Kroger Company (KR) — Q2 2023 Earnings Call Transcript

Good morning. Thank you for joining us for Kroger's second quarter 2022 earnings call. I am joined today by Kroger's Chairman and Chief Executive Officer, Rodney McMullen and Chief Financial Officer, Gary Millerchip. Before we begin, I want to remind you that today's discussions will include forward-looking statements. We want to caution you that such statements are predictions, and actual events or results can differ materially. A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filings. The Kroger Company assumes no obligation to update that information. I will now turn the call over to Rodney.

Thank you, Rob. Good morning, everyone, and thank you for joining us today. The Kroger team delivered another strong performance during the quarter, fueled by our strategy Leading With Fresh and Accelerating With Digital. These consistent results underscore the resiliency and flexibility of our business model, along with our associates' passion to deliver a fresh, convenient customer experience with no compromise on quality, selection and affordability. Customers continue to adjust their shopping habits in response to ongoing inflation. We are doing everything we can to help our customers stretch their dollars with high-quality fresh products at everyday low prices, an industry-leading fuel rewards program, and personalized savings on the items that matter most to them. Our customers are looking for ways to save, and we are there for them. During the quarter, digital coupon engagement hit an all-time high with 750 million digital offers downloaded, totaling almost $1 billion in savings. Our fuel rewards program continues to resonate with customers, with more than 600,000 incremental households engaged with our fuel rewards program this quarter compared to last year. And our fuel reward redemption rates were also up significantly. We continue to see more customers cooking from scratch and eating out less often. Our broad assortment of products meets the need for customers to buy what they want on their terms. For example, some customers are continuing to buy more of their favorite fresh products like apples, tomatoes, and grapes, while others are choosing products like frozen fruit and vegetables, allowing products to last longer in their homes. Overall, customers are looking to save money and make healthier choices by cooking more meals at home rather than eating out. Kroger's strong value proposition drove positive household growth and meaningful growth both online and in-store. Digital sales also returned to positive growth, driven by our one-of-a-kind Boost membership program and expansion of our Kroger delivery network. It's clear our go-to-market strategy is connecting with customers, and we continue to build long-term customer loyalty through Fresh, Our Brands, Personalization, and our Seamless ecosystem. Leading with Fresh, we are dedicated to serving our customers the freshest products so when they think food, they think Kroger. To achieve this goal, we are utilizing technology and deploying fresh innovation to deliver products faster, which stay fresher longer for our customers to enjoy. And it's working. In our 864 fresh certified stores, customers are purchasing more fresh products, and overall store sales are growing faster than the rest of the business. Supply chain remains an important part of our fresh strategy as well. To maximize freshness, we are utilizing our data science and collaborating with our partners to minimize dwell time in our distribution network and maintain the integrity of the cold chain. We are also improving productivity in our supply chain. During the quarter, we reduced fuel cost headwinds through technology and process efficiencies, such as controlling more product movement across the value chain and maximizing our trucking capacity. While some categories remain challenging, supplier in-stocks are improving, and we are cautiously optimistic this will continue in the back half of the year. Turning to Our Brands, we saw incredible engagement during the quarter with identical sales growth of 10.2% compared to last year. This increase was led by our Kroger and Home Chef brands. Convenience remains a priority, and Home Chef is meeting that need by providing high-quality family meals as a budget-friendly alternative to eating out at restaurants. For customers who enjoy cooking from scratch, Our Brands are delivering innovative products at a great value. Our Brands' product strategy is rooted in quality, providing customers with memorable meal experiences they crave. These products continue to earn world-class recognition. Most recently, Murray's Cheese varieties won five awards at the highly regarded 2022 American Cheese Society Competition. We were also recognized by Store Brands Magazine with 12 Editors' Picks awards for best new products, the most of any retailer. This recognition focused specifically on food that met customer needs for healthier products. As we continue to look for ways to help our customers stretch their budgets, this quarter, we launched