The Kroger Co. (NYSE: KR) Q3 2021 earnings call dated Dec. 02, 2021
Corporate Participants:
Rob Quast — Director of Investor Relations
W. Rodney McMullen — Chairman and Chief Executive Officer
Gary Millerchip — Senior Vice President and Chief Financial Officer
Analysts:
Robert Moskow — Credit Suisse — Analyst
Ken Goldman — JP Morgan — Analyst
Michael Kessler — Morgan Stanley — Analyst
Simeon Gutman — Morgan Stanley — Analyst
Robby Ohmes — Bank of America Global Research — Analyst
Spencer Hanus — Wolfe Research — Analyst
John Heinbockel — Guggenheim Securities — Analyst
Chuck Cerankosky — Northcoast Research — Analyst
Mark Carden — UBS — Analyst
Presentation:
Operator
Good morning, and welcome to The Kroger Co. Third Quarter 2021 Earnings Conference call. [Operator Instructions]
I would now like to turn the conference over to Rob Quast, Director of Investor Relations. Please go ahead.
Rob Quast — Director of Investor Relations
Good morning. Thank you for joining us for Kroger’s third quarter 2021 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 Co. assumes no obligation to update that information. Our press release and supplemental information regarding the quarter can be found on our website at ir.kroger.com.
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 related follow-up question, if necessary. I would also like to announce that we will be hosting a business update on March 4, 2022 in Florida, with an opportunity to tour our recently opened Kroger Delivery customer fulfillment center. We hope that you’re able to join us.
I will now turn the call over to Rodney.
W. Rodney McMullen — Chairman and Chief Executive Officer
Thank you for joining us today. We often say the holidays are our time to shine. And as we move through the holiday season, we feel great about our ability to deliver. I would like to say a huge thank you to our associates who remain engaged, energized and focused on taking care of our customers. We are incredibly proud of our third quarter results and the underlying momentum in our business. We returned to positive identical sales without fuel for the quarter. We saw triple-digit digital sales growth on a two-year year stack, and we’ve increased our full-year 2021 guidance.
Our agility and the commitment from our amazing associates is allowing us to navigate current labor and supply chain conditions and provide the freshest food at affordable prices across our seamless ecosystem. Customers are demonstrating more back-to-normal behaviors, and at the same time are eating more food at home because it’s more affordable, convenient and healthier than other options plus you can do it as a family. This was evidenced by our Thanksgiving holiday shopping behavior. Customers engaged in larger celebrations with friends and family compared to last year. We also saw them continuing to cook at home, leading up to and during the holiday and select more premium products to elevate the food experience. These are all reasons why we believe the food at home change is structural, and not temporary.
With most people consuming meals at home and grocery stores continuing to capture the majority share of stomach, it is more important than ever that we provide customers with flexibility on how they choose to shop with us. We have the right seamless ecosystem in place to meet our customers’ evolving needs. Leading into Thanksgiving, 70% of consumers said that they would be doing more of their holiday shopping in the store this year. At the same time, 84% of consumers said that they will continue to shop online the same amount or more in the future. These seemingly contradictory behaviors are exactly what Kroger’s seamless ecosystem was designed to accommodate.
We know that inflation is having an impact on customers as well. 82% of consumers polled across the country are feeling the impact of inflation. And one in four consumers are not confident in their finances right now. We are leveraging our data and personalization to enable our customers to stretch their food dollars. We deliver value when customers need it the most with personalized promotions, big packs and dynamic holiday offerings. Our brands also offer our customers flexibility within their spending without compromising, thanks to the wide variety of incredibly high quality and innovative products at various price points. And while price continues to be top of mind, customers continue to desire the freshest food options, and we’re there for them, leading with fresh.
We grew sales in natural and organics, as customers continue to gravitate toward better for you options. Our fresh departments outpaced total Company identical sales without fuel during the quarter as well. We had a record quarter in our alternative farming offerings, which includes new approaches to growing produce, including vertical and endured farm operations. These offerings expand customers’ access to produce picked at the peak of freshness. We are very proud to share that Home Chef became a $1 billion brand on an annualized basis in the third quarter, as meal time shortcuts and solutions as well as new product innovations have clearly resonated with our customers.
