KROGER CO Q3 2026 earnings call

Good morning. Thank you for joining us for Kroger's third 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, and good morning, everybody. Thank you for joining our call today. We're happy to deliver another quarter of strong results reflecting meaningful progress on our strategic priorities. This quarter, we continue to focus on what matters most: serving our customers, running great stores, and strengthening our core business. These efforts are improving the customer experience and creating a strong foundation for long-term growth. Today, we're going to talk about the things we got done this quarter, the proof points of our progress, and the ways we're positioning Kroger for continued success. I'd like to start with sharing the results of our e-commerce strategic review. It marks an important step in how we're evolving our business to meet customer needs and also to improve profitability.

In today's world, having a strong e-commerce offering is key to delivering a differentiated customer experience and also represents an important growth driver for our business. We've made good progress, building a more than $14 billion business and achieving six consecutive quarters of double-digit sales growth. Earlier this year, we formed our new e-commerce team headed by Yael Cosset, designed to align all of the teams who contribute to the online customer experience. By bringing these teams together, we've created a more integrated structure to support our strategy. Building on that foundation, we conducted a comprehensive review of our entire e-commerce model. This review helped us to identify where we can be more efficient and better meet customer demand. Customers increasingly value speed, flexibility, and convenience, and better leveraging store-based fulfillment helps us meet those expectations.

As a result, we're evolving our hybrid fulfillment model by using automated fulfillment in geographies where customer demand supports it and also leveraging store-based fulfillment through our Pickup business and relationships with well-established third-party delivery partners. These changes are fully consistent with our broader organizational goals to improve operational efficiency, to drive profitability, and to more effectively utilize our stores. We will make these changes to our network through a phased approach, ensuring we maintain flexibility to adjust our plans while minimizing operational and customer disruption. In recognition of this shift, we announced the closure of three automated fulfillment centers that haven't met operational and financial expectations. We expect these fulfillment centers to close by the end of January 2026.

Based on our customer and store-level analysis, in those geographies where we will close sites but continue to operate stores, we expect to retain most of our customers and their e-commerce spend through store-based fulfillment and in-store shopping. We expect these closures to have a neutral impact on Identical Sales without fuel. With more fulfillment occurring in stores, we recently expanded our relationships with third-party delivery providers Instacart, DoorDash, and Uber Eats. By using our store network, we're improving both geographic coverage and speed with delivery in as little as 30 minutes. Each of our delivery partners brings unique strengths and specific benefits to our customers. They will also create new opportunities for our media business, both on our platform and on theirs, something David will cover later. So, in summary, this refreshed hybrid model helps us attract new customers, improve delivery speeds, and leverages our growing store network.

We expect these decisions to contribute approximately $400 million in e-commerce profitability improvements in 2026, making our e-commerce business profitable in 2026. Turning now to store operations. Running great stores and delivering an exceptional customer experience are central to our strategy. Our internal composite scores, which measure key metrics such as in-stocks, fresh quality, and customer service, continue to show steady improvement. We're also investing in experiences that matter most to our customers, including adding store hours to improve checkout speed, increase service, and improve in-stocks. These investments are delivering tangible results, including significant year-over-year reductions in wait times for our customers. To support these changes, we're utilizing an AI-powered workforce management platform, which enables better coverage during peak periods and gives associates greater flexibility.

This tool combines real-time labor insights with intelligent scheduling, allowing store leaders to proactively fill open shifts and ensure the right staffing at the right time, especially during high-demand periods like weekends and holidays. Finally, as part of our commitment to simplifying our business, we are making good progress in reviewing all non-core assets to determine their ongoing contribution and role within the company. All of these actions strengthen our business and position Kroger for long-term growth. Before I talk about the results, I want to take a moment to just share what we're seeing from customers and how that's shaping our approach going forward. Macroeconomic uncertainty continues to influence customer behavior, and we're seeing a split across income groups. Spending from higher-income households continues strong, while middle-income customers are feeling increased pressure, similar to what we've seen from lower-income households over the past several quarters.