a new portfolio strategy for our opening price point brands. We consolidated 17 legacy brands into two: Heritage Farm for our fresh and dairy product lines and our newest brand, Smart Way for our non-perishable items. These brands are competitively priced and meet the needs of customers on a budget. We launched with 150 SKUs and expect to roll out additional products by the end of the year. Now moving to digital. We achieved positive sales growth, as I mentioned before, led by our strong delivery results. Early in the second quarter, we introduced our Boost membership nationwide, and it's already showing promising results, including an increase in overall household spend among members. We remain focused on adding new members and are encouraged that enrollment is in line with our internal expectations and projections. During the quarter, we opened a new Customer Fulfillment Center powered by Ocado's automated Smart Platform in Romulus, Michigan. Additionally, we are excited to expand the Kroger delivery network to more customers in four new geographies during the quarter through spoke facilities in Austin, Birmingham, Oklahoma City, and San Antonio. This brings our total CFC and spoke count to 18. We continue to invest in our pickup business, where demand remains strong. During the quarter, we increased capacity and shortened wait times to improve our customer experience. We invested in technology and implemented process efficiencies, which helped lower our cost to serve. Our customers are telling us they love our Seamless experience. We continue to see customers effortlessly shift between store, pickup, and delivery, which is building loyalty. We continue to improve the experience and will always encourage our customers to shop with us how they want to, with no compromises. Our associates' dedication and passion continue to fuel Kroger's consistently strong results, and we are proud to invest in our teams and improve the associate experience. We saw more people apply to work at Kroger this quarter as we continue to attract talented associates. For our current associates, we are making progress on retention. We've rolled out improved onboarding guidelines and implemented career planning tools. In addition, as part of our commitment to associate wellness, we recently introduced a new financial coaching service tool for hourly associates. This unique benefit offers free financial planning assistance. We are launching the tool in three pilot divisions and look forward to expanding the service across the company by January of 2023. It is always exciting to see our associates' commitment to creating an outstanding work environment recognized. For the third consecutive year, Kroger was named a Best Place to Work for Disability Inclusion, earning a perfect score on the 2022 Disability Equity Index. Additionally, the Brandon Hall Group, a leading human capital management firm, honored Kroger for our training programs and the ways in which our teams promote diversity, equity, and inclusion. Each team member is involved in creating our culture where associates come for a job and discover a career. Our Purpose: to Feed the Human Spirit inspires our team every day. One important way we bring our purpose to life is through Kroger's comprehensive ESG strategy. Our aim is to achieve lasting positive change for people and our planet. Our newly published 2022 ESG report called Nurturing Shared Values outlines Kroger's strong progress against dozens of environmental sustainability, social impact, and governance goals and commitments. We continued working to operationalize and integrate ESG within our business. Nowhere is this more evident than through our Zero Hunger | Zero Waste social impact plan. This month marks the fifth anniversary of the launch of Zero Hunger | Zero Waste. While we still have so much more work to do to achieve our moonshot goal of achieving a world free from hunger and food waste, we also have a lot to celebrate. Over the past five years, our team donated 2.3 billion meals to our neighbors in need, which included $1 billion in giving to fight food insecurity, 500 million pounds of surplus food donated to our food bank partners, and nearly $45 million in grants to support food recovery and system change from our Zero Hunger | Zero Waste Foundation. I am very proud to share for the first time ever that our store teams achieved 100% execution of Zero Hunger | Zero Waste food rescue, which is the strongest proof point yet of the value of operationalizing ESG. It took all of our teams working cross-functionally to achieve this important milestone. A huge congratulations and thank you to all involved. In summary, Kroger delivered another strong second quarter. We continue to delight our customers, strengthen our business model, and execute on our strategy of Leading With Fresh and Accelerating With Digital. We remain focused on delivering for our associates, customers, and communities. When we do that well, we deliver value for our shareholders. With that, I'll turn it over to Gary to take you through our second quarter financials. Gary?

