Q1 2024 Kroger Co Earnings Call

Participants

Robinson Quast; Director of Investor Relations; Kroger Co

William McMullen; Chairman of the Board, Chief Executive Officer; Kroger Co

Todd Foley; Interim Chief Financial Officer, Chief Accounting Officer, Group Vice President, Corporate Controller; Kroger Co

Rupesh Parikh; Analyst; Oppenheimer

Robby Ohmes; Analyst; Bank of America Merrill Lynch

Ken Goldman; Analyst; JP Morgan

John Heinbockel; Analyst; Guggenheim Partners

Michael Lasser; Analyst; UBS

Michael Montani; Analyst; Evercore ISI

Ed Kelly; Analyst; Wells Fargo Securities, LLC

Kelly Bania; Analyst; BMO Capital Markets

Krisztina Katai; Analyst; Deutsche Bank

Chuck Cerankosky; Analyst; Northcoast Research

Presentation

Operator

(Operator Instructions)
Good morning and welcome to The Kroger Co first-quarter 2024 earnings conference call. My name is Carla and I will be coordinating your call today. (Operator Instructions) Please note that this event is being recorded.
I would like now to turn the conference call over to Rob Quast, Senior Director Investor Relations to begin, please go ahead.

Robinson Quast

Good morning. Thank you for joining us for Kroger's first-quarter 2024 earnings call. I am joined today by progress Chairman and Chief Executive Officer, Rodney McMullen; and Interim Chief Financial Officer, Todd Foley.
Before we begin, I want to remind you that today's discussion 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.
Kroger company assumes no obligation to update that information. After our prepared remarks, we look forward to taking your questions. In order to cover a broad range of topics from as many of you as we can, we ask that you please limit yourself to one question and one follow-up question if necessary. I will now turn the call over to Rodney.

William McMullen

Thank you, Rob. Good morning, everyone, and thank you for joining us today. Before we begin, I'd like to provide an outline of our discussion topics this morning. I will start by sharing a recap of our first quarter performance and highlight how we continue to advance our go-to-market strategy, which powers our value-creation model and drive long-term sustainable growth for our shareholders. Then Todd will cover our financial results for the first quarter.
Finally, I will provide a few comments on our proposed merger with Albertsons before we open it up for questions. We're off to a solid start in 2024, reflecting the strength and diversity of our model. As better than expected performance from our grocery business helped us manage fuel and health and wellness results that were behind expectations.
Kroger is providing exceptional value and a unique omnichannel experience, which combined with strong store execution led to growth in household and an increase in customer visits. As inflation moderates, we expect customer sentiment to continue improving, but near term, many customers are managing economic uncertainty.
While we expect health and wellness profitability pressures to continue into the second quarter, our recent improvement on store execution metrics and strong customer trends give us confidence that we are building momentum for a strong back half of the year, and we are well positioned to deliver on our full year guidance. As we've seen over recent quarters, customers continue to seek value and are shopping with us differently based on their financial situations.
Spending premium and mainstream customers continue to be strong. Mainstream households drove our overall household growth, and we improved our share of wallet with premium customers who are deepening their loyalty spending more in our fresh departments and enjoying more premium products such as private selection.
Within our most budget-conscious household, we are starting to see positive momentum, and we grew households in this segment after experiencing declines last year. Historic multiyear inflation across the economy, high interest rates and reduced government benefits.
Disproportionately affect to these customers are influencing their spending behaviors, Kroger's long-standing commitment to low prices and personalized promotions create more value for customers at a time when many of them needed more than ever. Food and Home continues to be the most affordable meal option for customers.
While food inflation has impacted every meal occasion, inflation in food away from home has been even higher than food at home inflation since 2019. We are committed to making sure our customers can enjoy a great meal experience with zero compromise on quality selection, value and convenience.
We see a significant growth opportunity to deliver convenient restaurant quality meals at an attractive value, and we are our expanding our ready to eat and ready to eat offerings. For example, after we revamped our fried chicken recipe, we created a meal bundle, which feeds family for $3.50 a person, a fraction of what it would cost to eat out at restaurants with quality that's difficult to be.
Every day, we strive to provide an outstanding customer experience, and we are focused on sharpening our store execution to do just that. This year, we raised the bar on our full fresh and friendly customer experience metrics, and we are very proud of our store teams for delivering an even better shopping experience with service metrics at record highs.
To continue that momentum in our grocery business. We are committed to keeping prices low for customers and delivering a consistent experience while growing our pillars of fresh, our brands, seamless and virtualization. Bleeding with fresh, our store teams primary goal this year is to drive more consistent shopping experience and that begins with fresh.
We are introducing new technology that's enabling our teams to better track.

Operator

We have lost connection with today's speaker. Please stand by what we're trying to reconnect with them. Thank you for your patience everyone. We now have the speaker back on the line. Please continue.