They're making smaller, more frequent trips to manage budgets, and they are cutting back on discretionary purchases. Food spend has been more resilient than non-food spend. Categories like natural and organics continue to perform well, reflecting continued interest in healthy and premium options. At the same time, customers are turning to promotions and Our Brands as smart ways to save without sacrificing quality. Ready-to-eat and other meal solutions are providing another way for households to get quality and convenience at a great value. Inflation and uncertainty around government funding, combined with the pause in SNAP benefits during the final weeks of the quarter, added incremental pressure to our third quarter Identical Sales without fuel. These trends reinforce the importance of delivering value through lower prices, affordable quality in Our Brands' products, and more promotions for customers to save.

Turning to our third quarter results, Identical Sales without fuel grew 2.6% year-over-year and accelerated on a two-year stack basis up 4.9%. Sales growth was led by pharmacy and e-commerce. Gaining market share continues to be a top priority. In a challenging macroeconomic environment, we delivered share trend improvement again this quarter after adjusting for closed stores, reflecting the progress we're making in strengthening our competitive position. We also increased our price investments this quarter. Toward the end of the quarter, when SNAP benefits were held up, we increased promotions to help customers save. We are disciplined in those investments, balancing our gross margin rate to ensure we deliver value in a sustainable way. Our Brands had another strong quarter with sales outpacing national brands. Customers continue to choose these products because they deliver high quality at a great value.

Our premium lines, Simple Truth and Private Selection, were the strongest performers again this quarter. Our Brands' products carry a more favorable margin profile and also improve profitability during the quarter. These results highlight the strategic importance of Our Brands: driving sales, building loyalty, and improving profitability. E-commerce sales were strong again this quarter, growing 17%, led by delivery. We also improved e-com profitability with both Pickup and Delivery showing strong quarter-over-quarter improvement. We're encouraged by the early results from our DoorDash relationship. In its first month alone, we fulfilled 1 million orders, bringing new customers and incremental meal occasions to Kroger. As we evolve our hybrid model, we expect to continue to ramp up both sales and profitability. This quarter's results show the progress we're making. We also know we have more to do. Looking toward the future, as we've shared previously, we're accelerating expansion of our store footprint.

We expect to break ground on 14 new stores in the fourth quarter, marking a meaningful acceleration in activity. Earlier this quarter, we announced expansion plans for Harris Teeter, one of our strongest and most successful banners. These plans include opening additional new stores in the Southeast and entering Jacksonville, Florida, which is an important adjacent geography that positions us to grow households and gain share. Looking ahead, we plan to accelerate capital investment in new stores beyond 2025 to strengthen our competitive position, expand into high-potential geographies, and support long-term growth. As we expand our footprint, our approach to site selection and store format starts with the customer, then prioritizes improving ROIC with a focus on delivering greater shareholder value. We also see significant opportunity to continue taking cost out of our business, starting with procurement.

Both cost of goods sold and goods not for resale are areas with significant potential for savings, and we are acting to capture those benefits. At the same time, we are rethinking how we work. This includes leveraging technology and artificial intelligence to simplify tasks and operate more efficiently, putting talent closer to the customer and building a more streamlined organization. As part of this effort, we are returning to in-office work five days a week to strengthen collaboration, accelerate decision-making, and better support our stores. Working together also creates a better environment for our associates to learn and develop. These changes will allow us to move faster and lead to a more efficient organization. We're also looking to emerging technologies such as agentic AI to enhance the customer experience.

We plan to introduce new agentic shopping capabilities, starting with Instacart's AI-powered cart assistant on the Kroger website and mobile app in the first quarter of 2026. The cart assistant will help customers shop more effortlessly by making it easier to build personalized baskets, find meal ideas, and save time. We'll embrace this technology while making sure it complements what differentiates Kroger today: fresh products, unique Our Brands products, and an industry-leading loyalty program. While the landscape continues to evolve, we're confident we'll be able to use technology to improve the customer experience. Finally, we're continuing the foundational work toward refreshing our go-to-market strategy with the customer of the future in mind. This includes a deep dive into customer data and a rigorous assessment of our competitive positioning. This work is shaping the foundation for our next phase of growth.

