An Analysis of Kroger’s Reported Earnings from 2017 to 2022

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An Analysis of Kroger’s Reported Earnings from 2017 to 2022

Introduction

U.S. companies are required to report earnings determined based on generally accepted accounting principles (GAAP) to investors regularly. Investors, financial analysts, and other financial statement users rely on reported earnings to forecast companies’ future earnings. However, GAAP earnings include not only earnings from primary activities but also earnings from ancillary business activities or transitory shocks. The first component tends to be persistent over time and is the key determinant of a company’s long-term value, so it is often called permanent earnings. The second component is volatile over time, and it is often called temporary earnings.

In this study, I identify temporary earnings for Kroger in six years from 2017-2022 and determine permanent earnings after excluding temporary earnings from total earnings. I then compare total earnings, temporary earnings, permanent earnings to evaluate the persistence of each of them.

Data, analyses, and findings

Kroger is a prominent American retail entity engaged in the operation of supermarkets and multi-department stores across the United States and obtained its annual report for fiscal 2022 (which contains the income statements and the statements of cash flows for 2022, 2021, and 2020) and fiscal 2019 (which contains the income statements and the statements of cash flows for 2019, 2018, and 2017) from EDGAR on the SEC website. Temporary earnings typically stem from (1) acquisitions, (2) asset (PPE/intangibles/goodwill) impairment losses, (3) discontinued operations, (4) legal or regulatory events, (5) pension plans, (6) gains or losses on securities investments, and (7) gains and losses that companies label as “other” as a separate line item on the income statement. These items could be disclosed in the income statement or the operating cash flow section of the statement of cash flows.

I start from earnings before income tax expenses (EBT), and identify the following non-operating items as temporary earnings for each year from 2017 to 2022: Non-service component of company-sponsored pension plan benefits (costs), gain (loss) on investments, market to market gain on Ocado securities, and gain on sale of business. Most non-operating items are usually temporary earnings. Interest expense is also reported as a non-operating item. However, the interest expenses incurred by Kroger are considerable each year and persistent over time. Thus, I do not classify interest expenses into temporary earnings.

After identifying temporary earnings in the non-operating section, I begin to review the operating income section. Most operating income components are permanent earnings. However, operating income could also include restructuring charges, goodwill impairment losses, intangible impairment losses that either are non-recurring or have very different impacts on earnings in different years. Those items should be classified as temporary earnings. Kroger’s operating income section of the income statements does not separately report those items. Thus, I move to the operating cash flow section of the statements of cash flows for more information. After reviewing the statements of cash flows, I determine the following temporary earnings: asset impairment charges, goodwill and fixed asset impairment charges related to Vitacost.com, gain (loss) on the sale of assets (business), loss on deconsolidation and impairment of Lucky’s Market. Table 1 reports earnings before income tax expense (EBT or total earnings), temporary earnings, and permanent earnings.

Table 1: Total earnings, temporary earnings, and permanent earnings

Next, I analyze and compare the volatility and persistence of total earnings, temporary earnings, and permanent earnings. For each metric, I calculate the mean, standard deviation, and coefficient of variation (CV) for the six-year period from 2017 to 2022, and the correlation coefficients between the current year and the previous year’s performance. Standard deviation and CV measure the volatility, and the correlation coefficient measures the persistence of performance. The larger the standard deviation or CV, the more volatile the performance is. Correlation coefficients cannot be greater than 1. If the value of the correlation coefficient is close to 1, the performance from the past has a large ability to predict the performance in the future. Table 2 below reveals the following insights:

(1) Temporary earnings are extremely volatile, as evidenced by the value of CV (7.46). Total earnings are more volatile than permanent earnings. Total earnings’ CV is 0.33, larger than permanent earnings’ CV (0.30).

(2) Permanent earnings are more persistent than total earnings or temporary earnings. The coefficient correlation between the current year’s permanent earnings and the previous year’s is 0.84, close to 1. Thus, permanent earnings in the past have a strong ability to predict permanent earnings in the future.

Table 2: Mean, standard deviation, coefficient of variation, and correlation

Lastly, I plot the values of three earnings measures from 2017 to 2022 in the same chart. Figure 1 shows that both total earnings and temporary earnings fluctuate over the period, while permanent earnings exhibit a smooth-growing pattern during the same period. With the information about permanent earnings and the growth in permanent earnings in the past, we can relatively accurately predict Roger’s performant earnings in the future. I conclude that the quality of permanent earnings is higher than the quality of total earnings or temporary earnings.

Figure 1: Total earnings, temporary earnings, and permanent earnings

Attachment: The spreadsheet