William McMullen

Our ongoing work to differentiate and elevate our brands is driving higher profitability. We are identifying new supply sources using more effective promotions and improving product mix, which is contributing to further margin improvements.
Now, seamless delivery solutions led digital results again, this quarter was an increase in both household and visits. Pickup also had solid growth and focus on delivering best in class fulfillment, led to strong improvements in key customer experience metrics.
This quarter, our teams improved fill rates due to a new record high, reduced wait times and delivers a significant improvement in perfect orders compared to last year. Through the power of machine learning and AI, we are developing new ways to elevate the payer customers and at the same time, reduce costs.
With dynamic valuable orders, these tools are providing associated with the most effective pick routes, which is enabling us to dramatically reduce picked clean time in our highest volume stores. Our customers love the Kroger delivery experience with refrigerated products delivered directly to their door step.
As a result, Kroger delivery network. A good example of this is our decision in the first quarter to close three spoke locations to reallocate capacity closer to our automated fulfillment centers where we have higher customer density and better order level profitability.
This decision does not impact Kroger's automated sees for other spoke locations. We remain confident that our grocery Kroger delivery network for provides a differentiated customer experience. And we'll continue to be a key pillar of our digital growth strategy.
Turning to virtualization, the combination of seamless and our personalization capabilities generated another quarter of digital engagement growth, up 9% compared to the same quarter last year. Personalization enables us to balance the depth and breadth of our promotions or effectively and encourages customers to engage more with us by focusing on promotions that matter most to them.
This led to an at an 18% increase in digital coupon flips compared to last year. Capturing more digital household is a key to our long-term growth model. These households are more loyal spend nearly three times as much with us and drive our alternative profit businesses.
By executing our go-to-market strategy, we create momentum in our grocery business. In turn, this creates the data and traffic to accelerate growth in areas like health and wellness and our alternative profit businesses. Alternative profit businesses had a strong quarter, led by growth in Kroger Precision Marketing.
KPM results were in line with what we expected and keep us on track to meet our full year expectations of more than 20% median growth. Yesterday KPM continue to broaden its reach by offering a custom audiences and ad measurement capabilities to advertisers on the social media platforms.
This is another important step in KPN's growth, creating more opportunities for clients to each relevant audiences, and more places and providing better transparency into ad effectiveness. Health and wellness grew its top line this quarter.
However, profitability results were below expectations. We are optimistic about the potential of this area of our business. Our script adherence initiatives are on track, and our teams are providing excellent care, which helps patients live healthier lives.
Additionally, our marketing plans and in-store activations designed to raise awareness and attract new patients are launching now to help drive growth in the back half of the year. Turning now to associates for associates are doing an excellent job elevating the customer experience and improving our full fresh and friendly metrics this quarter, seen consistency leads to better execution and retention improved again this quarter.
We are retaining more associates through a holistic approach, which includes wage and benefit investments and also focus on associates well-being. And this work is being recognized. This quarter, Kroger received the 2024 platinum Bell Seal for workplace mental health.
This is the third consecutive year that we've been recognized with the certification and for the first time we received the top distinction. This program recognized Kroger as an employer who creates a mentally healthy workplace for our associates through culture, benefits, compliance and wellness programs will continue to invest in our associates. When our associates have a better experience, they provide a better experience to our customers.
With that, I'll turn it over to Todd to take you through our first quarter financial results. Todd.