Thank you, Rodney, and good morning, everyone. The Kroger team is laser-focused on executing our go-to-market strategy, which we outlined at our Investor Day in March. Our balanced business model has proven to be resilient in a variety of operating and economic environments, and our second quarter performance provided another proof point as we delivered significant year-over-year growth. I'll now provide additional color on our second quarter results. We achieved strong identical sales growth without fuel of 5.8% and saw momentum build throughout the quarter. Our Brands led the way with identical sales growing 10.2%. We believe the unmatched combination of innovation, quality, and value provided by Our Brands is a clear competitive advantage as inflation remains front of mind for many of our customers. Adjusted EPS was $0.90 for the quarter, an increase of 13% compared to the same quarter last year and ahead of our internal expectations. These results were driven by increased sales of our fuel, disciplined margin management, and strong fuel profitability. Our seamless digital ecosystem is critical to building deeper customer loyalty and accelerating market share growth. During the quarter, digital sales grew 8%, led by strength in delivery solutions, which grew by 34%. We continue to invest in digital growth initiatives, including the expansion of our Kroger Delivery network in new and existing geographies, investments in the customer value proposition via Kroger Boost membership, and the expansion of customer trip missions, including meal solutions and Kroger Delivery Now. As a result of these initiatives, we expect our positive momentum in digital sales will continue in the second half of the year. Kroger Health also contributed meaningfully to our second quarter results as we grew the profitability of our core pharmacy business. This allowed us to cycle the impact of higher COVID-19 vaccine revenue from a year ago, which is especially impressive given the number of vaccinations administered last year. Gross margin was 20.9% of sales for the quarter. The FIFO gross margin rate, excluding fuel, increased 2 basis points compared to the same period last year. This result reflected our ability to effectively manage product cost inflation through strong sourcing practices while helping customers manage their budgets and keeping prices competitive. Our team is doing an outstanding job navigating the current inflationary environment. We are experiencing the benefits of a multiyear journey in enterprise sourcing that is delivering significant and sustainable savings for Kroger and our customers. Our personalized pricing strategy is enabling us to maximize the reach and effectiveness of our promotional investments to drive loyalty and deliver value for our customers in ways they value most. Together, this has enabled Kroger to improve our price position relative to our key competitors. Due to continued heightened levels of product cost inflation, we recorded a LIFO charge for the quarter of $148 million compared to $47 million in the prior year. We expect inflation will remain at heightened levels in the second half of the year but moderate on a year-over-year basis as we start to cycle the higher inflation that began in the third quarter last year. Kroger's OG&A rate increased 36 basis points, excluding fuel and adjustment items compared to the same period last year. This increase was driven by investments in associates, higher incentive plan costs, and strategic investments in various margin expansion initiatives, partly offset by sales leverage and continued execution of cost savings. We continue to identify opportunities to remove costs from our business without affecting the customer experience, and we're on track to deliver our fifth consecutive year of $1 billion in cost savings. As I mentioned a moment ago, the increase in our OG&A rate during the quarter was unusual as it included an accrual catch-up for higher projected incentive costs covering the first half of the year, as well as strategic investments in a number of margin expansion initiatives that will drive future growth. We expect to achieve year-over-year improvements in our OG&A rate in the second half of the year and for the full year. Turning now to alternative profits. Kroger Precision Marketing continues to increase its relevance with our CPG partners. During the quarter, we saw an increase in brand reinvestment rates as CPGs experienced strong returns on their marketing spend with KPM. Kroger Personal Finance products and services are also connecting well with customers in the current environment, providing even more ways to save. This includes our KPF credit card featuring an introductory $0.55 off per gallon of fuel and our gift card program, which promotionally offers 4x fuel rewards. Fuel remains an important part of our business model and delivered exceptional performance in the second quarter. As Rodney mentioned earlier, our fuel rewards program is a key differentiator to help customers stretch their dollars, especially when fuel prices are high. Customers engage with our fuel rewards program at the highest rate since the start of the pandemic during the second quarter, ensuring our gallon sales outpace the market. The average retail fuel price was $4.62 this quarter compared to $3.13 in the same quarter last year. Our cents per gallon fuel margin was $0.62 compared to $0.39 in the same quarter in 2021. The strength of our fuel results is a great example of the flexibility that exists within our business model as higher fuel profit fully offset the higher LIFO charge in the quarter and allowed us to reinvest strategically in a number of margin expansion initiatives. Our associates continue to do an outstanding job executing our strategy and serving our customers, and we are investing in hourly wages to ensure Kroger remains an employer of choice. We're also committed to continuing to invest in our associates and sustainably growing hourly wages. These investments are fully contemplated in our long-term financial model. During the second quarter, we ratified new labor agreements with the UFCW for associates in Houston, Memphis, Lake Charles, Shreveport, Las Vegas, Southern California, and Indianapolis, covering more than 40,000 associates. In the second half, we plan to complete contract negotiations for Chicago, Columbus, Fort Wayne, Toledo, South Bend, and Southern California pharmacists. Turning now to our financial strategy and liquidity. Kroger continues to generate strong free cash flow. As a result of our operating performance and working capital improvements over recent years, our net total debt to adjusted EBITDA ratio is now 1.63 compared to our target range of 2.3 to 2.5. Initiatives to improve working capital also helped offset higher inventory balances during the quarter, which were a function of higher product cost inflation and in-stocks returning to pre-pandemic levels. We continue to prioritize capital investments that support our go-to-market strategy and see many opportunities to drive future growth. As we updated in our guidance today, we now expect our range for capital investments for 2022 to be between $3.4 billion and $3.6 billion, as various initiatives have been delayed due to supply constraints. Earlier this quarter, we raised our quarterly dividend by 24%, reflecting our confidence in our long-range plans and our ability to continue to generate strong free cash flow. The quarterly dividend has grown at a 14% compounded annual growth rate since being reinstated in 2006. This marks the 16th consecutive year of dividend increases. During the quarter, we also repurchased $309 million of shares and year-to-date have repurchased $975 million of shares. Earlier today, our Board of Directors authorized a new $1 billion share repurchase program. I'd now like to share additional color on our outlook for the remainder of the year. The Kroger team's consistent execution of our go-to-market strategy is building momentum in our business, which combined with sustained food-at-home trends gives us confidence to raise our full-year guidance. We now expect full-year identical sales without fuel of 4% to 4.5%, adjusted FIFO operating profit of $4.6 billion to $4.7 billion and adjusted net earnings per diluted share of $3.95 to $4.05, representing growth of 7% to 10% over 2021. This outlook includes a year-over-year headwind from LIFO of approximately $100 million in the second half of 2022. In closing, we have the right go-to-market strategy and are operating from a position of strength. Looking forward, we remain confident in our ability to deliver attractive and sustainable total shareholder returns of 8% to 11% over time.