Thank you, Ron, and good morning, everyone. Kroger delivered another strong set of results this quarter, driven by solid execution in our core grocery business and continued growth in e-commerce and pharmacy. In a challenging environment marked with cautious consumer spending, the government shutdown, and a pause in SNAP distributions, we improved market share trends, excluding the impact of store closures, by delivering meaningful value for customers. We delivered these results while continuing to balance the right investments for the customer with disciplined margin management. I'll now walk through our financial results for the third quarter.

We achieved Identical Sales without fuel growth of 2.6%, moderating slightly from last quarter as we cycled the impact of last year's Hurricane Helene and port strike, as well as the pause in SNAP distributions during our final week of the quarter. On a two-year stack basis, Identical Sales without fuel accelerated by 20 basis points to 4.9%, reflecting continued strength in our business. Our Identical Sales without fuel growth was again led by strong pharmacy and e-commerce results. Food inflation increased moderately compared to the prior quarter, with notable inflation in certain commodities, particularly beef. Our pharmacy business delivered another strong quarter fueled by growth in both core pharmacy scripts and GLP-1s. While the strong growth in pharmacy sales impacts our margin rate, it contributes positive gross profit dollar growth and supports our overall operating profit.

Our FIFO gross margin rate, excluding rent, depreciation, and amortization and fuel, increased 49 basis points in the third quarter compared to the same period last year. The improvement in rate was primarily attributable to the sale of Kroger Specialty Pharmacy, Our Brands' performance, 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 increased 24 basis points. As we communicated last quarter, 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, increased 27 basis points in the third quarter compared to the same period last year. The increase in rate was primarily attributable to the sale of Kroger Specialty Pharmacy and investments in associate wages and benefits, partially offset by lower incentive plan costs and improved productivity. After adjusting for the sale of Kroger Specialty Pharmacy, our Adjusted OG&A rate increased 9 basis points on an underlying basis. As we did in the first quarter this year, we took the opportunity to make an accelerated pension contribution in Q3, which was worth 8 basis points on our OG&A rate. This reflects a proactive approach to reducing future liabilities and, most importantly, helps secure long-term benefits for our associates.

Our LIFO charge for the quarter was $44 million, compared to a LIFO charge of $4 million last year, resulting in a $0.04 headwind to EPS this quarter. Our Adjusted FIFO Operating Profit in the quarter was $1.1 billion, and Adjusted EPS was $1.05, both reflecting 7% growth compared to last year. Fuel is an important part of Kroger's strategy and builds loyalty with customers through our Kroger Plus fuel rewards program. Fuel sales were lower this quarter compared to last year, attributable to fewer gallons sold. Fuel profitability was in line with expectations, just slightly ahead of the same period last year. We expect gallons sold to remain lower on a year-over-year basis for the fourth quarter. Turning now to e-commerce. Our e-commerce business delivered 17% growth this quarter, driven by an increase in both households and order frequency.

Orders delivered within two hours or less grew by more than 30%, reflecting the growing immediacy demand. Building on what Ron shared earlier, the recent update to our e-commerce strategy reflects a thoughtful evolution of how we serve our customers and drive sustainable growth. Our refreshed hybrid fulfillment model allows us to leverage the strength of both automation and store-based fulfillment to meet evolving customer expectations. This also allows us to optimize the performance and use of automated fulfillment centers when the right conditions exist and utilize third-party partners for faster delivery while reaching new customers and incremental trips. Our new model positions us for both strong, sustainable growth and improved flexibility. From a financial perspective, we're significantly accelerating the profitability of our e-commerce business. Closing three fulfillment centers and increasing store-based delivery will deliver approximately $400 million in incremental e-commerce operating profit in 2026.

