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Michaels turns in strong Q3

BY Marianne Wilson

Michaels Cos. reported third-quarter income and sales that beat Street expectations.

The arts and crafts retailer reported that its net income increased 5.0% to $83.8 million in the quarter ended Nov.3. Adjusted net income for the third quarter of fiscal 2018 was $79.8 million. Earnings per share came in at $0.50, an increase of 13.6% compared to the year-ago period. Adjusted earnings per share was $0.48, beating estimates of $0.44.

Net sales increased 2.7% to $1.27 billion, better than expected, amid the opening of 19 stores during the quarter. (The sales increase was partially offset by the closure of all 94 full-size Aaron Brothers stores in the first quarter of fiscal 2018.) Same-store sales rose 3.8%.

“We have invested significantly this year to create an easier shopping experience for customers, and we believe these improvements will strengthen our leadership position in the arts & crafts industry and help us deliver our revenue and earnings expectations for the year, said Chuck Rubin, chairman and CEO.

At the end of the third quarter, the company operated 1,256 Michaels stores and 36 Pat Catan’s stores.

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Kroger Q3 profit falls

BY Marianne Wilson

The Kroger Co.’s income fell in the third quarter as it continues to invest in online and offline initiatives to shore up — and transform — its business.

Kroger’s total sales decreased 0.3% to $27.67 billion, just above estimates, amid disruptions as the company continues to revamp stores to allow more shelf space to best-selling products. Excluding fuel, the convenience store business unit divestiture and the merger with Home Chef, total sales increased 1.7% in the quarter over the same period last year. Same-store sales, excluding fuel, rose 1.6%. Digital sales grew over 60%.

Neil Saunders, managing director, GlobalData Retail, commented that, given the unfavorable metrics around online, Kroger needs to counterbalance its digital efforts with growth strategies in other, more profitable parts of the business.

“In our view, online grocery has yet to prove itself as a viable business model,” Saunders explained. “Even in the U.K. – where the market is far more advanced and where the higher population density is more favorable to distribution – online has not been particularly helpful to the bottom line. If anything, it has eroded profits and put margins under severe pressure.” For more analysis, click here.

Net income fell to $317 million, or 39 cents per share, in the quarter ended Nov. 10, from $397 million, or 44 cents per share, in the year-ago period. It reported adjusted earnings of $394 million, or 48 cents per diluted share, when accounting for its investment in online U.K. grocery retailer Ocada Group, above the 44 cents a share analysts had estimated.

Kroger has launched a number of initiatives in recent months, including, most recently, a pilot with Walgreens to sell grocery items in the drug store chain’s stores. In November, it announced that it would open its first customer fulfillment center, with the automated facility leveraging digital and robotic capabilities, will be the first project that it is collaborating on with Ocado.

“Kroger is transforming our business model,” said Kroger chairman and CEO Rodney McMullin. “We’re moving from a traditional grocer to a growth company with both a strong customer ecosystem that offers anything, anytime, anywhere, and asset-light, high-margin alternative partnerships and services. We are strengthening the Kroger ecosystem by reducing costs and investing the savings in our associates, technology, and price to grow units, traffic and share. Leveraging our store, logistics and data assets in turn creates incremental new profit streams, which then further redefines the customer experience. In this way, our new growth model will be a virtuous cycle.

Kroger lowered its net earnings guidance for the year to $3.80 to $3.95 per diluted share from $3.88 to $4.03 previously. It maintained its adjusted operating profits of $2.00 to $2.15 for the year.

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Kroger—and entire U.S. grocery sector—hurtling towards a ‘day of reckoning’

We have mixed views about Kroger and this latest set of numbers does very little to change our position. Overall, the results are far from fantastic and continue to show pressure on top line growth and a significant drag on the bottom line. That said, the company is innovative and is putting in place a number of plays – from digital solutions to meal kits – that will allow it to generate some market share growth over the medium term.

The question is whether such growth will be profitable or whether it will come at the expense of the bottom line. For all Kroger’s enthusiasm around the online market and its crowing about 60% digital sales growth, we remain very skeptical about whether this push will be margin enhancing. In our view, online grocery has yet to prove itself as a viable business model. Even in the U.K. – where the market is far more advanced and where the higher population density is more favorable to distribution – online has not been particularly helpful to the bottom line. If anything, it has eroded profits and put margins under severe pressure.

This does not mean that Kroger is wrong to invest in digital. Indeed, we see its partnership with Ocado as appropriate and necessary. There is no doubt that consumer interest in online grocery is growing and Kroger needs to play strongly in this space if it is to defend its market share. However, given the unfavorable metrics around online, we believe that Kroger needs to counterbalance its digital efforts with growth strategies in other, more profitable parts of the business.

One area in need of desperate investment is stores. While Kroger has a very strong network of shops, we remain broadly unimpressed by the quality of its estate. Many stores, especially regional banners, feel run down and dispiriting. They are not great places to shop and they do little to showcase Kroger’s range in an effective way. As more and more money goes into digital we fear that investment in stores will fall further and further behind. Given the importance of stores to the consumer and the investments of other players – like Aldi, Lidl, Target, Walmart, and Amazon – in physical grocery, this position is simply not viable. Longer term, it will create pain on both the top and bottom lines.

In this regard, we are particularly worried by the statement from CEO Rodney McMullen that he sees Kroger moving to a company with more “asset-light” partnerships. This mantra was also one peddled by Eddie Lampert, who used it to justify the deterioration in stores. This did not work well for Sears and ultimately, we do not believe it will work out well for Kroger unless the company comes up with a more balanced growth strategy.

To be fair, these issues and dilemmas are not exclusive to Kroger. In our view, the entire U.S. grocery sector is hurtling towards a day of reckoning. Changing shopping habits, the rise of digital, more competition, and increased price pressures are all going to crimp margins, store productivity, profits, and will reduce returns on investment. There is simply no avoiding this pain and ultimately the battle will be about surviving rather than thriving. Kroger will survive, but we question whether it will thrive.

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