Thanks, Gary. The Kroger team successfully navigated another quarter in a dynamic operating environment with strong results. As our customers continue to deal with high inflation, our value proposition is resonating with them. This reflects the balance we've built into our model. We have demonstrated the ability to offer customers fresh, affordable food and the value they need to help manage their budgets while we continue to invest in our associates, reinvest in our business, and consistently generate strong results. Our performance gives us the confidence that we have the right plan in place to build on our momentum and continue delivering value for all stakeholders. So with that, Alex, we'll turn it over for questions.

I want to start a little quick with the improvement you saw in IDs. Can you break that out into traffic and ticket? And then maybe within ticket, right, AUR versus items per basket? And I know nonfood has been a big drag. Is that still a drag? Did that get better at all?

I'll start on that and let Gary add some more of the details. The biggest part of the drive in improving trends is continued improvement in our loyal household growth and total household of people coming to our stores. We continue to see average transaction size smaller as people come into the store more often and more frequently. We would continue with some headwinds from the nonfood products as well. Gary, any additional insights you want to provide?

I think you covered most of it, Rodney. As Rodney mentioned, John, we're seeing for our most loyal shoppers continuing to win that first basket, and we're definitely seeing, as we look at our trends, that's holding up very well compared to what we're seeing overall within the market. For our most loyal customers, as Rodney mentioned, we're seeing that number grow overall and trips also growing with our customers, with our most loyal shoppers starting to increase the number of trips into the store as well. So I think those are the key points that I would call out.

Yes. The only other thing that might be helpful insight, John, is it's pretty consistent across the country as well.

Your nonfuel gross is one of the best we've seen in a while despite inflation. Is the product mix having an impact, or are you benefiting from a lot of forward-bought product? Or is that still difficult to obtain?

Yes. If you look, one of the things that our teams have done a nice job on is procurement. The other piece would be, as you mentioned, mix. The fresh departments continue to help on mix. We continue to see a lot of customers add value-added products as well.

Yes, I think you picked up the biggest drivers with sourcing and the benefits. It's not so much forward buying but continuing to be really disciplined, John, with how we look at the designer product and how we're managing relationships with our supply partners as well. One of the areas I would say, specifically in that, that was a tailwind this quarter versus last quarter is the sourcing team and supply chains working really well together to offset the pressure on fuel costs and making sure that we're improving efficiency in the supply chain and operating at optimum levels to really offset that. Whereas in the last couple of quarters, supply chain would have been a headwind to gross margin, it was essentially flat this quarter. That wasn't because fuel costs were not a headwind year-over-year; it was really how we applied our approach to the challenge across sourcing and the supply chain to make our operation more efficient.

