The Kroger Co. (KR) Earnings Call Transcript & Summary

So I did want to ask you about Home Chef. So there's the sort of -- I get the ingredients and I cook it myself kind of a thing. That's not Home Chef. Tell us what Home Chef actually is because I don't know that it's well understood.

It actually is both. There is a component of Home Chef, which is the classic kit that is mailed to your home with a number of components to prepare a given meal. They're measured to the specific recipe, so there's no waste. That is one component of Home Chef. That is also the brand that we deploy in what we call ready to heat and eat or convenience meals, if you will, which are now meals that are already cooked namely lasagna, meat lasagna. And it's cold, it's refrigerated but it's ready, it's completely finished. All you need to do is put it in the microwave for actually 30 seconds. And voila, it's ready. There's all the components inside of the store that may be ready to prepare. So it is both, but it is the brand, the positioning of the brand is the convenience meal solutions ready to eat, ready to heat or ready to cook.

And Home Chef brand is now our latest billion-dollar brand.

And just to clarify, it's all 3, right,? Ready to prepare, which is I have the ingredients and then I cook dinner. The second is ready to heat, right? And then ready to eat is I go into the store, it's hot. I buy it, I take it home and I put it on the table.

Correct. All 3 stages are covered by that brand. That's why we call it a convenience meal solution brand.

And just out of curiosity, right, this is one of the categories that we think there is potential to grow pretty significantly, right? We're capturing meal occasion -- we. I'm not in the business. You -- the industry is capturing meals from other sort of takeaway prepared food solutions. What's the margin structure on this look like? And I want to be specific, right? There's the product straight -- product margin structure, but it's also -- there's a lot of preparation, production of it involved and if you don't sell it, there's a lot of waste because it's a very sort of tight consumption fresh product. What does the gross margin look like on a Home Chef portfolio relative to the Kroger brand?

Okay. there's a lot to unpack there. I'm going to start with your first point, which is a critical point and one that I think is lost, but you hit on it, Dean. We are in the food business. We aim to be the company you think of when you think of food. So whether that's a kit that you cook at home, whether that's ready to heat oven, microwave or ready to eat hot just as you articulated in-store. We want to do that. Now think about DoorDash. Think about Uber Eats. We are now on those apps. Kroger is the largest sushi seller in America. Well, when you're picking up that sushi, why wouldn't you want those 5 tenders for $5? Phenomenal value under the Home Chef brand. That brand plays across a broad portfolio and allows us to compete in places we haven't competed with in the past. If you look at the restaurant space or food away from home, the fastest-growing space is QSR, quick serve restaurants, right? We can play there. We have a right to play there. With sushi being so big, think about chicken now being a massive place to play within Home Chef. So that's one aspect of what you touched on there, where we can now broaden that share of stomach, if you like, to food away from home. So that's one place. Your margin structure piece across the store. Within the store itself, you might imagine ready to heat or ready to eat, both of those are significantly greater margin businesses than the rest of the store. And just orders of magnitude think double the average store. So under that Home Chef brand ready-to-heat, ready-to-eat almost double the margin. Then from a kit perspective and why we merged with Home Chef was the fact that they are making money on kits. The fact that their loyalty is so significant and their annual renewal rates are incredible because of their renewal or upgrades of recipes of kits, what they are and what they offer to consumers. And in fact, we're just getting ready now to ship not just kits but also ready-to-heat items in those same kits. And that margin structure because of the shipping is less. However, it's still helpful to the total business.

And if you control for also having to prepare all of these things, running essentially the operating cost against COGS, there's still tens of points above the center store or overall store average?

After cost that's in line, Dean. After those additional labor costs, et cetera, it's in line.

Got it. Super. That's helpful. So we do have one question from the audience, I just want to throw in here. How is your approach to frozen changed over time? And so my sense is the question is like, so now we have Home Chef ready to prepare, ready to heat, ready to eat, potentially taking share from the sort of frozen prepared foods category, ready-to-eat pizza, ready-to-eat or ready-to-heat frozen dinners, et cetera. How has that frozen aspect changed now that Home Chef is playing, obviously a much fresher role in a similar space.

