Cash Flow and Liquidity In the Absence of Easy Money Steven C. Isberg, Ph.D Senior Fellow, Credit Research Foundation Associate Professor of Finance, Merrick School of Business, University of Baltimore Presented to the National Chemical Credit Group Ft. Lauderdale, Florida February 2018
Recent Stock Market Behavior DJIA Feb 2017-2018 Feb-17 Peak: Feb-2018 Fri Feb 16 20,172 26,616 25,219 31.95% -5.25% Net growth 25.02% Impact of Tax Cut Pre tax income $10 $10 Tax rate 35% 21% Net income $ 6.50 $ 7.90 Payout ratio 50% 50% Risk Free rate 2.10% 2.10% Beta 1.00 1.00 Cost of Equity 9.100% 9.100% Growth 2.00% 2.00% Price $ 45.77 $ 55.63 Net change 21.54% Price = Dividend / (k - g) Cost of Equity = k = Risk free + (Beta * 7.00%)
The Cash Flow Statement • Cash Flow from Operations (Income statement plus changes in current assets and liabilities) • Net income • Add non-cash expenses such as depreciation • Adjust for changes in current assets (e.g., AR) • Adjust for changes in current liabilities (e.g., AP) • Cash Flow from Investing (changes in Long Term Assets) • Capital spending • Mergers, acquisitions, spin-offs, asset sales • Cash Flow from Financing (Changes in long term liabilities and equity) • Debt borrowing/repayment • Dividend payments • Stock issue/repurchase
Kroger Cash Flow Statements: Operating Activities 12 Months Ended 12 Months Ended CONSOLIDATED STATEMENTS OF CASH FLOWS - USD ($) $ in Millions Jan. 28, 2017 Jan. 30, 2016 Jan. 31, 2015 Feb. 01, 2014 Feb. 02, 2013 Jan. 28, 2012 Cash Flows from Operating Activities: ' ' ' Net earnings including noncontrolling interests $ 1,957 $ 2,049 $ 1,747 $ 1,531 $ 1,508 $ 596 Adjustments to reconcile net earnings including noncontrolling interests to net cash provided by operating activities: ' ' ' Depreciation and amortization $2,340 $2,089 $1,948 $1,703 $1,652 $1,638 Asset impairment charge $26 $46 $37 $39 $18 $37 LIFO charge $19 $28 $147 $52 $55 $216 Stock-based employee compensation $141 $165 $155 $107 $82 $81 Expense for Company-sponsored pension plans $94 $103 $55 $74 $89 $70 Deferred income taxes $201 $317 $73 $72 $176 $31 Other -$28 $54 $72 $47 $23 $3 Changes in operating assets and liabilities net of effects from mergers of businesses: ' ' ' Store deposits in-transit $13 $95 -$27 $25 -$169 -$120 Receivables -$110 -$59 -$141 -$8 -$126 -$63 Inventories -$382 -$184 -$147 -$131 -$78 -$361 Prepaid and other current assets -$172 -$28 $2 -$49 -$257 $52 Trade accounts payable $16 $440 $135 $3 $67 $83 Accrued expenses -$118 $275 $249 $77 $67 $215 Income taxes receivable and payable $261 -$359 -$68 -$47 $164 -$106 Contribution to Company-sponsored pension plans -$5 -$100 -$71 -$52 Other $14 -$109 -$22 -$15 -$367 $338 Net cash provided by operating activities $4,272 $4,917 $4,215 $3,380 $2,833 $2,658
Kroger Cash Flow Statements: Investing and Financing Cash Flows from Investing Activities: ' ' ' Payments for property and equipment, including payments for lease buyouts -$3,699 -$3,349 -$2,831 -$2,330 -$2,062 -$1,898 Proceeds from sale of assets $132 $45 $37 $24 $49 $51 Payments for mergers -$401 -$168 -$252 -$2,344 -$122 -$51 Other $93 -$98 -$14 -$121 -$48 -$10 Net cash used by investing activities -$3,875 -$3,570 -$3,060 -$4,771 -$2,183 -$1,908 Cash Flows from Financing Activities: ' ' ' Proceeds from issuance of long-term debt $2,781 $1,181 $576 $3,548 $863 $453 Payments on long-term debt -$1,355 -$1,245 -$375 -$1,060 -$1,445 -$547 Net borrowings (payments) on commercial paper $435 -$285 $25 -$395 $1,275 $370 Dividends paid -$429 -$385 -$338 -$319 -$267 -$257 Excess tax benefits on stock-based awards $97 $52 Proceeds from issuance of capital stock $68 $120 $110 $196 $110 $118 Treasury stock purchases -$1,766 -$703 -$1,283 -$609 -$1,261 -$1,547 Investment in the remaining equity of a noncontrolling interest -$26 Other -$86 -$92 -$55 $193 $125 $23 Net cash used by financing activities -$352 -$1,338 -$1,288 $1,554 -$600 -$1,387 Net increase (decrease) in cash and temporary cash investments $45 $9 -$133 $163 $50 -$637 Cash and temporary cash investments: ' ' ' Beginning of year $277 $268 $401 $238 $188 $825 End of year $322 $277 $268 $401 $238 $188
