CEO search. There is no specific news to share at this time, but the board remains actively engaged in the process. We'll now open it up for questions.