So I'll take the macro look and let Juan tackle what we're doing with Our Brands. So frozen is actually creating -- if you look at the industry, there's a bit of a renaissance happening around frozen. Customers are perceiving it as actually what they should, a fresher product than what they thought of it in the past. So we are seeing a shift to frozen. And in fact, in many of our remodels, we are adding additional frozen doors to our stores. The beauty of frozen, there's less shrink in frozen departments, obviously. And from a product standpoint, customers are seeing much greater value in there as well. A great example is think about chopped fruit. For us, chopped fruit is a phenomenal competitive advantage, especially if you do it in store, and we've got over 1,000 stores now of fresh-cut fruit. But frozen fruit now is a massive category and growing incredibly well for us. So how are we doing in [ OB ]

Actually, I would add to what you said, Stuart, which is they are both coexisting extremely well. Eat now or eat later. That's the positioning, right? Your fresh offering refrigerated has a shorter shelf life. So I have to plan to eat that pizza within 3, 4, 5 days. I can have the pizza in my freezer waiting for the day that I wasn't planning on getting a fresh product and again, cook it and get a hot product. So eat now, eat later, they can coexist very, very well. Some of what we're doing to add value and talk about that premiumization and adding more value and bringing more customers and ultimately improving the profitability of the categories. We're bringing in more value-added frozen products into the mix, whether it's entrees, meals, instead of your commodity veg or in addition. I should say in addition to your commodity veg, it's the sauced product. It's the product with a component that is free from under the Simple Truth brand or a very complex and culinary recipe of veggies with sauces under the Private Selection. So they both coexist extremely well. And what we're doing is to grow the category, to answer the need of the customer and to improve the profitability of the category ultimately, is to bring more value added to it, which is, by the way, ultimately what the customers are looking for.

Juan and I were in [ Cayuga ] couple of weeks ago is the largest food show in the world. Almost 80,000 people in Germany and some of the innovation that's happening from a frozen food perspective is incredible. So nothing but opportunity in that space for customers coming.

So Frozen is not a future former?

Nope.

All right. Okay, Juan, I want to dig in a little bit. You run this business for Kroger, right? And like I'm a strategy guy and I had on my wall every place I've ever worked. We can do anything, we just can't do everything, right? And like when I think about all the choices that you have in front of you of what you could do in Our Brands, it's kind of baffling. So can you help us understand how you think about what to prioritize and what to actually invest time in? What's your process there? And as investors, what should we be thinking about keeping an eye on in order to interpret from our side, what's going on in your world?

Well, absolutely. That's a great question. And yes, we would love to do a heck of a lot more than we already do, but we do a heck of a lot. So -- but having said that, we are very data driven, and that data is driven and it's generated -- the genesis of that data is our customers, ultimately as well as the trends. So we have a team, the innovation center of excellence inside, like Stuart was alluding to. The Our Brands team at Kroger, which is absolutely, in my opinion, best-in-class has multiple centers of excellence. One of them would be the one that is looking after innovation. And what they're doing besides developing products, proprietary and unique products is looking at the trends happening, whether it's in the restaurant industry, whether it's around the world, whether it's what customers are wishing to get. So we're constantly evaluating those. Indeed, we publish some of the trends that we have encountered, and we have published them over the last few years multiple times. So we focus a lot -- to answer your question in those trends and addressing those trends in a proactive fashion in addition, to ensuring that we're covering the basis of what our customers need. So when we were developing the trend, for example, of plant-based, Simple Truth was the first brand to have a full-blown portfolio of plant-based under one single brand. We did not forget that we also needed to address the value cost -- the customer that needs that entry-level price product or opening price product and have Smart Way available to them. So a little bit of everything, ultimately, but we focus and prioritize based on those trends and data-driven from our customers.