Kroger is focused on delivering a customer-centric seamless experience that requires zero compromise, no matter how customers choose to engage with us. We launched three new offerings during the quarter that support the plan to double digital sales and digital profitability by 2023. First, Boost by Kroger builds on our industry-leading loyalty program to deliver additional savings and personalized offers to our members. We are encouraged by the initial engagement in the program, which is ahead of internal expectations.
Second, we launched Kroger Delivery Now in partnership with Instacart. This unique convenience and immediacy offering positions us to win more trips with current customers and to bring new customers to the Kroger ecosystem by offering the largest selection of quality fresh products at affordable prices in 30 minutes. Here’s what’s so special about this offering. It was profitable on Day 1, contributing to our goal to double digital profitability by 2023 that was announced during our 2021 Investor Day.
And third, we announced a strategic collaboration with Bed Bath & Beyond and buybuy Baby that will expand our current marketplace offering and provide Kroger shoppers easy access to essential home and baby products. This exclusive offering will be available through both Kroger.com and on a small scale physical store pilot at select stores beginning in 2022.
We continue to be pleased with the rollout of our customer fulfillment centers in Groveland, Florida and Monroe, Ohio, which are exceeding internal expectations, and we are especially proud of our net promoter scores driven by our teams delivering a world-class experience for our customers, and we’re really looking forward to hosting you in Groveland early next year.
Turning now to our supply chain. We feel great about our ability to serve customer needs through the holidays and beyond. This is because our teams have done such a good job planning well ahead to maintain a full, fresh and friendly customer experience. In fact, our customers took action to prepare for today’s supply chain constraints back in the spring. And a great example of leveraging learnings from our operate — from operating during the pandemic, we kept the additional warehouses originally brought on to support business through COVID to ensure we were able to provide for customers throughout the holiday season as well. Because of our team’s agility, we are better in stock today than we were a year ago, and we were able to serve customers through the Thanksgiving holiday with items they needed for their celebrations. In fact, we increased our year-over-year pickup fill rate by over 130 basis points during the week of Thanksgiving.
We chose to incur significant costs in our supply chain during 2021 [Phonetic], which has allowed us to provide our customers today and into 2022. We continue to deploy a wide array of tools, including our own — owned and operated fleet, and we’re working closely with suppliers to mitigate pain points for the customer. We are eager to welcome thousands of new associates to our organization, as we began an incredible holiday season. Our hybrid hiring event last month contributed to the hiring of over 64,000 new associates during the quarter. We continue to invest in our associates by expanding our industry-leading benefits, including continuing education and tuition reimbursement, training and development, health and wellness and continued investments in associate wages.
As we reflect on the one-year anniversary of our Framework for Action in response to racial injustice across the country and in the communities we serve, we are pleased to share our progress with you. Over 405,000 associates have completed diversity and inclusion training. We’ve increased our strategic hiring partnerships with historically Black colleges and universities and Hispanic-serving institutions from six to 17. The Kroger Co. Foundation has awarded more than $3 million in grants to support innovative organizations focused on building more equitable and inclusive communities. And we increased Kroger’s diverse supplier spend by 21% to $4.1 billion last year alone, and remain on track toward our long-term goal to spend $10 billion annually with diverse suppliers by 2030.
While we know that there is more work to be done, we are energized and look forward to keeping our stakeholders updated on our progress. One of Kroger’s greatest strengths is our ability to manage our business successfully in every operating environment. We remain customer-obsessed and focused on operational excellence to deliver for our customers, associates, communities and shareholders.
With that, I would like to turn it over to Gary to take you through our third quarter financials. Gary?
Gary Millerchip — Senior Vice President and Chief Financial Officer
Thanks, Rodney, and good morning, everyone. As Rodney shared this morning, Kroger delivered strong results in the third quarter, highlighting the flexibility of our business model in a dynamic operating environment. Our focus on execution combined with our disciplined approach to balancing investments in our associates and customers with strong cost management and growth in our alternative profit business is positioning us well for the future. Over time, our model has proven to be resilient during different economic scenarios, and this was true again during the third quarter as we grew the top and bottom lines while navigating higher product cost inflation, a tight labor market and supply chain constraints.
Our identical sales without fuel in the quarter returned to positive, growing 3.1% as we delivered for our customers across our seamless ecosystem and customers again signaled higher food-at-home consumption is here to stay. Adjusted FIFO operating profit and adjusted EPS both increased year-over-year and grew by compounded annual growth rates of 22% and 29% respectively versus 2019.