Could you help us understand how fuel costs are affecting that? I recall your previous estimate was a $50 million headwind. You mentioned LIFO, which appears to be around $150 million higher for the year. I'm trying to consider how these factors influence the core flow-through of the increase and how that impacts the second half of the year.

Gary, go ahead.

Yes, absolutely. Thank you for the question, Kelly. I think you've highlighted many of the key points. We expect that the strategies we are implementing to grow sales, enhance customer loyalty, and manage margin performance will remain effective in the second half of the year. The primary factors that could make our EPS growth appear less significant in the latter half are important to note. Firstly, our total LIFO charge for the year is around a $250 million headwind, translating to approximately $100 million or about $0.10 impact on EPS for the second half. Regarding fuel, our perspective remains unchanged. Fuel has been challenging to predict, and we prefer not to depend on potential increases in fuel when it’s not something we directly control. Our reward program strongly influences our strategy concerning fuel. We are anticipating a comparison to $0.43 to $0.44 of CPG profit from the same period last year, but if fuel prices stabilize at normal levels, that would present a $50 million to $60 million headwind. Thus, we've accounted for about $0.16 of EPS headwinds from LIFO. Without these two factors, our EPS would fall within the 6% to 8% growth range, aligning with our TSR. We still anticipate that the underlying profitability of our supermarket business will enhance in the second half once we exclude LIFO and fuel considerations.

Yes. Just a couple of additional things. Gary mentioned one of these in his prepared remarks, but the organization still has incredibly strong cost control, and this will be the fifth year in a row that we've been able to get over $1 billion in cost out. Obviously, that's an important part of that. And we do expect alternative profit to continue to be a little strong, a little bit stronger in the second half of the year as well.

That's very helpful. As a follow-up regarding digital, there's an 8% growth which seems to leave it flat for the first half. Could you clarify how that aligns with your expectations and how Ocado is progressing within that? I see a 34% growth in delivery sales. Are you on track with Ocado's ramp-up? Additionally, regarding your goal to double digital sales, what is your current perspective on that?

Yes. It's important to note that Ocado is a key component of our overall digital strategy. We aim to create a seamless system that allows customers to transition easily between delivery, pickup, and in-store shopping. We've noticed that most customers who stop using pickup tend to return to the store, which helps us capture those sales in-store rather than through delivery. Our focus remains on creating this seamless experience, which is one reason we introduced Boost to foster customer loyalty across all interactions. I'm extremely proud of our teams, as the new sheds we're opening are achieving impressive Net Promoter Scores, and customers are engaging with us more frequently in those locations. Overall, I'm satisfied with our results, but we recognize there is still much work to do.

Yes. Thanks, Rodney. Just a couple of things. Overall, I would say, Kelly, we're pleased with the progress that we saw in the quarter. As you heard me mention in my prepared comments, we're certainly starting to see some traction on some of the key initiatives that we've been investing in, whether it's the Customer Fulfillment Centers powered by Ocado in both new and existing markets, the launch of Boost, and as Boost continues to ramp up, we see about 25% of customers that sign up for Boost are completely new to digital. So that's a really good driver for the digital business. We're still in the early stages of some of those convenience trip missions, whether it's Kroger Delivery Now with our partnership with Instacart, where products can be delivered, smaller baskets, within 30 minutes, along with meal solutions like sushi and others. So a lot of really exciting developments and activities that we're focused on, and we saw some good momentum in those areas coming through, which is why we also shared that we'd expect the momentum to continue in the second half of the year. I think the only other comment I would make is that we are taking a step back to figure out what the overall market digital growth is likely to look like this year because Rodney mentioned during his prepared comments, we're building a seamless ecosystem for customers, and we're seeing customers move between the channels, making decisions on where they shop. Ultimately, we want customers to choose to shop at Kroger, whether through the store, pickup, or delivery. We have certain assumptions around how we thought the digital market would grow this year, and we've taken a step back as we look at the back half of the year and assess how we think the market is growing overall. But our focus is really on ensuring that seamless ecosystem is building customer loyalty across all channels.