[ From a data ] driven standpoint -- sorry, Dean, just from a data-driven standpoint. You think about -- Juan does this acceleration work by category. And then think about Porter's Five Forces. So what's happening from a competitor standpoint, economic standpoint, blah, blah, blah. He takes that lens on it, users either Sakano or Nielsen data to look for voids in the portfolio up and down the range, and then actually lays out what every competitor is doing. So we can see very quickly where the gaps are and the opportunity before us. The other key when you do that is sizes. And we see big differences in sizes and opportunities in sizes.

Absolutely. It's an incredible exercise that gives us an ability to do what Stuart just alluded to, but also to look ahead and see where we need to go based on the unmet needs or desires of customers. Sometimes they don't even know what they're missing until they find it. And that's our job, to develop and stay ahead of that and give them the answer to what they didn't know they needed, but now they cannot live without.

So the innovation process to me is just baffling as to how complex it could be in picking a lane. So thank you for the color there. I want to move to a question that we get a lot from investors. And I just want to call time check. We have about 16 or 17 minutes left. So I want to get to at least 2 or 3 more topics. This is the first of those. How does the role of your owned brands, your Our Brands portfolio, how does it affect your interaction, be it negotiation, the power leverage, the sort of dynamics between you and your CPG suppliers and HPC potentially?

Yes. It's been priceless for us, especially as commodity prices increased through COVID. We were all faced with unbelievable price increases and price pressures. But when you're creating spreads that are so significant between national brand and Kroger, for example, you're forcing the customer to make that trade. You are forcing them to do so. And we're okay with that. And we just show the data to our national brand players that we will take this cost increase because we understand there's pressures. But the commodity cost increase, you're overcommitting to the increases. We believe it should be here. That spread is going to create too big a spread for the consumer and the consumer is going to trade to our product. We're fine doing that if you're comfortable doing that. And honestly, those are some of the best conversations to have. It's data-driven, it's commodity driven. And from a taste test equivalent standpoint, that's not good for CPGs, but great for Kroger.

You're using in 2 ways then if I'm hearing correctly. One is to say, look, if you guys want to push this much through, we'll take it on shelf, but then the gap to our brand is going to be even bigger and your going to lose unit volume share or secondarily, maybe it's pushing back saying, look, we have the cost bar too. What you're saying your percentage increase is, that's not what we're seeing. So stick to your guns if you want, but it doesn't seem accurate to us. Is that...

That's very fair, Dean. And it works both ways as the commodity is going up, but also as the commodities are going down right now. And those are examples of what we're using today to say, well, we're lowering our brands, you need to be thinking about yours because the spread is going to become such that the consumer is going to jump. And you just have to look at the elasticity, right, of the category to very quickly say what sort of unit movement we're going to see move to Our Brands, and that moves the CPG too.

So Stuart, you just opened the door that I wasn't ready to walk into, but I'm going to ask it quickly and say, maybe we come back to it in another call. There's a lot of concern about deflation in retail grocery right now. Historically, we look back on it, we see disinflation, but rarely do we see actual food inflation go negative. Yet what you just alluded to suggests that there is potentially downward pricing movement on the table in some categories. How should investors think about the risk or the exposure for deflation overall? And how does the Our Brands portfolio contribute to that or protect against it?

Happy to come back to at another time. But from a high-level standpoint, you've got to remember, we talked about 80,000 SKUs, right? That's a lot of commodities. And various commodities are moving in various directions. I don't see us getting to deflation. But let me give you some examples. Do you remember the memes last year, when you were paying $5.50 for a dozen eggs today, you're spending $1.50 eggs. Now eggs is a key ingredient and many items, think mayonnaise, think, bakery, think you name it. So within those commodities, we see that coming down. Beef on the other hand, a massive commodity for us. Inflation is up, herds are down. So you're having these offsetting big, big commodities across the business right now. Do I see us going deflationary? No.