Todd Foley

Thanks, Rodney. Good morning, everyone. First quarter performance reflects the resiliency of our model, which enables us to manage a variety of economic cycles. The strength in our model, combined with the momentum in our grocery business gives us confidence to reaffirm our full year guidance even as we continue to navigate an environment of economic uncertainty.
I'll now take you through our first quarter financial results. We achieved identical sales without fuel growth of 0.5%, as Rodney mentioned earlier, our identical sales were driven by several positive customer metric trends, including increases in total and loyal households and increased customer visits.
We continue to see sequential unit improvement and our teams remain focused on returns deposit of units later this year. Inflation continues to moderate, which is consistent with our expectations at the start of the year. And towards the end of the first quarter, we began cycling the headwinds from the reduction in SNAP benefits.
Digital sales grew by more than 8%, which was led by 17% growth and Delivery Solutions, gross margin was 22.4% of sales, and our FIFO gross margin rate, excluding fuel, decreased seven basis points. The decrease in rate was primarily attributable to lower pharmacy margins and increased price investments, partially offset by favorable product mix reflecting our brands margin performance.
The decline in our FIFO gross margin rate was in line with our expectations. We expect our FIFO gross margin rate to improve beyond our first quarter results, driven by the core components of our margin expansion initiatives.
During the first quarter, we recorded a LIFO charge of $41 million compared to a charge of $99 million for the same quarter last year. The decrease charge for the quarter was due to lower inflation expectations for the current year compared to last year.
The OG&A rate, excluding fuel and adjustment items, increased 22 basis points, driven by planned investments in associate wages and increased incentive plan costs, partially offset by continued execution of cost savings initiatives.
In the second quarter, we expect the factors identified in the first quarter to continue leading to a similar to slightly higher OG&A rate.
We expect our OG&A rate to improve in the second half of 2024. We continue to make progress on our digital profitability, delivering another quarter of improvement in our pickup cost to serve. The remains a long-term margin opportunity with runway to improve to increase volume and process enhancements.
Our store associates played a key role in the cost to serve improvements, as Rodney mentioned earlier, did so while they improve key customer experience metrics. Adjusted FIFO operating profit was $1.499 billion. Our adjusted EPS was $1.43 per diluted share, a decline of $0.05 compared to last year.
Fuel continues to be a key driver of our strategy to build loyalty by providing compelling fewer awards to customers. We continue to see more award activity was 8% more redemptions contributing began with sales, which outpaced the industry this quarter.
However, our fuel profitability was below expectations this quarter with our cents per gallon fuel margin down low single digits compared to last year. I'd now like to provide a brief update on associates and labor relations.
We continue to invest in our associates as part of our long-term strategy, resulting in an average hourly rate of $19 an hour and a rate of nearly $25 with comprehensive benefits factored in.
During the first quarter, we ratified the labor agreements for Houston Clerks and the Mid-Atlantic Division stores in West Virginia, South Carolina stores in Colombia in Myrtle Beach and Portland distribution center and drivers covering more than 21,000 associates.
Turning to cash flow for continues to generate adjusted free cash flow, strong adjusted free cash flow through consistent operating results, which is enabling us to continue deleveraging in anticipation of our merger with Albertsons.
At the end of the quarter, Kroger's net debt to adjusted EBITDA ratio was 1.25 compared to our target range 2.3 to 2.5. Our strengthened balance sheet provides ample opportunities for Kroger to pursue growth and enhance shareholder value.
We continue to take a disciplined approach to deploying capital with a focus on projects which drive long-term sustainable net earnings growth while remaining committed to our investment grade debt rating, increasing our dividend over time, subject to Board approval and returning excess capital to shareholders when we are able to do so.
As part of our capital investment plans for 2024, we shared last quarter our plans for approximately 30 major storing projects focused on higher growth geographies where we have traditionally achieved a strong ROIC and operating profit growth.
We've made good progress on our projects so far and remain on track with our plans. While early, we're happy with the results from projects completed in the first quarter. We are confident these new storing projects will help advance our omnichannel strategy and be an important component to our sales growth and TSR model going forward.
During the first quarter we announced we had entered into an agreement for the sale of our curve, a specialty pharmacy business. As part of our regular and ongoing review of our portfolio, we did to determine that specialty pharmacy was not part of our core strategy going forward, and a sale would enable us to focus on our health and wellness strategies that revolve around our retail pharmacies.
Due to the sale and nonrecurring held for sale tax adjustment of $31 million was record of note in the quarter, and it has been reflected as an adjustment item in our results. The sale of KSP is not expected to have an impact on our 2024 guidance. I'd like I'd now like to provide some additional color or an outlook for the rest of the year.
Today, we reaffirmed our annual guidance, reflecting both positive momentum we are seeing in our business along with a more cautious customer environment in the near term. In terms of quarterly cadence, we now expect a decline in adjusted EPS for the second quarter, similar to the rate we observed in the first quarter as we expect price as we expect pharmacy business profitability pressures to carry over into the second quarter.
This reaffirms where we expected to be through both the first half of the year as well as the full fiscal 2024. In closing our first quarter performance reflects the strength and resiliency of our model. We are strengthening our grocery business with stress the data and traffic to accelerate growth in our alternative profit businesses, and we remain confident in our ability to drive attractive and sustainable returns for our shareholders.
I'll now turn the call back to Rodney.

William McMullen

Thanks, Todd. As you've heard from both of us, our grocery business is performing well and we are building momentum across our business progress operating from a position of strength. We have the right strategy, which is resonating with customers, and we have the financial strength to pursue growth and enhanced shareholder value. As we continue to prepare for our merger with Albertsons, I'd like to thank our associates for their incredible commitment.
Since we announced the proposed merger back in October of 2022, our associates have done an exceptional job preparing for the integration with Albertsons, while never once taking their eye on off the ball and serving our customers, advancing our strategy, operating our business and driving results.
Because of their efforts, we will be prepared to hit the ground running as a combined company ready to serve more customers from day one. As a more general merger update, in April, we announced an expanded divestiture plan with C&S, which directly respond to the concerns raised by federal and state antitrust regulators regarding the original agreement.
We believe that package switching, which includes a modified and expanded stores set and more non-store assets, bolsters Kroger's position and regulatory challenges to the proposed merger, including our upcoming court proceedings. It also positions C&S to be a strong and successful competitor.
We are prepared to defend our merger because it will produce meaningful and measurable benefits for customers for associates and for communities across the country. Customers will benefit from lower prices and more choices following the merger close, we have committed to investing $500 billion to begin lowering prices day one following close, along with an additional $1.3 billion to improve Albertsons stores.
Employees will benefit from progress commitment to invest $1 billion to raise wages and comprehensive benefits. Further building on our $2.4 billion in incremental investments since 2018. As union membership continues to decline nationwide.
This merger will secure union jobs and communities will benefit from the strength in the ability of the combined company to accelerate progress commitment to ending hunger as a combined company, Kroger has committed to donating 10 billion meals to families across the US by 2030.
In closing program is off to a solid start to the year, positioning us well to deliver on our commitments. We continue to invest in associates in the associate experience because when they have a better experience, our customers do as well.
Grocery results are off to a better than expected start, which provides the foundation for growth in alternative profit businesses. And our model is generating strong free cash flow, which has strengthened our balance sheet and positions us for future growth.
With that, Todd and I look forward to taking your questions. Because we are in litigation, we will be not be taking questions on the merger this morning.