Third quarter EPS was impacted by two unusual items that were excluded from our adjusted EPS results. First, we engaged in an annuity buyout on lump sum distribution transaction related to the Company’s consolidated retirement benefit plan, which will reduce future administrative costs. This triggered a write-off of deferred losses and the non-recurring non-cash charge of $87 million on a pre-tax basis. This Company pension plan is currently 100% funded as a result of previous action taken to freeze the plan and protect benefits for our associates. This transaction was fully funded by assets in the plan. The second unusual item was Kroger recording a non-recurring benefit of $47 million, or $0.07 per diluted share, primarily due to the favorable outcome of income tax audit examinations covering multiple years. This amount is also excluded from the Company’s adjusted net earnings per diluted share result for the third quarter.
I’ll now provide more detail on our operating results in the quarter. On a two-year stack basis, our identical sales without fuel increased 14%. We also saw digital sales increase 103% on a two-year stack. As we have previously shared, we do not expect digital growth to be linear, especially as we cycle last year’s sales spike and customers become more comfortable shopping in store again. The launch of several new digital offerings, which Rodney outlined earlier in addition to the rollout of new customer fulfillment centers, gives us confidence in our ability to deliver against our growth targets for digital sales and profitability. We look forward to sharing more detail on our digital roadmap at the business update in March that Rod noted earlier on the call. With regard to digital profitability, we continued to make progress during the quarter and achieved our best cost to serve on record for pick-up orders.
Gross margin was 21.66% of sales for the third quarter. The FIFO gross margin rate, excluding fuel, decreased 41 basis points compared to the same period last year. This decrease primarily related to higher supply chain costs and continued price investments, partially offset by sourcing benefits. Our investment was in line with expectations and fully funded by cost savings and OG&A improvement. Recognizing recent inflation trends and our outlook for the rest of the year, we recorded a higher LIFO charge for the quarter of $93 million compared to $23 million in the prior year. This increase represents a $0.07 headwind to EPS in the quarter versus 2020.
The operating, general and administrative rate decreased 49 basis points, excluding fuel and adjustment items. This improvement was achieved even with continued investments in our associates and growth in our average hourly rates and reflects the outstanding work our associates are doing to execute cost saving initiatives in a very dynamic environment. We remain on track to deliver $1 billion of cost savings during 2021.
Our alternative profit business had a record third quarter, and remains on track to deliver the high-end of our expected range of $100 million to $150 million of incremental operating profit in 2021.
We saw increased strength in Kroger Personal Finance results during the quarter. And Kroger Precision Marketing introduced a new programmatic advertising marketplace to unleash first-party targeting and measurement capabilities, further highlighting our ability to differentiate in the advertising space. Fuel is also an important part of our overall value proposition and a key offering to help customers stretch their dollars, especially in times when fuel prices are high. During the quarter, we saw a significant increase in the number of customers actively engaging in our fuel program. Gallons grew in the third quarter by 5%, outpacing market growth. The average retail price of fuel was $3.24 this quarter versus $2.15 in the same quarter last year. Our cents per gallon fuel margin was $0.42, compared to $0.37 in the same quarter in 2020.
I’d now like to spend a couple of minutes providing some additional perspective on how we are proactively managing inflation. We are currently operating in a more volatile inflationary environment. And during the third quarter, Kroger saw higher product cost inflation in most categories. We are being disciplined in managing these increases. Our teams are doing an excellent job working to minimize the effect on our customers and our financial model by using our data and working closely with our suppliers. We are passing along higher cost to the customer, where it makes sense to do so. In some key areas, we are choosing not to pass through cost increases and continuing to invest in value for the customer. We are investing where it matters most using our proprietary data to be strategic in our pricing and personalization with the objective of winning long-term customer loyalty. We also believe our brands is an important — is an even more important differentiator for Kroger in an inflationary environment, offering customers an unmatched combination, a great value and great quality.
Turning now to our financial strategy. Kroger is operating from a position of strength and continues to generate strong free cash flow, as evidenced by our net debt to EBITDA ratio hitting an all-time low of 1.68 in the third quarter. While we continue to see attractive opportunities to invest in the business to widen our competitive moats and drive sustainable revenue and earnings growth, our capital expenditures in 2021 are now expected to be below our original guidance range of $3.4 billion to $3.6 billion. This is because of delays in project implementations, primarily due to COVID-19-related supply challenges.