Kroger Future Debt Obligations Kroger Debt Structure Expected Year of Maturity 2017 2018 2019 2020 2021 Thereafter Total (in millions) Debt Fixed rate ($MM) $ (716) $ (1,298) $ (1,246) $ (699) $ (797) $ (6,955) $ (11,711) Average interest rate (%) 4.94 4.54 4.68 4.62 4.63 4.57 Variable rate ($MM) $ (1,481) $ (17) $ - $ (25) $ - $ (81) $ (1,604) Average interest rate (%) 0.93 3.53 0.00 5.00 0.00 3.73 $ (2,197) $ (1,315) $ (1,246) $ (724) $ (797) $ (7,036) $ (13,315)
9 Months Ended CONSOLIDATED STATEMENTS OF CASH FLOWS - USD ($) $ in Millions Nov. 04, 2017 Nov. 05, 2016 Cash Flows from Operating Activities: Net earnings including noncontrolling interests $ 1,036 $ 1,455 Adjustments to reconcile net earnings including noncontrolling interests to net cash provided by operating activities: Depreciation and amortization 1,871 1,768 LIFO charge 46 19 Stock-based employee compensation 118 110 Expense for Company-sponsored pension plans 68 62 Deferred income taxes 267 5 Other 5 (27) Changes in operating assets and liabilities net of effects from mergers of businesses: Store deposits in-transit (268) (120) Receivables 45 48 Inventories (466) (798) Prepaid and other current assets 426 219 Trade accounts payable 620 509 Accrued expenses 26 (144) Income taxes receivable and payable 143 267 Contribution to Company-sponsored pension plans (1,000) Other 117 83 Net cash provided by operating activities 3,054 3,456
9 Months Ended CONSOLIDATED STATEMENTS OF CASH FLOWS - USD ($) $ in Millions Nov. 04, 2017 Nov. 05, 2016 Cash Flows from Investing Activities: Payments for property and equipment, including payments for lease buyouts (2,137) (3,025) Proceeds from sale of assets 120 114 Payments for acquisitions, net of cash acquired (16) (401) Other (2) 39 Net cash used by investing activities (2,035) (3,273) Cash Flows from Financing Activities: Proceeds from issuance of long-term debt 1,503 1,785 Payments on long-term debt (769) (1,332) Net borrowings (payments) on commercial paper (45) 1,200 Dividends paid (333) (316) Proceeds from issuance of capital stock 31 51 Treasury stock purchases (1,292) (1,401) Other (84) (73) Net cash used by financing activities (989) (86) Net increase in cash and temporary cash investments 30 97 Cash and temporary cash investments: Beginning of year 322 277 End of year 352 374
Component cost of debt: Financial Statement Breakdown method 28-Jan-17 Kroger Debt Structure Expected Year of Maturity Fair value 2017 2018 2019 2020 2021 Thereafter Total Fair value adjustment (in millions) Debt Fixed rate ($MM) $ (716) $ (1,298) $ (1,246) $ (699) $ (797) $ (6,955) $ (11,711) $ (12,301) $ (590) Average interest rate (%) 4.94 4.54 4.68 4.62 4.63 4.57 Variable rate ($MM) $ (1,481) $ (17) $ - $ (25) $ - $ (81) $ (1,604) $ (1,604) $ - Average interest rate (%) 0.93 3.53 0.00 5.00 0.00 3.73 $ (2,197) $ (1,315) $ (1,246) $ (724) $ (797) $ (7,036) $ (13,315) Debt Fixed rate (weight) 0.0538 0.0975 0.0936 0.0525 0.0599 0.5223 Average interest rate (%) 4.94% 4.54% 4.68% 4.62% 4.63% 4.57% 4.05% Variable rate (weight) 0.1112 0.0013 0.0000 0.0019 0.0000 0.0061 Average interest rate (%) 0.93% 3.53% 0.00% 5.00% 0.00% 3.73% 0.14% Weighted Average Rate 4.19% Cost of debt: Financial Statement method Interest expense $ 522 Interest Bearing debt Current portion of LTD (average past two years) $ 2,311 Long term debt (average past two years) $ 10,767 Total Debt $ 13,078 Capital lease obligations $ 1,016 Debt net of capital lease obligations $ 12,062 Rate estimate 4.33% Fair value adjustment $ 590 Fair value debt $ 12,652 fair value adjusted interest rate estimate 4.13% Cost of Debt: Market Benchmarks Moody's Aaa 3.51% Moody's Baa 4.22% NYU Estimate 3.91%
Cost of Equity Capital Risk free Rate Six month treasury 1.66% One year treasury 1.88% Three year treasury 2.27% Five year treasury 2.51% Ten year treasury 2.73% Average 2.21% CAPM Beta (Yahoo finance) 0.43 Market premium 7.00% Cost of Equity (CAPM) 5.22% Relevered CAPM Beta: relevered Industry beta (NYU database) 0.71 Industry equity/capital 54.44% Industry debt/capital 45.56% Industry D/E 0.84 Industry unlevered beta 0.39 Kroger D/E 1.99 Kroger relevered beta 1.15 Cost of Capital (relevered) 10.29%
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