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Commentary: Compliance with sales tax ruling will be ‘problematic’

From an economic perspective, today’s Supreme Court ruling will come as a relief for states desperate for revenue. It will also be welcomed by those physical and omnichannel retailers which have a national presence and, therefore, already charge and remit sales tax in most states.

The losers from the ruling are online-only retailers, especially smaller players, and consumers who will end up paying more for products. By our calculation, the additional costs for consumers could be up to $15.2 billion a year.

The concern for retailers like Wayfair is that their prices will now effectively rise across many states. This weakens one of their competitive advantages over both physical players and those larger online and omnichannel retailers which have more of a national presence. However, in our view, this outcome is fair. It means that retailers will now compete on a level playing field.

A more problematic issue is one of compliance. Because of county and city taxes, there are well over 10,000 tax jurisdictions across the United States. Within each, there are various exemptions and rates for different products. This results in an extremely complex and intricate web of rules, that will require a lot of processing by retailers in order to calculate the taxes owed to each state and locality.

While larger retailers will be able to cope with this, it will still impose an initial burden on them which may further increase costs that could be passed on to consumers. That said, this is nothing that physical retailers operating across multiple locations don’t already have to deal with.
The challenge for smaller players will be significant and the concern here is that complexity could stymie innovation and entrepreneurialism. However, in our view, most states will likely exempt smaller players and, even if they don’t, their small scale will probably allow them to escape scrutiny.

As unfortunate as these problems and consumer losses are, in our view the Supreme Court’s ruling and negation of previous judgments which prevented the taxation of some online transactions by states, is correct and valid. The Court cannot and should not concern itself with practicality. It must only concern itself with the law and the Constitution.

In that regard, the judgment is reasonable. Provided states do not engage in discriminatory taxation, they have a sovereign right to sales taxes on business conducted within their jurisdiction. The courts and the federal government can only step in when taxation is levied unfairly and unequally to different actors or businesses and therefore impedes interstate commerce.

All that noted, we do not expect this to be the final ruling by the Court, as retailers and states are likely to raise further challenges on other grounds.

 

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Kroger Q1 profit beats Street; gives upbeat outlook

BY Marianne Wilson

The Kroger Co.’s investments to make itself more competitive in the rapidly evolving grocery sector are paying off as the supermarket giant delivered a strong first quarter performance that topped the Street.

Net income totaled $2.03 billion, or $2.37 per share, in the quarter ended May 26, up from $303.0 million, or 32 cents per share, in the year-ago period. (The gain includes the sale of Kroger’s convenience store business, which added $1.59 per share.) Adjusted earnings per share was 73 cents. Analysts had expected earnings per share of 63 cents.

Revenue increased 3.4% to $37.5 billion. Analysts had expected sales of $37.3 billion. Digital sales surged 66%.

Same-store spaces, including Kroger Specialty Pharmacy and ship-to-home but excluding fuel, rose 1.9%.

Kroger made some key moves in the first quarter, including extending its partnership with U.K.-based online grocery retailer Ocado, Kroger will be Ocado’s exclusive partner the U.S., a move that will enable the grocer to leverage Ocado’s smart platform, which supports online ordering, automated fulfillment and home delivery capabilities.

Also in the quarter, Kroger said it is acquiring Home Chef ,the country’s largest private meal kit company by sales.

Analyst Neil Saunders of Global DataRetail commented that “as much as Kroger is managing the daily dynamics of the market, it also has one eye on the future.”

“The recent partnership with Ocado and the Home Chef merger agreement both speak to the fact that Kroger is looking to stay one step ahead of the competition by gaining a toehold in rapidly-growing segments of the market,” he said. For more analysis, click here.

In a statement, Kroger chairman and CEO Rodney McMullen said the chain’s Restock Kroger program, which involves major investments in technology and other areas, was off to a fantastic start.

“Everything we do supports our customers engaging seamlessly with Kroger,” he said. “Kroger is creating the future of retail by innovating our core business and adding exciting partnerships like Ocado and our planned merger with Home Chef. We are on track to generate the free cash flow and incremental FIFO operating profit that we committed to in Restock Kroger.”

Kroger expects 2018 same-store sales growth excluding fuel to range from growth of 2% to 2.5%, ahead of Street estimates for 1.9% growth. It also raised the low end of its earnings guidance to a range of $3.64 to $3.79, from $3.59 to $3.79. Adjusted EPS is now expected to be in the range of $2.00 to $2.15, up from $1.95 to $2.15.

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Analysis: Kroger winning the battle against rival chains

Kroger has started its fiscal year on an optimistic note, with solid increases in both total and underlying sales. On the bottom line, the $1.8 billion gain on the sale of the convenience business has helped push net income past the $2 billion mark. Although the convenience store benefit is non-repeatable, Kroger’s operational improvements and efficiencies also contributed to the bottom line uplift and will provide an ongoing benefit to profit.

On the sales front, we are encouraged by the 1.9% increase in comparables. Although this came off the back of a weak performance in the prior year when the number dropped by 0.2%, the result suggests that Kroger’s investment in lower prices and its push on digital, where sales were up 66%, are both paying dividends.

We are particularly pleased by the uplift to forecasts for the year and think that the 2.0% to 2.5% comparable growth prediction is a respectable and attainable target.

Across Kroger’s various fascia, the emphasis on low prices is now more evident in terms of marketing, in-store messaging, and the reductions made across many parts of the range. From our data, this has stemmed the loss of customers and has improved shoppers’ perception of Kroger when it comes to price.

In our view, while further investments may be needed to maintain a competitive edge, Kroger is now on a much more stable footing than it was a year ago and is winning the battle against other rival chains like Albertsons.

The push of own brands has also been helpful both in protecting margins and in differentiating Kroger from rivals. Even so, the continued growth of discounters like Aldi, Lidl, and the dollar stores, may necessitate further price cuts and measures to fund them. In this regard, we are pleased that Kroger is looking to consolidate brands to generate greater efficiencies. We also believe that the development of new streams of revenue, such as marketing using Kroger’s customer data, are sensible.

As much as Kroger is managing the daily dynamics of the market, it also has one eye on the future. The recent partnership with Ocado and the Home Chef merger agreement both speak to the fact that Kroger is looking to stay one step ahead of the competition by gaining a toehold in rapidly-growing segments of the market.

On the Ocado deal, we believe that the technology will be beneficial for automating general warehouse operations. However, we are less certain that it will be effective in terms of home delivery. Ocado’s delivery model works in the U.K. because of the country’s high population density, which means the catchment area of one warehouse contains many households.

While the same logic applies to some urban areas of the US, there are many other locations where population density is too low to support profitable home delivery out of a central warehouse. The bottom line here is that grocery fulfillment is a necessity for driving sales, but even with Ocado’s technology we still believe it is damaging to profits.

We are more optimistic about the Home Chef deal. The meal kit market is growing rapidly and is taking share from both CPG firms and supermarkets. Kroger needed a response to that, and Home Chef is a good choice from a brand and commercial perspective. Over time, we think Kroger can use its channels and distribution to expand the business.

Overall, Kroger remains in a very pressured part of the retail market. However, we believe it is getting to grips with the challenges and is future-proofing its business.

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