Kroger’s 2023 GAAP Profitability Outlook Leads Our Estimates, After Outsize 2022 LIFO Charge

We plan to raise our $52 fair value estimate for narrow-moat Kroger KR by a mid-single-digit percentage after its fiscal 2022 results. We view shares as attractive, even after a similar rise following the results.

In fiscal 2022, Kroger posted $148.3 billion in sales, modestly below our $149.3 billion estimate, and $4.1 billion in GAAP operating income fell shy of our $4.3 billion figure. Kroger also swallowed an elevated last in, first out, or LIFO, charge of $626 million, well above fiscal 2021′s $197 million. As such, cash from operations fell to $4.3 billion from $6.2 billion (we assumed $6 billion), with product cost inflation the culprit.

Since inflation is expected to keep moderating in fiscal 2023, Kroger anticipates a LIFO charge will fall between $300 million and $350 million. When taken together at the midpoint of guidance for $5 billion-$5.2 billion in adjusted operating income, $4.8 billion in implied GAAP operating income lies ahead of our $4.4 billion preprint estimate, and we expect to push it closer to Kroger’s target, which is the key driver in our valuation update, outside of the time value of money. This will then lead us to raise our $4.24 EPS projection closer to Kroger’s expected range of $4.45-$4.60, although we note $0.15 of the guide stems from the extra week in fiscal 2023. From a sales perspective, we don’t anticipate any significant change as management expects 1%-2% identical sales growth excluding fuel, just below our 2.5% estimate.

Neither the final-quarter results nor 2023 outlook change our long-term thesis. Kroger continues to invest in its brand to remain relevant to its consumer, with $3.4 billion-$3.6 billion slated for capital expenditure in 2023 and another $770 million in operating expenses to support staffing demand. While this is above prepandemic levels, it doesn’t jeopardize Kroger’s ability to raise dividends nor repurchase shares as it’s still set to generate more than $2 billion in free cash flow to equity annually.