Post-pandemic stagflation and the policy responses to it, including higher interest rates, are having complex impacts on different parts of the economy, from putting the brakes on new housing starts (down 22% year over year in April) to drying up West Coast import container volumes (down 15% year over year in May). 

Meanwhile, GDP growth is slowing: In the third quarter of 2022, year-over-year (y/y) growth came in at 3.2%; in the fourth quarter of 2022, it was 2.6%; and in the first quarter of 2023, it was 1.3%. Real wages have been falling for two years and are now flat with 2019 levels.

It’s a complex environment for manufacturers, suppliers and retailers, where both costs and prices are higher and demand is evolving in multiple directions.

Some retailers have been able to thread the needle: Kroger is one of them, emphasizing operating margin and profitability ahead of its merger with Albertsons. First, it raised prices to match rising costs and protect its margins, then it promoted its own more profitable private-label brands to customers looking to stretch their dollars further. Now, as its national brand CPG vendors have become more focused on maintaining volumes, Kroger gets them to finance additional promotions while the grocer welcomes a new cohort of higher-income customers who have migrated to Kroger from specialty retailers. 

According to Kroger’s management team on the grocer’s Q1 earnings call on Thursday, Kroger was able to use price to drive some of its customers into higher-margin private-label items and then backfill the demand for premium brands with new higher-income customers.

Kroger Chairman and CEO Rodney McMullen cut right to the chase in his prepared remarks, almost immediately acknowledging the difficulties presented by current economic conditions.

“We’re off to a great start in 2023 with results that reflect the strength of our go-to-market strategy,” McMullen began. “Kroger is continuing to navigate a challenged environment as our customers manage the effects of high inflation, fewer SNAP dollars and micro-macroeconomic uncertainty.”

What did McMullen mean by “a great start”? There are a couple of ways of looking at Kroger’s top-line revenue numbers: Overall sales increased by 1.2% y/y to $45.1 billion, but identical same-store sales grew 3.5% excluding fuel sales. If same-store sales grew faster than overall revenue, presumably, Kroger operated fewer stores in the first quarter of 2023 than in the first quarter of 2022. But the company’s focus on margin has made it more profitable: Net earnings were up 44.4% y/y to $962 million in the quarter. Net debt was $1.5 billion lower than the same period last year.

“These results were underpinned by key elements of our go-to-market strategy,” McMullen explained. “Our Brands sales grew 4.9%. Our Brands continue to be an important source of savings for our customers who are attracted to the unmatched quality and value they provide. At the same time, Our Brands helps drive stronger profitability, typically providing 600 basis points to 800 basis points higher margin compared to national brands.”

Prospects for the rest of the year, McMullen cautioned, look more dim: “Looking toward the balance of the year, we would expect identical sales without fuel to be at the low end of our guidance range of 1% to 2% for the remaining three quarters of 2023, reflecting continued slowing inflation, partially offset by underlying improvement in unit growth.”

Kroger’s slightly more pessimistic outlook — it’s still technically reaffirming the revenue projections it issued last year — comes in a year when freight markets, even the refrigerated trucking markets heavily exposed to food, are starved of volume. Refrigerated trucking carriers are only rejecting 4.8% of the loads tendered to them by shippers, a far cry from rejection rates around 40% at the beginning of 2022. And volumes have settled back down to pre-pandemic levels, sharply down on a y/y basis. 

There wasn’t a significant seasonal bump in refrigerated trucking spot rates in April and May, which means that the incremental volumes coming out of Florida, California and Arizona weren’t enough to meaningfully tighten capacity. Rates will stay lower for longer until more carriers exit the market. 

One way that Kroger is supporting sales volumes in the face of a cash-strapped consumer environment is with promotions. Retailers deploy euphemisms like “investing in price” to describe putting items on sale when they sacrifice margin for volume, but in Kroger’s case, many of these sales are being paid for by the food and beverage companies themselves. The national CPG brands are becoming increasingly concerned with absolute levels of product flows and are financing Kroger’s discounts.

Equity analyst Chuck Cerankosky from Northcoast Research asked McMullen about the promotions during the Q&A portion of the earnings call.

“You mentioned the increased amount of promotional activity that Kroger was in during the quarter,” Cerankosky noted. “To what degree are the CPGs involved in that and how much of … it is Kroger spending its own, call it, gross profit dollars to promote your own brands?”

In his response, McMullen differentiated between the nationally branded products in Kroger stores and Our Brands, the store’s private-label goods.

“[The CPGs] are extremely engaged in that process,” McMullen said. “If you look at items that are national brand items, it would be heavily financed by CPGs. We would see CPGs, as supply chains have gotten much fuller, products are starting to flow. We have started seeing CPGs more starting to worry about tonnage and supporting that. Obviously, with targeted promotions on our products, those are funded … by Kroger, and it would be a pure economics in terms of the increase in tonnage in the investments we’re making.”

The CPG companies are bearing their share of the burden of supporting Kroger’s sales, and they will face the same pressures to reduce costs in their supply chains and elsewhere to maintain margins. It’s an uncertain outlook for transportation providers and other supply chain participants, which may have customers determined to ship the same volume of freight, but only if they can do it at a lower cost.