I just wanted to talk about the price gaps for a minute. Could you talk about how comfortable you are with where you're trending today? And have you noticed any change in your ability to pass through price increases as some of your peers have been a bit more rational on that front?

Yes, if you look overall, we continue to be satisfied with inflation and the pass-through. As Gary and I both mentioned, we're doing everything we can to minimize those increases and do it in a way that helps the customer in any way we can. We feel very good about our ability to balance all the pieces and minimize the impact on the customer as much as possible. We feel very comfortable with our price gaps, and price gaps with various competitors is something that we track on an ongoing basis. We feel good about the everyday price gap, and as you know, we receive great feedback from customers on our promotional approach, and customers really appreciate the promotional values we offer to allow them to stock up on items they use the most. We are very focused on using our data to ensure our offers are personalized for each household individually, with discounts that apply just to them. That's probably part of what's driving the fact that we had 750 million coupons downloaded as well.

Got it. That's helpful. And then just to go back to Ocado for a minute. What are you seeing from the facilities that are located in the new geographies versus your existing markets? And as we think about the profitability of these sheds, any updated view on when we'll get to breakeven EBITDA there?

Yes, I'll answer the first part of that and let Gary answer the second part of your question, Spencer. We continue to ramp up, and the ramp in new markets would be among some of the best sheds across the Ocado network. As I mentioned before, the NPS scores are outstanding, achieving world-class results. As customers engage with us through our Boost membership or other programs, this causes them to be even more loyal. In terms of the financial side, Gary, I'll let you take it from here.

Sure. Yes. Thanks, Rodney. I wouldn't say, Spencer, there is anything dramatically changed in our view that we shared previously around how we think about the CFCs powered by Ocado maturing over time. As Rodney mentioned, we've certainly been pleased with what we are seeing in customer connection and sales trends. When we think about the Net Promoter Scores and the value we are offering, we are seeing that the gross margin profile of that customer is in line with what we originally envisioned. One of the key things for us is that it is a 4 to 5-year journey to build to maturity and scale. So there are elements that until we understand customer density at scale, we are still figuring out some operational efficiencies. There is nothing new to highlight, but we continue to work on building that full picture. In the first two facilities, we are only 18 months into a 4-year journey to capacity. But generally, I would say it remains consistent with what we shared previously.

There was about a 50-basis point acceleration in your 3-year geometric stack. Was that all driven by an acceleration in inflation from the first to the second quarter? And it looks like your guidance implies that you're expecting your IDs to go back to that kind of high 5% run rate in the second half of the year on the same 3-year geometric stack basis. So would that also imply that you're expecting a lower contribution from inflation in the back half of the year?

Part of it, Michael, is we're starting to cycle higher inflation from a year ago. We do not expect inflation on inflation to be as high. It's really driven by the cycling of where we were a year ago. As you would recall, as we get later in the year, inflation ramped up aggressively in the back half of last year. We expect the business to stay strong and continue to make progress. We just don't expect inflation to be quite as high as it was.

Yes. Michael, I think we tend not to look at it specifically in the way you described at that 3-year view. But I would say that overall, we believe our progress in the second quarter was able to accelerate relative to Q1 compared to the market. We felt that we were able to win customers and change trajectory versus how the market was moving from Q1 to Q2. We feel very positive about the momentum we saw in the business in Q2. As Rodney mentioned, we believe that momentum will continue in the back half of the year, but we expect while inflation will remain at heightened levels, we anticipate it will start to taper out as we cycle about 4% higher inflation from the back half of last year compared to the first half of last year. We are starting to see some data indicating things may be leveling off somewhat, but there's been many shocks in the last 12 months that can change that quickly. So, the data points we can see now align with a forecast showing slightly tapering inflation rates in the back half of the year.

Okay. My follow-up question is Kroger's been pretty nimble in managing its FIFO gross margin, as was evidenced by this quarter. Was some of that due to the ability to pass along price increases a little faster than you’re getting the price increases passed along to you from your vendor community? And some consumable retailers are announcing that they're going to make sizable price investments in the back half of the year. So how does that influence your view of the ability to sustain this FIFO gross margin performance over the next couple of quarters?

