Kroger's Management Making Prudent Moves

We do not plan to materially change our $32 per share fair value estimate for narrow- moat

Although the deflationary environment is suboptimal, we are encouraged that Kroger posted stronger-than-expected margin performance, with first-half merchandise costs at 77.4% of sales versus 78.2% in the same period of the prior year. We believe this supports our contention that Kroger benefits from a durable throughput-driven cost advantage, allowing the company to benefit from increasing tonnage even in a lower pricing environment. The firm’s attractive cost structure is difficult for smaller competitors to replicate as Kroger is able to leverage its distribution capabilities across a large store network, spreading inventory and supply chain investments over a large base.

In response to slowing top-line performance, the company announced it would reduce its capital expenditures for the year to $3.6 billion to $3.9 billion (from $4.1 billion to $4.4 billion). We believe the move is prudent given the deteriorating operating environment, and believe management's indication that it may instead be more aggressive in repurchasing shares could deliver value if the stock price dips further below our valuation. We continue to rate Kroger’s management team as Exemplary stewards of shareholder capital because of a strong track record of identical-store sales growth alongside excess returns in a competitive landscape.

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