Question and Answer Session

Operator

We'll now begin the question-and-answer session. (Operator Instructions)
Rupesh Parikh, Oppenheimer.

Rupesh Parikh

Good morning and thanks for taking my question. So I wanted to dig deeper into the gross margin line. If you can maybe walk us through the puts and takes as you guys see for the balance of the year, including, how you think about the pharmacy margins in the back half of the year?

Todd Foley

Yeah. Thanks, Rupesh, a great question. I mean, we talk to giving you that our expectation was that have relatively flat year over year gross margin, and that is still the expectation, as mentioned in my comments that we do expect results for the balance of the year to improve beyond our Q1 results.
And that's really reflective of some of the gross margin expansion effort. It's that we have going on there go and actually really well, we alluded to our brand's performance. Margins in our brands continue to do very well.
And as that business continues to grow, particularly in today's environment, we talked about the budget conscious consumer and that continues to connect with them. And so the growth in that business helped helps drive margins. And we expect to see that as the year goes on.
Fresh is another category where we've had a meaningful growth. Fresh is doing really well. We've talked a lot about produced by end to end fresh and how that business is growing.
And certainly that comes with higher margins, which has it positive effect on our mix. And then when you look at alternative profits, in particular, retail media, that business continues to grow well and especially the second half of the year, we expect retail media that continuous momentum to achieve our growth is in excess of 20% for the year.
A lot going on in that space and we went to a new platform a year ago. And as we when we ramped up the platform a year ago will be cycling that period of time with some of the momentum we have in that business. So all of those are what are a lot of our confidence comes from the we talked about we are reaffirming our guidance for the year, and we alluded to some of the pharmacy headwinds to even though we expect some of those to carry over into the second quarter.
I think all of the results that we're seeing from our margin expansion efforts are going to continue to drive us so that we hit our expectations to improve the results relative to Q1.

William McMullen

I would just add a couple of points on Todd's Last point, we continue to have good success with value add product. And typically that project is something that the customer can eat almost immediately in the car at home, and that's helping on margin and then our sourcing teams continue to have making progress in cost of goods, which helps as well.

Rupesh Parikh

Great, maybe just one quick follow-up question. In light of some of the competitor announced reducing pricing on certain items. Just wondering how you guys feel about your price gaps today?

Todd Foley

If you look at overall, as you know, for the last, I don't know, 15, 18 years part of the Kroger's strategy has always been to invest in pricing every year in 2024 wouldn't have been any different than any of the previous years, and we continue to execute against that plan helping the customer stretch their budget.
If you look at where we feel on our relative price position, we feel very good. And one of the things that we had, even though I was glad to see is if you look at the customer that's on a budget, for the first time in over a year, we actually had growth in count from that customer base.
So we overall we feel good about where we are. one of the things I always think it's important to remember too, is a promotional merchant. People buy a lot more when things and promotion we also have a very sophisticated rewards program and that for personalized offers that publicly you wouldn't see and also our fuel rewards.
So overall, we feel good about where we are and we feel good about where we are relative to any of our competitors. Thanks, Rupesh

Rupesh Parikh

Great, thank you. I'll pass it along.

Operator

Robby Ohmes, Bank of America Merrill Lynch.

Robby Ohmes

Hey, Rodney. I had an adjusted two follow ups on them in the first question, I'm just in terms of the on price investments, and I know you guys always do we'll do them.
But has anything changed with that? What is your CPG partners are doing with Kroger to, you know, to drive volumes high because we know that they're looking to do that? And then also would love to just get further perspective on what progress you're seeing competitively, either the same or different sort of theirs kind of Wal-Mart and target the what are the regionals and independents doing competitively? Are they changing at all what they're doing?

William McMullen

If you look at CPG partners overall, we would be seeing more trade dollars than in the past. And I think some of that ties to the comment I made before on sourcing the oil-based economies, always sale short statements are correct.
We there are some CPG partners that are worried as much about tonnage and wouldn't be as aggressive. But we are seeing an increased trend where CPG most CPG partners are starting to focus on tonnage again and then trying to partner with us more aggressively to help Kroger.
If you look at it on a regional competitors really wouldn't see much difference there than the national competitor. And overall inflation is up slightly with the people raising and slightly more prices and lowering, but nothing that especially different there than what we would see. And as you know, there's a ton of great often regional competitors out there. Thanks, Robby.

Operator

Simeon Gutman, Morgan Stanley.

Hi, this is Zack on for Simeon. Thanks for taking our questions. First, with respect to the Q1 performance would say that you set up the guidance with some conservatism or was it genuinely stronger than what you thought it would look like?
And maybe as a follow up, why should we extrapolate that level of upside for the full year and was driven primarily by price or units or some of both? Thank you.