Good. I mean -- and look, just for the folks on the call, actual raw ingredients, particularly in center store, comprise a relatively modest portion of the total cost bar when you consider packaging, manufacturing cost, transport, et cetera. So there's -- even if you see sort of explicit commodity deflation in the market, it doesn't necessarily translate to price on shelf in my experience.

No, you're exactly right. Think about diesel right now. We've got crude. I know it dropped, I think, a couple of bucks today, but crude trading in the $86, $88 a range. But if you look at diesel, which is how we move product either shipping or transportation, diesel is significantly up, and that's a big proportion of those costs as well, Dean. So you're spot on.

Cool. So I wanted to ask about the -- hang on just 1 second. I just made myself a note and then I lost it. Hold on,

You didn't want to walk through that door.

See, you took me to the price thing and then I got all fatutzed. Oh, here it is. So I live in Phoenix, Arizona. Your local banner here is Fry's, which isn't a particularly big banner in your portfolio. Many people probably haven't even heard of it, but it's a pretty important banner here in the Phoenix market. And when I see a Kroger branded product on shelf, it makes me scratch my head because I'm in Phoenix. And honestly, I've never lived in a place that had a Kroger banner. So with Kroger as your center plate owned brand compared to national brand, half of the Our Brands portfolio, how do you see the Kroger brand playing in stores that are branded Kroger versus the myriad of other banners that you have in your portfolio? And how do you communicate to people, no, no, no, this is a thing and something you actually want to buy?

So we test that all the time. And we talk to customers in Fry's and Ralphs in Southern California, Smith's in Utah, Fred Meyer in the Northwest. We talk to customers all the time. And they understand that Kroger actually owns the banner itself and are very comfortable buying Kroger product in all of those banners. From an efficiency and cost standpoint for the Our Brands product, it's so much more efficient as you might expect.

Absolutely. That is the case. And with the support of our marketing team, an enterprise marketing team led by Tom Duncan and we have been able to build that equity in the customer mind where they're able to connect the logo outside and the card with the Kroger logo in our products, and there's a ton of equity. However, in some of our banners, the ones that do not have the Kroger logo in the marquee in the front of the store, we do deploy in some categories. For example, in Fry's -- you keep referring to Fry's. We do the Fry's brand in some very specific categories based again on consumer feedback and consumer input where they want to see it, whether it's a dairy product or maybe the bottled water because there's a public relations aspect that goes -- involved with those bottled waters that show up perhaps during times of crisis, et cetera. But again, it's all data-driven. I am very, very happy to tell you that our customers do see the connection, make the connection and find the equity inside of the Kroger brand regardless of what banner they're buying that day from.

so Kroger, the brand, the product brand is not widely -- more heavily penetrated in, say, Cincinnati than it is in Southern California for...

Let me give you a great example, Dean. As you know, we opened up a shed in Florida. We only have 1 store in Florida and it's in Jacksonville and it's Harris Teeter. But in the state of Florida, we really don't have much of a brick-and-mortar presence. Our brands and our sheds have a higher penetration than what our brand's penetration is in our headquarters, big city of Cincinnati. So when people try our product, they love it, repeat purchase rate is fantastic, and our sheds are just a great example of that which helps the profitability of that modality as well.

That is super interesting. There's more to unpack there, but not for today. We have about 7 minutes left. I want to get to 2 more things really quick. One is -- and I think this is a question for you, Juan. And then, Stuart, obviously, please add more what you think. What's next? Like if I look at the Our Brands portfolio today -- and I'm a strategy guy I think where does this need to be 3 years from now and 4 years from now and how do we get there? What's the point out in the distance? Describe the vision, where is this going? And what should investors be watching for, for signs of progress?