Kroger continues to return cash to shareholders. During the quarter, we repurchased $297 million of shares and year-to-date have repurchased $1 billion of shares. Since 2000, we have now returned more than $20 billion to shareholders via share repurchases at an average price of $16.45 per share. As of the end of the third quarter, $511 million remains outstanding under the current Board authorization announced on June 17, 2021. We look forward to sharing more about our plans for future deployment of excess cash to drive sustainable growth and create value for our shareholders at our business update in March.
As Rodney mentioned, we continue to invest meaningfully in our associates. In addition to the $350 million of hourly rate investment already planned this year, we’re committed to further investments in the fourth quarter, which equates to an incremental $100 million on an annualized basis. During the third quarter, we ratified new labor agreements with the UFCW for associates in our Columbus and Mid-Atlantic divisions, covering over 4,500 associates. We continue to negotiate contracts with the UFCW for store associates in Houston, Lake Charles, Shreveport, Dallas Meet, Little Rock, Memphis, Portland and Denver.
Our financial results are pressured by inefficiencies in healthcare and pension costs, which most of our competitors do not face. We continue to communicate with our local and international unions, which represent many of our associates about the importance of growing our business in a profitable way, which will help us create more jobs and career opportunities and enhance job security for our associates.
I’ll now turn to our expectations for the remainder of 2021. Driven by the momentum in our third quarter results and sustained trends in food at home, we are raising our full year guidance. We now expect identical sales without fuel for the full year to be between negative 0.4% and negative 0.2% and a two-year identical sales stack of between 13.7% to 13.9%. There remain some uncertainties as we look ahead and our guidance of positive ID sales excluding fuel of between 1.5% to 2.5% in the fourth quarter reflects this.
We expect adjusted net earnings per diluted share to be in the range of $3.40 to $3.50. We expect our adjusted FIFO operating profit to be in the range of $4.1 billion to $4.2 billion, reflecting a two-year compounded annual growth rate of between 17% and 18.4%. The midpoint of our adjusted EPS range for 2021 now equates to full year results approximately in line with our 2020 results, despite cycling the unique COVID-19-related demand spike last year.
Our guidance fully reflects the investments in our customers and associates I shared earlier, plus increased marketing to support the exciting new digital initiatives we launched in the third quarter. It also reflects the latest projection for LIFO, and because we recorded a LIFO credit in the fourth quarter last year, LIFO is now expected to be a $0.13 headwind to EPS in the fourth quarter.
Overall, we are very proud of our results, which are projected to be significantly ahead of where we originally guided for the year. In conclusion, Kroger is executing against this key financial and operational initiatives and continues to invest in strategic priorities that will deliver attractive and sustainable total shareholder return of 8% to 11% over time. We believe our business is emerging stronger through the pandemic and through the investments we are making is well positioned to grow beyond 2021.
I’ll now turn it back to Rodney.
W. Rodney McMullen — Chairman and Chief Executive Officer
Thanks, Gary. Kroger’s strong year-to-date results are the outcome of our customer obsession, our incredible associates who bring our vision and values to life, and our commitment to bringing fresh affordable food to everyone. The strength of our teams have never been more apparent. With every new challenge, they raised to the occasion, whether by implementing solutions to minimize supply chain disruptions, delivering the freshest produce to our customers or using our data to offer personalized promotions that surprise and delight, our team is bringing our competitive moats to life.
Now, we look forward to your questions.
Questions and Answers:
Operator
We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Robert Moskow with Credit Suisse. Please go ahead.
Robert Moskow — Credit Suisse — Analyst
Hi. Thank you for the question.
W. Rodney McMullen — Chairman and Chief Executive Officer
Good morning.
Gary Millerchip — Senior Vice President and Chief Financial Officer
Good morning.
Robert Moskow — Credit Suisse — Analyst
You’ve obviously done a very good job of passing on inflation to consumers, while shielding them at the same time. Your gross profit dollars are up now. Can you talk a little bit about what came — what drove that outperformance versus your expectations last quarter because last quarter I think you’re pretty cautious on gross margin? And then secondly, I think there is another big tranche of pricing coming in January from a lot of your vendors. How would you characterize that next tranche? Is it a — an unusually high acceleration, or is it just kind of a continued acceleration similar to what you’ve seen so far? Maybe if you could even put it in context of CPI for us, it would be helpful. Thanks.