William McMullen

If you look into the first quarter performance, as Todd and I both mentioned, we felt very good about where we were finished or were turned out. What are the things? I always think it's them in the first quarter. So early in the year, I never feel it would be unusual for us to feel comfortable changing too much.
If you look at the things that we felt good about are the things that we've outlined in the prepared comments around our or our customer count growth, the growth that's a broad based across all of our customer type, our store teams doing a very good job of continuing to improve the experience and in-stock positions in all those things up.
A couple of headwinds that we do have is if you look at like incentive plans, especially in the second quarter, will have significantly higher incentive plan accruals in the second quarter than what we did it a year ago, which is partially what's affecting the second quarter.
But overall for the year, we feel good about where we are. We feel good about where we are relative to where we thought we would be easy. But it's really too early in the year to make too many changes.

Todd Foley

As you're kind of running actually to put together, the strength we saw in the first half of that business is really tied year incentive plan comment.
A big contributor to the strength we're seeing in our grocery business is shopping experience and improvement in those metrics is an important part of our incentive plan this year. So it's those two thoughts are on connected with one another.

William McMullen

Thanks, Zach.

Operator

Ken Goldman, JPMorgan.

Ken Goldman

Hi, thank you. I just wanted to clarify, are you still on track to see inflation increase as the year progresses. I think that was mentioned last quarter. I didn't hear any update on that rate of change and then I don't think you provided again; I may have missed it gross profit dollars are pennies per gallon for fuel. Just trying to follow up on those to.

William McMullen

Yeah, relative I'll let Todd to answer the second part. On inflation for the year, the first quarter was pretty much where we expected to be where we for the year, it's pretty consistent with where we thought it would be.
So if I am going off memory, but I think we said was slightly over 1% and we will continue to see it slightly over 1%. If you look at some of them commodity cost, the commodities themselves, obviously that will bounce up and down.
And as you get later in the year, we that some of that balance will be driven by what kind of crop year is that relative to corn and some of those things. But really overall, what we expect inflation to be similar to renewables did last year, and that is starting to stabilize.
We don't see deflation broad-based at all, but it is stabilizing around that well, over 1%.

Todd Foley

Yeah, that's great. And on the fuel point, we did in my comments that we did see that the cents per gallon margin was down low single digits.

Ken Goldman

Okay. Thanks, Todd.

Operator

John Heinbockel, Guggenheim Partners.

John Heinbockel

Hey, Rodney. I want to start with some when you think about delivery and pickup from profitability. I mean, I know you're losing in those areas. Do you have an idea in mind when you can begin to approach breakeven? I know it's going to take a while, but the thought on that and then if you had to pick a couple of key drivers, right, that would get you there. What do you think they are?

William McMullen

Yeah. If you look and John, we've talked about it a lot of times. I would say our job one is to make sure we don't lose the customer. And job two is we have the responsibility to figure out how to be profitable with each of those customers.
We do have some divisions that are now at breakeven or slightly profitable. And if you look at incrementally on a per order basis of certain almost all of our channels now there incrementally they're contributing in terms of our expectation of ourselves is that that customer will be just as profitable as the store customer over time.
I don't know that I wouldn't put a specific date on it yet, but that is the expectations we have for ourselves and the key thing, but it will be continuing -- for me, I think number one is making sure the [S4] stays strong because that's what causes that customer to continue to repeat them, making sure that each basket we started getting where the customer adds items with in a basket and then all ways from an operating cost standpoint, we'll continue to use our technology to be more efficient.

John Heinbockel

Okay. Maybe to follow up on pharmacy. So what's your sense that the pressures coming from, where is it solely reimbursement or something else? I mean, what's your take on reimbursement longer-term? And are we basically going to see less capacity right now and drugstores rider closing a lot of locations, but do you think between that supermarkets getting out of the business that will be a lot less capacity in pharmacy three or four or five years from now that will help profitability?

Todd Foley

John, I'll talk to that a little bit. What we're seeing there was really a couple of items and product mix. One was around [CLP-1]. We've talked about that before. It's a high retail lending, but at an extremely low margin and so that puts pressure on our margins.
And coming into the year. If you recall, the latter part of last year, we had supply constraints on [CLP-1] and so, some of those restrict restraints were relieved in the first quarter.
And frankly, our team did a really nice job with suppliers getting out there to get product to meet demand in our stores. And so our sales exceeded what we expect to see in the first quarter that put a little bit of that unexpected pressure on margins.
And then the second, there's another category of drugs as well. We saw some regulatory restrictions that were unexpected that drove up the costs on those meds and put some pressure on margins. So when we talked about some unexpected trends and pharmacy was really around product mix in those couple of areas and wanted to make sure we called it out because we do see that carrying over into the second part of the year wasn't necessarily reimbursement.

