Table of Contents:

Corporate Overview ………………………………………………….. 03

Financial Ratio Analysis ….…………………………………………... 04

Current Ratio ………………………………………….……… 04

Quick Ratio ……………………………………………....…… 05

Inventory Turnover Ratio …………………………………….. 07

Debt Ratio ……………………………………………….……. 08

Net Profit Margin Ratio …………………………………....…. 10

Return on Investment (ROI) ……………………………….…. 11

Return on Equity (ROE) …………………………………….... 12

Price-to-Earnings Ratio (P/E) ……………………………….... 13

Analysis of Working Capital Management …………………………... 14

Common-size Income Statements …………………………..... 15

Inventory Conversion Period ……………………………….....16

Receivables Conversion Period ……………………………….17

Payables Deferral Period …………………………………….. 17

Cash Conversion Cycle ………………………………………. 17

Long-term Debt …………………………………………………….... 19

Stock Issues ………………………………………………………..… 20

Weighted Average Cost of Capital (WACC) ……………………..…. 21

Recommendations for Investors ………………………………..……. 25

References ………………………………………………………….... 26

Corporate Overview:

The Kroger Co. is one of the largest supermarket chains in the United States with approximately 2,500 stores in 31 states. Total food store square footage exceeded 145 million as of February 2008. In addition to Kroger’s success in the supermarket industry, the Kroger Co. is also one of the largest jewelry retailers in the United States. Nevertheless, the company's primary operating format is combination food and drug stores (combo stores). In addition to combo stores and jewelry stores, Kroger operates multi-department stores, marketplace stores, price-impact warehouses, convenience stores, fuel centers, and food processing plants. Thus, Kroger is a highly diversified and successful company operating throughout the United States.

Kroger aims to increase shareholder value through its dividend program and sustained earnings growth created by strong identical store sales, slight operating margin improvement, and continued share repurchases. At the beginning of 2008, the company held the number one or number two market share position in 39 of its 44 major markets, which consist of nine or more stores. The company strives to grow market share as this allows it to leverage fixed costs over a wider revenue base.

To generate identical store sales growth and market share gains, the company adheres to its Customer 1^st strategy. This strategy focuses company efforts on improving employee communications and training; using customer research and loyalty data analysis to personalize stores on a market by market and store by store basis; improving customer loyalty by improving customers' shopping experience; and pricing within an acceptable range of discounters' prices so price becomes a neutral factor in customers' shopping decisions.

Financial Ratios:

A variety of ratios assist in analyzing the capital structure of The Kroger Co. This report evaluates Kroger’s profitability, liquidity, and financial leverage for investors. The following current, quick, inventory turnover, debt, net profit margin, return on investment (ROI), return on equity (ROE), and price-to-earnings (P/E) ratios along with the computations for each, will assist investors in making wise decisions concerning investment opportunities with The Kroger Co.

Current Ratio:

The current ratio assists in measuring Kroger’s liquidity at a certain point in time. The current ratio is calculated by dividing current assets by current liabilities. The Kroger Co.’s current ratio of 0.82 as of February 2, 2008 is interpreted to mean that to satisfy the claims of short-term creditors exclusively from existing current assets, Kroger must be able to convert each dollar of current assets into at least $1.22 of cash ($1/$0.82 = $1.22). Thus, Kroger’s current ratio, which has lowered over the past three years, may be cause for concern.

The Kroger Co. Current Ratios for Years 2005, 2006, and 2007 [ Current Assets (in millions) / Current Liabilities (in millions) ]
Date of Report	Current Assets	Current Liabilities	Current Ratio
January 28, 2006	6,466	6,715	0.96
February 3, 2007	6,755	7,581	0.89
February 2, 2008	7,114	8,689	0.82

However, according to Bernstein and Wild (2000) the need for a higher current ratio (such as 2:1) has decreased over the years likely due to the lenders’, and particularly bankers’, reduced conservatism along with improved accounting practices that have allowed lenders and bankers to “reduce the cushion acceptable as their minimum protection” (p. 126). Nevertheless, Kroger’s current ratio requires further analysis to determine if the ratio is a red flag interpreted as a company unable to meet its financial obligations or simply in normal range for companies in the same industry. To do so, the following chart provides the current ratios for two of Kroger’s major competitors as well as the industry averages.