Everything that you asked would have been reflected in our guidance for the balance of the year. Most CPGs inform us of their cost increases well in advance, so we balance the actual cost increase with what we pass through to customers. We constantly monitor our pricing weekly, assessing whether we're better or worse than our competitors. Another important point is that customers who shop at Kroger receive personalized rewards that are tailored for each household, which adds significant value for them, in addition to fuel rewards and other advantages. It's crucial to evaluate the entire value proposition.

Yes. To add, Michael, from the perspective of how we manage gross margin, it is more of a long-term approach rather than managing to a quarterly number. There are multiple moving parts involved. Tailwinds include the work we do in sourcing, the mix improvements from fresh and Our Brands growing, along with new innovative products. We are continuing to invest in our customers. Overall, we believe we are managing the model effectively through this evolving environment. If you look at our rolling 12-month gross margin, it aligns with our expectations at the beginning of the year. We are delivering on the plan we shared.

My question is on the consumer to diagnose some of the changes we're seeing. It looks like there was some trade down brewing across all of consumer. You mentioned that your business picked up from June throughout the quarter. Can you talk about if you're seeing a level of either trading down or movement to private brands you heard? Is the level stabilizing? Did it correlate with gasoline prices leveling off?

Regarding customer behavior, they're telling us they're modifying behavior more so outside of the grocery store than with us. The movement to Our Brands is generally driven by customers looking to save money initially, but they often fall in love with the product as well. The acceleration of growth in Our Brands is driven by the value offered but also the quality of the product. This trend has been consistent over the long term, not just currently. We take pride in our overall offerings, allowing customers to move between different types of products. We still see customers engaging in fresh, healthy products as well. Our approach is to remain agile in meeting customer needs.

Abbreviated follow-up is inflation. It sounds like we're not quantifying what the absolute level is. You all know we're going to see a moderation in the second half. Let's just say you're running in line with CPI for food and home. Could that actually get cut in half in the back half of the year? Is it going to be more moderate? In terms of elasticity, does it actually behave that quickly where you're seeing units for volume respond and go back up, so we're in the same place anyway?

From what we see, we wouldn't expect it to be a dramatic change. We would expect some flattening of inflation in the back half of the year, but there’s nothing indicating a dramatic change in the level of inflation in the back half. I think it ties back to Rodney's earlier comment. We are monitoring and using our data closely to adapt to how customers change behavior. We believe our strong portfolio of fuel rewards, Our Brands, pricing, and promotional offers will allow us to navigate customer needs effectively.

I was curious. You mentioned Home Chef. Were there any other categories or broader departments where your brands were surprisingly strong this quarter? Are the usual suspects like milk and soy healthy? Were there others where the share shift was bigger than you might typically see in this kind of environment?

It's a great question, Ken. The performance was really broad-based. The banner brand continues to gain solid share, but even our private selection brand, which has unique new products, saw continued strong growth. It was very broad-based across really the whole store.

Got it. Regarding the increase in OG&A this quarter, you mentioned a few reasons for it, and thank you for that. One of those reasons was a one-time accrual catch-up. Could you provide us with an idea of how significant that catch-up was? Additionally, concerning the margin expansion initiatives, I understand it's an ongoing process. However, in light of the OG&A results, were there any new initiatives introduced? Is there anything we should consider that might be unique and not previously mentioned, or is it more about the ongoing efforts you have in place?

Yes. Thanks, Ken. I think overall, if you think about the three pieces that impacted OG&A materially this quarter. The one you mentioned was the true-up for the first half of the year on our incentive calculation based on our improved performance; we had to catch up for the first two quarters of the year. Secondly, we're investing in strategic initiatives that we believe will accelerate growth as we look into 2023 and beyond. The third was cycling one or two items that were particularly strong in Q2 last year. If you remove those three factors from the number, we would have achieved improvements in the OG&A rate this quarter. That’s why we mentioned guiding to overall expected OG&A improvements for the rest of the year. We expect it to be fairly flat in Q3 but likely to be much improved in Q4. Regarding new initiatives, it is primarily about our response to customer changes and our evolving business model. We identified opportunities in areas like shrink by investing in capabilities for better shrink performance which, of course, helps gross margin.