W. Rodney McMullen — Chairman and Chief Executive Officer
Okay. Rob, I’ll start, and I’ll let Gary get into more of the details. First of all, I think it’s important to remember what’s allowing us to continue to invest in the customer and value is the great work our team is doing on cost reductions. And as Gary mentioned, we’re on track to take a $1 billion of cost out. And this is the fourth year in the row that we’ve been able to accomplish that, which really gives us the flexibility to be able to continue to invest in our customers.
The other thing that our teams have done a nice job on, if you look at our procurement team, they’ve done a nice job of identifying opportunities to save money by working with our suppliers, and we continue to aggressively work and partnership with them. If you look at inflation during the quarter, it continued to increase throughout the quarter. As of right now, it’s starting to stabilize, but obviously at a pretty high rate. So, it’s something that we aggressively use our data to understand, and we aggressively try to make sure that the customer has alternatives to be able to stretch their budget as well. And that’s — in some cases, that’s switching to a cheaper price meat; in some cases, it’s buying our brands, which has amazing quality as well.
So with that, Gary, I’ll let you get into more — some more of the details for Rob.
Gary Millerchip — Senior Vice President and Chief Financial Officer
Sure. Thanks, Rodney. Thanks for the question, Rob. Yeah, I would say, Rob, obviously when we guided at the second quarter, we said that the gross margin contraction could be similar to what we’re seeing in Q2. And I would say the dynamics that are — that are in place haven’t changed dramatically. Obviously, it’s a dynamic environment that we’re managing. And our goal, as Rodney mentioned, is to continue to find sourcing benefits and savings to offset the — the cost increases where we see them and to pass on pricing where it makes sense, but also to keep investing in the customer. And I’d say that we — in Q2, we were doing that. In Q3, we continued to do that. Supply chain would have been a similar sort of headwind in Q2 and Q3. I would say, we were successful in mitigating some of the cost increases and shrinks during the quarter, which helped during the quarter, although we still think shrink is a dynamic metric to manage based on some of the organized crime and that we see in shrink. But overall, we were pleased with the progress in shrink during the quarter.
And I think for us, we kind of guided while we never get into specific numbers on individual gross margin and OG&A metrics because as Rodney mentioned that our goal is to be dynamic in managing it, ensuring that we’re delivering sustainably for our customers and growing loyalty, while also being able to improve profitability over time by managing the different levers across selling growth rates, cost of goods savings, taking cost out of the business and continuing to grow alternative profit streams.
So I think it’s a dynamic environment we continue to manage. I think somewhere between that Q2 and Q3 range is where we think that we’re operating right now. We think Q4 would likely be similar to what we’ve seen in Q2 and Q3. And as I mentioned on my prepared comments, we are increasing some advertising in the fourth quarter to support the accelerated growth in some of those new initiatives. So I think — again, I wouldn’t be guiding to a specific number, but in the range that you’ve seen in Q2 and Q3 is where we feel comfortable in managing the business and driving the right balance of sustainable growth to shareholders, while continuing to win customer loyalty over time.
Robert Moskow — Credit Suisse — Analyst
And just a quick follow-up. I think Rodney you said that you’re seeing your inflation kind of leveling off. Are you looking at like PPI inflation there? Because I would agree with you, it seems like in the low teens, it’s leveling off. Is that what you’re looking at?
W. Rodney McMullen — Chairman and Chief Executive Officer
We would be looking at more of our own costs in terms of what we are incurring and what we see coming forward. And one of the other things that I always think it’s important to remind people, we manufacture a lot of our own products. So we also understand the raw materials themselves and what’s going on there. And we would be looking at CPI and PPI both. In terms of trying to estimate inflation, we would be looking at our actual cost increases that we’re incurring.
Robert Moskow — Credit Suisse — Analyst
Okay. Thank you very much.
W. Rodney McMullen — Chairman and Chief Executive Officer
Thanks, Rob.
Operator
The next question is from Ken Goldman with JP Morgan. Please go ahead.
Ken Goldman — JP Morgan — Analyst
Rodney, I’m glad you mentioned the fact that you make your own products. That’s a good lead into one of my questions, which is, we’re still seeing at least in the scanner data, we get some pretty poor trends on top of last year’s poor trends for store brands in general. I’m not talking about Kroger, I’m talking across the measured industry. And I’m just hoping for an update for what you’re seeing there. I know you’ve talked about this a little bit in the past, but are there any signs of improvement from that? And again, I know you’re somewhat agnostic, you’ll make money either way. But just trying to get a sense for what the outlook is, what you are seeing, any updates from your side.