As the chart shows, Safeway, Costco, and the Industry Averages have remained steady or also lowered over the past three years. Though Costco’s current ratio appears better than Kroger’s and Safeway, by at least holding with the lower industry averages, Kroger is not too far behind and is doing better than Safeway. Certainly, further investigation should reveal profitable reasons for Kroger’s high financial leverage and thus lower than average current ratios.

Quick Ratio:

The quick ratio, otherwise known as the acid test, removes inventories from the numerator in the current ratio. Inventories are often the least liquid of current assets and therefore are removed from the numerator of the current ratio to offer a more stringent test of liquidity. Therefore, the quick ratio is calculated by dividing the sum of cash, marketable securities, and accounts receivable by current liabilities or more simply stated, by dividing current assets minus inventories by current liabilities.

The Kroger Co. Quick Ratios for Years 2005, 2006, and 2007 [ Current Assets – Inventories (in millions) / Current Liabilities (in millions) ]
Date of Report	Current Assets – Inventories	Current Liabilities		Quick Ratio
January 28, 2006	6,466 – 4,486		6,715	0.29
February 3, 2007	6,755 – 4,609		7,581	0.28
February 2, 2008	7,114 – 4,855		8,689	0.26

The Kroger Co.’s quick ratio of 0.26 as of February 2, 2008 is interpreted to mean that to satisfy the claims of short-term creditors exclusively from existing current assets without the help of inventories, Kroger must be able to convert each dollar of current assets minus inventories into at least $3.85 of cash ($1/$0.26 = $3.85). Thus, Kroger’s quick ratio, which has lowered over the past three years, could also be cause for concern. However, much of Kroger’s inventories, especially food products, are easily liquidated and thus, the acid test is not as great of a concern as it would be for a clothing or airline company. Nevertheless, as with the current ratio, the quick ratio does require further investigation.

Upon comparing Kroger’s quick ratio to Kroger’s current ratio it becomes obvious that inventories account for a large portion of Kroger’s current assets. Recall that Kroger’s current ratio as of February 2, 2008 was 0.82. The acid test drops the ratio to 0.26. This dependency on inventories may also be cause for concern, or at minimum, further investigation. The following chart assists in understanding how Kroger’s quick ratio stacks up against two competing stores and the industry averages.

Again, Kroger is doing better than Safeway but not near as well as Costco. Costco’s inventories appear to account for far less of its current assets than both Safeway and Kroger and thus is exceeding the industry’s upper averages. However, Kroger is within range of the industry’s lower average. Nevertheless, the continued decrease in both the current and quick ratios along with Kroger’s dramatically decreased current assets when inventories are removed is cause for concern.

Inventory Turnover Ratio:

The inventory turnover ratio measures the average rate of speed inventories move through and out of a company. Inventory turnover is calculated by dividing the cost of goods sold by the company’s average inventory. The figures for the beginning and ending inventories for the year are divided by two to obtain the average inventory figure for The Kroger Co. This is a qualified method of obtaining the figure because of Kroger’s continued and ongoing growth rate in sales.

The Kroger Co. Inventory Turnover Ratios for Years 2005, 2006, and 2007 [ Cost of Goods Sold (in millions) / Average Inventory (in millions) ]
Date of Report	Cost of Goods Sold	Average Inventory	Inventory Turnover Ratio
January 28, 2006	45,565	(4,886 + 4,356) / 2	9.86
February 3, 2007	50,115	(5,059 + 4,886) / 2	10.08
February 2, 2008	53,779	(5,459 + 5,059) / 2	10.23

Though Kroger’s inventory ratio shows consistent improvement over the past three years, the inventory turnover ratio is best understood when compared to industry averages as shown below.