William McMullen

And then we look longer term three or five years, we definitely think there will be less capacity. And as you noted, there's a significant number of closures by the other three players in that space. And there's a lot of work that's being done from a governmental standpoint around PBMs.
That thing that I get super excited about our pharmacies and our health and wellness team, they continue to do a great job of improving the experience. And I think it's amazing that a third of our customers don't even realize we have a pharmacy.
We're obviously working incredibly hard to make sure that third of our customers that don't even realize we have a customer that we have a pharmacy to get them to convert the patient of our pharmacy because our team do an amazing job on service. We have incredibly quick lines and things like that. And it's one less trip that somebody estimate.
Thanks, John, for the question.

Operator

Michael Lasser, UBS.

Michael Lasser

Good morning. Thank you so much for taking my question. [Rodney], with a clean some of the comments from other concrete before between some of the comments from other food retailers as well as your own discussion around increased price investments, there is perception that that industry is becoming more competitive that is going to disrupt the profitability of the food retail in the back half of the year.
So could you compare where the overall promotional intensity that you're witnessing is today versus where it's been in the past, especially around disruptive time? And how much did you were pricing segments contribute to the improvement that you saw in more price sensitive customers, lower income consumers in the quarter?

William McMullen

In terms of overall, I would say in terms of promotional activity, looks very similar to pre-COVID and for the first time in finally, US starts looking and feeling more linked pre-COVID times. As I mentioned a second ago, overall, we saw more prices go up and go down.
So when you look at the individual number of SKUs, I feel really good about where we are able either to you taking care of customers. In terms of the value customer, I think a lot of it is driven more from some of the things that we've done relative to our new brand in terms of smart way, helping that customer understand that they can come and shop with us.
And it's you don't have to compromise relative fresh and quality and some of those other aspects and experience if they come experience or associate experience that they give.
So when you look at overall, it's pretty consistent with what we thought it would be and a part of it. I think it's just the moderating inflation, but we still continue to expect a little bit of inflation.

Michael Lasser

My follow-up question is the progress financial formula works very well. When it's ID sales are above 3%. When is a realistic expectation that it could resume as seeing ID sales back at that level?

Todd Foley

I think you're right, our model is to drive 2% to 4% ID sales. And as you looked at, we've talked a lot of last quarter around the dynamic inflation. And what we saw last year with, though with the rapid disinflation throughout the year, as we get back to this year, that more normal inflation environment that Rodney alluded to and we start cycling those heavy disinflation.
We talk about the getting towards the high end of our guidance range relative to sales come from the second half of the year. And I think that starts to get us back into that range that are long long-term model is based on the 2% to 4%.

William McMullen

And to add thing, that's a great question. It's hard to give a specific date other than I can assure you that our team is working really hard to get. There were also and this is something I would say we I've always done, but you always trying to get better.
And if you look at capital investments, we would also be using capital investments to support that growth. And as you know, we're starting to increase the number of stores that were opening in the maturity of those stores and remodel those stores also help with identical over time.
And we would expect that the obviously being the case now. And as Todd mentioned, it's early in the slightly higher capital spending for new stores and expansions and stuff, but we're pleased with the early results. Thanks, Michael.

Operator

Michael Montanim, Evercore.

Michael Montani

Hey, thanks for taking the question. I wanted to ask if you could discuss the ID sales cadence through the quarter and then the month of June, how should we think about ID sales for 2Q? And then I had a follow-up.

Todd Foley

The first quarter was a little choppy because we had a had a Easter mismatch relative to the calendar. But the general trend throughout the quarter was that we saw IDs increase steadily as we went through the quarter on average. And then as we look to Q2 to date, so far, we're right on plan relative to our expectations for Q2, Q2 results and the guidance that we've given.

William McMullen

And as you know, we that we do expect ideas to improve throughout the year and we continued so far. We're continuing to see that and would expect that to continue.

Michael Montani

Yeah, that's helpful. If I could just wanted to trying to better get their arms around some of the pharmacy pressures. Is there anything that you could point to in the back half of the year, whether it be comparison based or otherwise that help to alleviate some of those pressures or perhaps other sources of profit, whether it be media fuel that could offset somewhat?

William McMullen

I'll make a couple of governance and Todd feel free to add. one of the things that you get to the third quarter and early in the fourth quarter is vaccines. And as you know, last year, our teams did an amazing job of increasing the number of vaccines we gave, and we have a ton to learn things that we think we'll be able to do that again this year.
And so when you look at just the pharmacy business, part of that will be that and also on some of the supply issues, we would hope that you expect for those to get more normalized. And like the one drug, Todd was talking about the generics as they come out and stuff historically, that's always improved profitability.
We would expect at some point in the later part of the year for the things that happen relative to the other pieces, title --

Todd Foley

You're right, I was rather than us our pharmacy route into. So overall, the business I alluded to earlier, the margin expansion efforts that we're seeing and those are all factored into the guidance for the rest of the year.
And even given those pharmacy headwinds, we expect the pharmacy or the of the margin expansion, the gross margin expansion initiatives that we have, some blended with the pharmacy headwinds that we call it out our home should enable us to achieve gross profit results beyond what we saw in the first quarter.

William McMullen

Thanks, Michael.