I wonder if you could give a little more color on the Smart brands initiative. Is it providing anything new to the consumer in terms of opening price points, like lower price points than before? Or are you just consolidating several of your sub-brands to make it easier to shop? And I just had a quick follow-up.

The majority is consolidating the sub-brands, just making it easier to shop. Those items offer great value for money. There are also new items introduced under the Smart Way brand in terms of the absolute number of SKUs. It’s a combination of introducing some new items and consolidating several sub-brands to enhance the shopping experience.

Okay. And then a follow-up on CapEx. You're not the first to lower CapEx guidance among consumer goods companies. It usually seems to be due to project delays. But I imagine volume is less than what you had expected this year because pricing is so high. Is there any correlation here between a lower volume environment in an inflationary cycle and what your CapEx plans might be for the next couple of years?

I wouldn't say, Robert, that it changes our view of our future opportunities. We've laid out a clear plan at our Investor Day in March, and we're confident in the growth model we outlined. Our strategic investments will make sense across the supply chain, store portfolio, and digital space. So I wouldn't interpret it as being less excited or confident about these plans. It's more about addressing short-term supply challenges and balancing the investment plan, adjusting the schedule due to the short-term cost situation.

This is Brandon Cheatham on for Paul. I was wondering if you could help us a little on the fuel margin. Cents per gallon were very strong in the quarter, but it sounds like you expect fuel to be a headwind in the second half. Can you help us understand how much of the fuel margin was driven by internal initiatives or external market forces that you're not expecting to repeat in the second half?

Our team did a fantastic job managing fuel margins. Our goal is to stay very competitive on price, providing significant savings to our customers through our fuel rewards program. Last quarter showed great work by our team in capturing value through effective sourcing of fuel and customer engagement strategies. However, it also stems from market volatility. As we look at our strategy for delivering value, we believe fuel margins will normalize, and we are cautious not to forecast extremely high unusual profitability. Our focus is on being prudent in our expectations moving forward.

Got it. That's helpful. And a quick follow-up. I was just wondering if you could break out price inflation concerning how much that drove ID sales in the quarter? And how much of that was offset by units? I assume units declined slightly in the quarter.

Certainly, our sales growth exceeded the increase in cost inflation from Q1 to Q2, which we're pleased with. We believe we improved our growth trajectory from Q1 to Q2, especially compared to our market response overall. The overall growth is linked to household growth and loyal household growth, which remains essential for our future.

Alex, we have time for one more question.

So maybe just a follow-up to the prior question. Any perspective on market share? It sounds like your GAP versus peers may have narrowed this quarter, but any thoughts on performance this quarter and how you're looking at that for the balance of the year?

Yes. The gap has continued to narrow and it's narrowed during the quarter as well. For the balance of the year, our teams expect to continue making progress, and we're really proud of our position. We believe the overall value for the customer, the seamless experience, and our focus on fresh continue to accelerate, leading to customer loyalty.

Great. And one follow-up question on CapEx as well. This year, CapEx is significantly below your prior plan. Do you believe we could be in a period of lower sustained CapEx given some headwinds?

I think, Rupesh, we feel good about our plans to achieve our long-term TSR model around growing earnings at 3% to 5% and our TSR at 8% to 11%. We've laid out very clear capital expenditure plans to enable sustained growth. We are being deliberate about how we adjust our timing in light of pricing challenges in the market. However, this change reflects short-term adjustments rather than a less optimistic view of our investment opportunities moving forward.

Thank you, everyone, for joining us today. I want to acknowledge our associates listening in. We are proud of all your achievements this half of the year. Our outstanding associates provide a world-class customer experience. Thank you on behalf of everyone for what you do for our community, customers, and each other every day. I also want to recognize our Louisville and Delta divisions and our manufacturing and distribution teams who responded immediately to help in the aftermath of a devastating flood in Eastern Kentucky and a water shortage in Jackson, Mississippi. Our teams went to work to offer company and customer donations of supplies and funds, delivering more than 55,000 gallons of freshwater to both communities when they needed it most. A huge thank you for stepping up to support our neighbors. I also want to congratulate our stores on achieving 100% execution of our Zero Hunger | Zero Waste food rescue. Your efforts provide healthy food to neighborhoods in need. Thank you for your commitment to creating and supporting communities free from hunger and waste. Thank you once again for joining us today. That concludes our second quarter earnings call.