W. Rodney McMullen — Chairman and Chief Executive Officer
If you look at Our Brands, if you look at the third quarter trends, they were better than the second quarter trends. And if you look within the quarter, it improved during the trends. Ken, the point you made is, for us, we want to make sure we have the products customers want. So Kroger brand item has to earn its right on the shelf just like any other brand. But for us, it’s obviously one of our competitive moats. As I mentioned in the prepared remarks and we did a press release earlier in the quarter, we are proud that Home Chef became our fourth brand that is over $1 billion a year. Our Brands for us is incredibly important on our connection with our customers because it’s an incredible great value for our customers with amazing quality. And when you look at Simple Truth and Private Selection, both of those brands offer something that’s unique in the marketplace and continue to grow aggressively. Private Selection, most of the items or things that you can’t get somewhere else, and Simple Truth just makes it super easy for a customer to eat healthy. So the trends are improving. But for us, it is an incredibly important part of our overall strategic strategy and a competitive moat.
Ken Goldman — JP Morgan — Analyst
Thank you for that. And then a quick follow-up. I think you mentioned that you’re not passing on cost increases fully in either certain categories or certain products. Is it safe to assume that like many of your peers, you’re a little more hesitant to take pricing up on items that draw people into stores on a regular basis, things like milk and bread et cetera? Or is it a little more strategic and nuanced than that? I’m just trying to get a sense for how you’re thinking about which items to take pricing up on and which not?
W. Rodney McMullen — Chairman and Chief Executive Officer
Yeah, we would be using our data and our historical data over the last several years on elasticity by category and by products within categories on deciding what to pass through or not. We would also just on certain products, it’s an opportunity to create deeper loyalty. Some of which is obvious, some of which is not. And some of the items in the past wouldn’t have the same amount of penetration across households as what they used to do. So it really is dynamic information that’s based on what’s going on right now in the market. The other thing just to — our data would also show in different parts of the country, some of those elasticities would be different.
I don’t know, Gary, anything you’d want to add to that?
Gary Millerchip — Senior Vice President and Chief Financial Officer
No, I think you covered it all.
Ken Goldman — JP Morgan — Analyst
Thanks, everyone.
W. Rodney McMullen — Chairman and Chief Executive Officer
Thanks, Ken.
Operator
The next question is from Simeon Gutman with Morgan Stanley. Please go ahead. Mr. Gutman, your line is open on our end and is muted on yours.
Michael Kessler — Morgan Stanley — Analyst
Sorry about that. This is Michael Kessler on for Simeon. Can you hear me?
W. Rodney McMullen — Chairman and Chief Executive Officer
Yes, good morning.
Michael Kessler — Morgan Stanley — Analyst
Hey, guys. Thanks for taking our question. First, I wanted to ask about any initial thoughts if you have any on 2022. Another good quarter in Q3. It looks like the full year is going to end up basically a retention, or maybe slight growth off of 2021 on earnings. So I guess any more confidence or conviction that next year could be another call it algo type of the year on both IDs and EBIT? And I guess, any puts and takes as you’re starting to think through that outlook?
W. Rodney McMullen — Chairman and Chief Executive Officer
It’s a good question, and we appreciate it. Obviously, we’ll get into a lot more detail when we get out to our March Investor Day. That’s really when we’ll go into depth. We’re in the middle of going through developing our budgets and partnering with our Board on our 2022 expectations. The only comment that I would give in depth is, as we shared in our Investor Day in 2019 and we’ve continually updated, over time, we would expect a TSR of 8% to 11% on an annualized basis made up of earnings growth and free cash flow made up — and returning cash to shareholders. So overall, we would expect that. We do feel good about the momentum in the business in terms of the connections with the customer. Our seamless business processes on identifying ways to take costs out, so we can invest some of those cost savings in our associate wages, cost savings in the customer connection and other things, so — and the business continues to generate good cash flow. And Gary, it looks like you want to say something.