Operator

Ed Kelly, Wells Fargo.

Ed Kelly

Hi, good morning, everyone. I wanted just to have two question. The first question I had is just around them morning. It's just around the second quarter guidance. So Q1, you beat on lower fuel margins and lower pharmacy, in Q2 the guidance is coming down. Is that just solely based on pharmacy and incentive comp? Is there something else happening within here? And I'm just trying to figure out in at a level of conservatism that, you know, is sitting in there in the second quarter guidance, given what you just did in Q2 against all this.

Todd Foley

Yeah. you're right. And it is primarily based on pharmacy and [Senate]. You are correct from a fuel perspective, that steps of volatile, it's really week-to-week. It's part of what we keep our keep our eye on as we go forward come so far, it has been closer to our expectations for the quarter, but that's one that we truly monitor daily and weekly to understand the impact seven business.

Ed Kelly

I guess a quick follow-up is just on leverage. You continue to reiterate your leverage target. You are well below that at this point it taking a step back. Are there any advantages that you see into the business running?
or the target long term on this metric that you think you would reassess post the Albertsons precision. Just curious as to how you're thinking about that.

Todd Foley

I think long term, our target to 2.3 to 2.5 or in the right place at that, that is one of our key objectives is to maintain our investment-grade rating. And over time, it's proven that that that is the range that enables us to be able to do that.
So I think we've long term continue to look to operate within that, that range of with or without the merger, frankly. And the beauty is where we're at here, you're right, we do have a lot of capacity there. Obviously, we're firmly focused on closing the merger and being able to use that capacity relative to the merger and come up the other end.
But I think in any scenario the capital allocation approach to take over time, we've got a long track record on what that is and how we do it. And I would expect us to execute under that framework of on a go-forward basis.

William McMullen

We really view our lowest cost of capital is it's BBB rating. And if you look at it historically, it's like 80% of the time that would be the lowest cost to capital. And as you look at the markets going forward, we don't see anything that would cause that to change. So that gives you the financial flexibility to do things like merging with Albertsons.
So it creates the lowest cost of capital. And the reason we always reiterate that 2.3 to 2.5 is that really is the point that we believe creates a solid BBB rating. And the thing that the Todd and I both mentioned, the business continues to be incredibly strong from a free cash flow standpoint and the anticipation going forward.
So it gives us the opportunity to continue to invest in the business, continue to grow the business and we can't wait to be able to merge with Albertsons. So we can do that even a still a little bit bigger.
So thanks, Ed, for the questions.

Operator

Kelly Bania, BMO.

Kelly Bania

Hi, good morning. This is Kelly Bania from BMO. I'm going to ask about the volume and the [tonnage] outlook. I think you mentioned some positive momentum at the consumer and maybe an increasing customer count there. But how are volumes and tonnage trending year-over-year with in your different of customer cohorts? And how is that impacting your outlook for the full year in terms of [tonnage] and volume overall?

William McMullen

If you look to tighten up the tonnage trends are all trends. I think if there's any exception to this, they're all in the right direction and they're improving.
If you look at historically, part of that, we believe is because of the moderating inflation. Part of it is because of doing a better job on in-stock and the customer experience and connecting better with each customer segment.
So we feel good about those trends for multiple reasons. Was there a follow-up question or?

Kelly Bania

Yeah. Thank you. I just wanted to ask maybe another question on the promotional and the competitive environment. It sounds like you characterize it may be back to normal. I guess what's different today about Kroger's kind of gross margin profile being more stable?
And it sounds like maybe up a little bit in the next couple of quarters here relative to a few years ago. How much of that just rest on the alternative profit and the magnitude of that and the growth continues growth there versus anything different that you see in the gross margin for the kind of the core business?

Todd Foley

Yeah, Kelly, I think as you can on part of it, I don't think it's just alternative products. And I think we have today have more levers maybe than we've had in the past to be able to drive that value through margin expansion. So it's alternative profit in retail media. It's what our merchants to.
We've already talked a little bit today about our brands and revise our brand strength and our margin expansion there. And same with fresh. I think it's all of those areas. I think it's also things that we continue to do with process improvement, whether it's in supply chain, whether it's continuing to drive down shrank, et cetera, et cetera.
So I think it's the variety of margin improvement initiatives that we have is what's a little different than maybe what we saw several years ago because we have various stores, the value that help fund those investments in our customers in our associates.

William McMullen

Yeah, if you look at some of the things that's in margin like warehouse and transportation costs, our teams are making good progress there, reducing the number of empty miles ticking and managing more of the transportation.
So there's a lot one of the things that, you know, we've done a ton of work over the last 5 or 10 years on diversifying our business model and how we create value. And part of it is the traffic that our base business creates being able to monetize that in ways that the customer actually views and finds value. Thanks, Kelly.

Operator

Krisztina Katai, Deutsche Bank.

Krisztina Katai

Hi, good morning. Thanks for taking the question. And I wanted to ask about the store execution plan that you implemented with the daily scoring system really addressing some of the underperforming stores relative to the chain average.
So what has been the biggest opportunity for some of the store level improvements or So seeing? How much are they contributing to the traffic gains that you are also seeing? And just help us to think about further upside with close to budget conscious customers, but also the mainstream and premium customers?