Well, Stuart referred to it at the beginning of the call. We are not developing private label. This is not what we do. We are a CPG team building brands in brands that will resonate and will be a destination driver for the Kroger banners across the U.S., whether they say Kroger or Fry's or Ralphs or even in the state of Florida. So what you can look for is truly the solidification, if you will, cementing that strategy of building brands that have tremendous equity, that bring -- that connect the customer and develop an emotional connection with that customer that is even more powerful, one would want or argue than any other brand available throughout multiple categories. You can expect to see more and more innovation and unique and differentiated products in key categories that our customers are looking for. You can expect more value-added offering. That goes in line perhaps with innovation, but more value-added offering for our customer. And again, staying ahead of all these trends, whether they are innovative or not innovative, but staying ahead of the trends and keeping up. And maintaining our brands. One saying that some -- that retailers have been known for is perhaps to not keep up in keeping the brands up to date as often as a national brand or a CPG company would do. You will not expect that -- I can assure you, you cannot expect that to be the case for the Kroger team. We will update our brands and keep them relevant, modern and appropriate regardless of as time continues to go. So that's the big difference.

So how high is high? The question you're answering.

I'm 6'3", so got to add...

That's pretty high. That's pretty high. I want you to think about Murray's and specialty cheese and the penetration we own in that space. It is significant. And there's very few national brands who come close to competing with us. And for a category, we own it. Why can't we do that in more places across the store, own the category, own it because the brand truly does matter. We've got that with Murray's Cheese. We've got that with Simple Truth and only expanding that further. Think about Private Selection in the context of, let's say, finest in Europe or Marks & Spencer in the U.K., huge opportunity to own the space because the brand matters. That's what Juan means when he says a CPG within a retailer.

That makes sense to me. I have 1 question from the attendees and then 1 final question to end. We have 3 minutes just to be respectful of everybody's time. I think I know the answer to this, let me do it quick. You mentioned eggs and if eggs deflate -- eggs are in a lot of things, including mayonnaise. So if the price of eggs goes down, we're going to see deflation in mayonnaise. There's like 1 egg yolk to a pint of oil in mayonnaise. It's not a major ingredient. I presume if eggs deflate, eggs might go down like actual cartons of eggs, but not necessarily mayonnaise.

You answered it perfectly.

And then my favorite ending question of all is what did we not ask you that you can't believe we just didn't even think of asking you? That if we left without knowing it, we'd be missing something. Maybe start with Juan.

I would say a little bit of our billion-dollar brands and how do we get them to be at that level could be one question. And the answer to that would be because the team have developed truly items that resonate with our customers in a very powerful way, looking -- preserving the quality and not compromising in any way, shape or form on the quality side. And perhaps there could be another question, which is how much or why do we put so much emphasis on the quality of our product and the satisfaction. And I would say the other part would be the our efforts on the sustainability side. Sustainability is a major priority for us as a retailer and as a corporate citizen, if you will. And part of what our packaging engineer is doing is figuring out ways to develop more sustainable packaging that is reusable, recyclable or compostable to help the environment. So I would say sustainability would be perhaps a question that I'm surprised we didn't get to.

And then I'll just add to Juan's first point and bring the margin component of it, which is, okay. So if you're at, call it, 27%, 28% today, how high is high? What proportion of your margin is coming from Our Brands and how high is high on that as well. The potential we see is enormous, especially if we manage this business like a CPG does, focused on the big brands, focused on growth, focused on pruning categories. How high is high? Maybe a little higher than [ 6-3 deep ].

So am I overextrapolating here to suggest that we, as investors might expect expanding gross margin and operating profit over time?

On Our Brands, our now brands, yes. And if you've looked at the last 3 years of our performance, where does it come from? Our Brands.

All right. Well, gentlemen, we are now at the half hour. I want to thank you both for taking the time to join us here today. Appreciate the conversation. Lots more to talk about. Thank you all investors for dialing in. As always, we appreciate your engagement, we appreciate your time and of course, we appreciate your business. Good luck out there. And we're here to help any way we can. Stuart, Juan, thank you so much and take good care. We'll talk soon.

Thank you, Dean. Likewise.