As a result, we now expect our e-commerce business to be profitable in 2026. The benefits from these decisions will be primarily used to reinvest in our business, to increase value for customers, and improve the shopping experience as we look to accelerate sales. We also remain focused on expanding operating margins, and a portion of these benefits will be used to increase shareholder value. Given the financial performance of our automated fulfillment network and the closure of specific sites, and as previously announced, we recorded an impairment and related charges of $2.6 billion in the third quarter. We will continue to monitor our retained sites with a focus on improving operating efficiency and strengthening financial performance. Our updated hybrid model also creates new opportunities for our media business.

Our broad reach and unmatched food retail capabilities are attractive to delivery partners, and we've structured these relationships to benefit our media business. For example, our unique approach to collaboration with Instacart, DoorDash, and Uber unlocks new media opportunities across both platforms, and we're already seeing strong interest from several large CPG brands. By integrating our customer data and loyalty insights with third-party platforms, we can bring more targeted and innovative media campaigns to reach new customer segments and create additional monetization opportunities. Our media business had a strong quarter with double-digit growth and continues to be a meaningful contributor to profitability. We're encouraged by the momentum and believe we have an opportunity to accelerate growth even further as we leverage new capabilities and improve coordination between our media and merchandising teams. 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 1.73x, which is below our target ratio range of 2.3x-2.5x. This provides us with financial flexibility to pursue growth investments and other opportunities to enhance shareholder value. We expect to return to our target leverage ratio over time and will share more details about our plans for 2026 next quarter. 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. During the third quarter, we completed our $5 billion ASR program under Kroger's $7.5 billion share repurchase authorization. We are currently executing open market repurchases and expect to complete the remaining $2.5 billion under the authorization by the end of the fiscal year, which is contemplated in full year guidance. Improving ROIC is a key priority. As we shared earlier, we expect our updated hybrid e-commerce model and investments in new stores to drive stronger returns going forward. Building on that, we continue to sharpen our focus on cost structure.

We've made meaningful progress so far, but we see greater opportunities ahead by modernizing operations and ways of working across our organization, from stores to support centers. We also see opportunities to improve procurement to unlock additional cost savings. The combination of disciplined cost management and capital deployment positions Kroger to deliver stronger returns and create more shareholder value. I would now like to provide some additional detail on our outlook for the rest of the year. We are pleased with the continued momentum in our business, supported by strong performances in pharmacy and e-commerce. Given our year-to-date results and outlook for the remainder of the year, we are narrowing our range for Identical Sales without fuel growth to a new range of 2.8%-3% and raising the lower end of our Adjusted Earnings Per Share guidance to a new range of $4.75-$4.80.

This includes the impact of LIFO, which is now expected to be a 7% headwind compared to what we expected at the start of the year. As we move into Q4, we expect a slight improvement in our OG&A rate to help mitigate the impact of a slight decline in FIFO gross margin rate. One additional factor to note is the impact of the Inflation Reduction Act on our pharmacy business. Beginning on January 1, this legislation is expected to reduce Medicare drug prices on 10 highly utilized medications. Sales on these medications will be recorded at the new reduced prices. Kroger will continue purchasing these drugs at current acquisition costs, and manufacturers will fully reimburse Kroger for the difference through rebates, which will then be recorded as an offset to cost of goods sold.

Thank you, David. In closing, we're encouraged by the progress we're making. Our priorities are clear, and we're executing with greater speed and discipline. We're strengthening our core business and investing in areas that will contribute to long-term growth. We're taking decisive actions today that will make Kroger stronger now and in the future and deliver greater value for our shareholders over time. Before we move into Q&A, I want to provide a brief update on the CEO search. Our board remains actively engaged and is making good progress.

While we don't have a specific timeline to announce today, we're engaged in a thorough process and expect to appoint a new CEO during the first quarter of 2026. We'll now open it up for questions.