CEOs rarely publicly admit their mistakes but, this week, David Dillion, boss of US retail giant Kroger did just that after the company slashed its profit forecast and sent its shares tumbling. However, while Wall Street may be concerned that Kroger is cutting prices and investing in margin to stay competitive, some industry watchers believe that the retailer remains on the right track. Dean Best reports.

On Tuesday (8 December), Kroger chairman and CEO David Dillon, as usual, addressed analysts in the wake of a quarterly results statement from the US’s largest traditional grocery retailer.

However, the comments from Dillon, a veteran of the grocery industry, were far from usual. After Kroger cut its full-year earnings forecast, sending its shares tumbling 12%, Dillon admitted he had misread the market when he had spoken to analysts three months earlier on the day the retailer issued its second-quarter numbers.

“We did not read the market right. We did not properly read the market in the second quarter release when we were telling you where the third quarter and the rest of the year would come out, and I fault myself,” Dillon admitted. He stopped short of apologising but, nonetheless, the candid admission raised eyebrows.

With the anxiety over the economy still running high among US consumers, and with unemployment holding steady at around 10%, these remain challenging times for US retailers. Dillon said competition between US retailers had intensified during the third quarter and deflation was “more pronounced” than he had expected.

“I actually thought it was going to begin turning but I guess I was looking through rose-coloured glasses,” he said. “You saw a lot more reactions throughout the industry – more competitors and more geography with competitive reactions. I wasn’t surprised to see some of it but it was more widespread than I had expected. Those are the two biggest areas that I think we just didn’t see properly.”

Kroger did book a 1.3% rise in identical supermarket sales excluding fuel for the third quarter to 7 November. However, the group filed a third-quarter loss of US$874.9m due to a goodwill write-down at its Ralphs division in California.

The write-down, combined with the reduced targets and Kroger’s continued moves to invest in margin to lower prices, left some Wall Street analysts nervous about the prospects for the business.

“We maintain our cautious stance following Kroger’s surprisingly weak third-quarter results,” BMO Capital Markets food retail analyst Karen Short wrote in a note to clients. “Unit volume was strong, but deflation and basket declines offset volumes. Furthermore, it appears the environment into the fourth quarter remains extremely challenging, with IDs still only trending at the +1.3% level, despite easier year-over-year comparisons.”

Dillon’s prognosis of two of the key trading periods in the US – Thanksgiving and Christmas – would have helped feed the pessimistic outlook for the industry. Dillon said Kroger had had a “soft” Thanksgiving, which led him to be less than upbeat about the prospects for Christmas. “Given what happened in Thanksgiving, I’m not as bullish about where Christmas is going to come in for the industry,” he warned.

With the prospects for US retailers looking anything but rosy, Kroger will likely have to continue with its price cuts and investment in margins.

Over at BMO Capital, Short is unsure what such a strategy will mean for Kroger. She described the fall in Kroger’s margins during the third quarter as “alarming” as it “only served to drive slightly improved sequential unit volume”.

Short added: “Only time will tell if this strategy is sustainable – or superior longer term. Given Kroger’s overlap with Wal-Mart and slightly lower income demographics versus Safeway, Kroger may have no choice but to continue investing in gross margin. However, at this stage, we can’t help but wonder if the company is only encouraging the cherry picker – a strategy that has yet to demonstrate it will result in sustainable and profitable market share gains.”

Nevertheless, Kroger, with the bulk of its store network made up of supermarkets selling goods at higher prices than the likes of Wal-Mart, has had to become more competitive to retain customers during the recession. Inevitably, the strategy has led to pressure on margins but other industry watchers believe Kroger has had more success than other US retailers.

“Despite their slowing comps, they are better than any publicly-traded competitor, who have all gone negative, with the worst down 4-5%,” argues Neil Stern, senior partner at US retail consultants McMillanDoolittle. “This investment is buying market share and customer loyalty for the long term but not pleasing Wall Street [but] all in all, it is the right thing to do.”

Michelle Chang, retail analyst at Morningstar, also offers praise for Kroger’s performance during the recession despite the depressed margins. “Relatively speaking, I think Kroger is navigating through the downturn fairly well but the environment has been much more challenging than the company initially expected, which is what contributed to its lowered earnings forecast,” she tells just-food. “By continuing to lower prices, I think Kroger has been able to retain some customers that it would have lost otherwise.”

What is certain is that the battle between US grocers for customers will continue into 2010. Most industry watchers are pessimistic about the outlook for the US economy next year and, after the Kroger management perhaps got a little ahead of itself during the summer, there is a now a tone of “realism” at the company, as Dillon himself acknowledged on Tuesday.

Nevertheless, Kroger seems better placed than some to navigate the downturn effectively. As Stern says: “Ultimately, Kroger will emerge from this in very good shape.”