William McMullen

When you look at upside. And I think we are all team feels incredibly good if you thought things that we can get better at, and it's things that matter to our associates and matter to our customers. So we're incredibly excited about the continued opportunity we have on getting better.
On the same your execution. And obviously, they always say reach studied. Retail is detail, and it literally is working with every single store. As we mentioned in prepared remarks, I'll turn it over, continue to improve when turnover is lower, when retention better, it helps on the experience that helps on the execution in the store, on in-stocks and other things.
Our teams are doing a very good job on fresh, and that's everything from our supply chain to our folks. But our ordering product to using AI to make sure the right stores, get the right price product to the stores, getting that out on the shelf and helping the customer have a couple more days of freshness at home.
So it's really all of those things together that we think that's what's driving the increase in traffic and increase in connection with our customer service. Obviously, super. I'm proud of the whole team and excited about the opportunities what's in front of us.

Krisztina Katai

Great. And just a quick follow-up on (Inaudible), but just on the promo backdrop, just how should we think about your promotional basket? How much of that is proactive versus reactive that you are doing in the current environment?
And I think you said that it's pretty much back to pre-COVID levels. Is it fair to assume that your vendor funding is also in line with pre-COVID levels? Or do you anticipate that to continue to ramp as your vendors are focusing on driving volumes? Thank you.

Todd Foley

Yeah, if you look at vendor funding, we would expect it to continue to increase because the CPGs are trying to move tonnage. If you look at overall, we would think feel like it's pretty much back to pre-COVID, but at a higher level, some CPGs and improve increase their margins without, so them it's just making flat up or profit.
So we think they actually have room to even further invest in trade dollars.

William McMullen

To your comment on reactive versus proactive, only put our plan together for the year and our guidance for the whole nine yards, we put together our pricing strategy for the year, and we're executing on the strategy that we've put in place.
And we think clearly customers are responding to that very favorably. We're not deviating from the plan that we have that we've put into place. We're executing our playbook. Todd mentioned it earlier. That's what we've done for 15 or 20 years. We've stuck to our playbook and we think that's what's resonating with our customers.
There isn't done good things that are going on out there than I would say that's causing us to be reactive. You always pay attention and I spend as much time getting to the competitors' stores as they do our own stores.
But when I look at overall, we're running our plan and we're using our data and insights to make sure that we're taking care of our customers and associates. So really good about where we are overall and that. So thanks for the questions.

Operator

Chuck Cerankosky, Northcoast Research.

Chuck Cerankosky

Good morning, everyone. I was cut off for a while, but it sounds like you said, Rodney, that your delivery sales doubled year over year in the first quarter. What's driving that?
Is it just your execution on the customer demand and when you look at customer demand for delivered growth countries, how does it break down between budget conscious customers and more affluent customers?

William McMullen

It looked like they are sorry that you got cut off, but the delivery business almost doubled year on year, it's segments. But I think one of the things that's important to remember is that our technology allows us to do a better job now accepting SNAP and some of those things than what it did a year ago.
So it's really across all come customers. I think the thing that's driving it is our teams are doing a nice job on making sure the experience is good. I can tell you in Florida, he will get ice cream that's still frozen and chocolate. That's not melted because of our delivery because of the delivery trucks in it.
It's really it's one of those things were all of the things you feel good about. We still have a lot of work to make sure that we're satisfied with the profitability .

Chuck Cerankosky

Are there any CPG promotions or money is made available to help to get that customer to make the first delivery order?

William McMullen

Yes, the short answer is yes. And there, as you know, on line with our data and personalization, there's all kinds of things that you're learning in terms of different customers, find it attractive at different times.
So this is the short answer is absolutely yes. The other thing is obviously online really supports the alternative profit businesses as well from the from the media standpoint.
Thanks, John.

Chuck Cerankosky

Thanks, Rodney. Good luck for the rest of the year.

William McMullen

Thank you. Appreciate it.

Operator

The question-and-answer session is now finished. I will hand the call over to Rodney for any final remarks.

William McMullen

Thank you for all the questions. As always, as you know, I always like to share a few comments with our associates listening in today, I'd like to take a moment to celebrate our Alex Spurlock is a Store Leader at QFC store, #860 of Redmond, Washington and recently was named the 2024 Food Industry Association Store leader of the Year.
Obviously, this is a huge honor and we are so impressed by the amazing words that Alex does at our store. With more than a decade and the grocery business colleagues understand the industry. She has a gentle spirit and a [fierce] attention to detail that clearly earned her this recognition.
What's most impressive is Alex's passion for our associates. She has always ready for Kroger team and celebrate their success in meaningful ways. Thank you, and congratulations, Alex, for everything you do for our customers. Your fellow associates and congratulations on this amazing honour and thank you to all of our teams for all the work they do every day to take care of each other and our associates, and thank you for everyone for joining us today.

Operator

That does concludes today's conference call. Have a nice day. You may now disconnect your lines.