Gary Millerchip — Senior Vice President and Chief Financial Officer
I think you said it well, Rodney. I would just add where you were going, I think, we’re — hopefully, we’ve been conveying very clearly, while we won’t be getting into detailed guidance for 2022 because that’s [Indecipherable] March meeting, we’ve been trying to be clearing all of that communication I think around the confidence we have in the long-term prospects of the business. So not specific to ’22, but thinking as we’re continuing to build the business from the base that we’ve established through COVID that the opportunity to grow and deliver on that TSR commitment that Rodney mentioned. And specifically, we do believe that some of the food-at-home trends that we’ve talked a lot about, we’ve said for some time and continue to believe that data shows that a number of those changes will be structural in nature, and we’ll continue to see sustained trends in food-at-home. I think if you look at our performance over the last two years, Rodney was alluding to some of the individual drivers, but I think it’s demonstrated in our mind the confidence in the value creation model, while creating the balance in our model to be able to drive sustainable growth and the alternative profit stream is continuing to grow at double digits off a higher base. So certainly, I would endorse Rodney’s comment more broadly around that commitment to TSR over time. But obviously, we’ll get into more details on 2022 in March.
Simeon Gutman — Morgan Stanley — Analyst
Hi, guys. It’s Simeon for the follow-up. I thought maybe Michael might have a better shot at the ’22 question than me. But my follow-up is on the puts and takes on IDs. It looks like it held pretty consistent Q2 to Q3, and you talked about inflation lifting but leveling. Can you talk about anything puts and takes sequentially got worse or better in terms of units, traffic, et cetera?
W. Rodney McMullen — Chairman and Chief Executive Officer
If you look at most pieces, it would — third quarter would have been better than second quarter. If you look at household trends, if you look at — basket size would have been a little bit smaller, but not significantly. We continue to see people premiumization during both the quarters, we continue to see people buying larger pack sizes on just about every category. So when you look at the puts and takes, I think there’s as many puts and takes.
Gary Millerchip — Senior Vice President and Chief Financial Officer
Maybe just to add, Rodney, Simeon, the trends were pretty consistent through the quarter in Q3. They got slightly better as the quarter went on. And we would be trending at the top-end of the range that we shared in the quarter-to-date so far, top-end of the range that we shared the guidance for Q4. And if you look at the trend so far in this quarter, I would say that the quarter would have started a little bit slower because of we were cycling in that week before Thanksgiving a fairly large spike in consumer behavior that I think started to signal maybe a potential increase in cases this time last year and then Thanksgiving was very strong. We were very pleased with the results over the Thanksgiving week itself.
I think some of the questions in our mind as we look towards Q4 that some of the reasons that we guided to some of the uncertainties, it’s hard to predict exactly what will happen with government stimulus dollars in the market, particularly at the state level. That’s kind of really hard to get over the skin of what will happen in individual states around ongoing funding. We obviously know there are some continued supply chain challenges around product availability in certain categories, and that’s getting better gradually, but still has certainly some challenges in the market. And it will be those kind of things that for us would be some of the puts and takes in how strong Q4 plays out in our mind.
Simeon Gutman — Morgan Stanley — Analyst
Thank you, everyone. Happy holidays.
W. Rodney McMullen — Chairman and Chief Executive Officer
Thanks. Happy holidays.
Gary Millerchip — Senior Vice President and Chief Financial Officer
Thanks, Simeon.
Operator
Next question is from Robby Ohmes with Bank of America Global Research. Please go ahead.
Robby Ohmes — Bank of America Global Research — Analyst
Hi. Good morning. Thanks guys for taking my question. I guess, Gary, for you, could you — I wanted to just follow-up on the sourcing benefits to gross margin. Can you remind us what you’re doing to achieve kind of sourcing benefits in this environment? And also, you’re doing an amazing job with the cost savings initiatives, offsetting labor and other cost pressures. Can you remind us also there, what you’ve been doing and maybe some thoughts on how sustainable those two things could be into next year?
Gary Millerchip — Senior Vice President and Chief Financial Officer
Sure. Thanks for the question, Robby. Yes, we’re really proud of the team’s work in those areas, as you mentioned. It started out at the beginning of Restock Kroger is a sort of let’s grab the opportunities that are immediately in front of us. And I think it’s really become a core competency within the organization to drive sustainable savings in our model.
On the sourcing side, I think I would describe it across a number of different areas. You start with how do you make sure, you’re consolidating all the buying in the right places, so you can maximize the data and knowledge and use our own experiences from the cost of commodities and the fact we manufacture many of our products, so that we’re getting smarter and more effective in how we buy. It’s evolved into product design and packaging design and how do you really optimize the value, while not compromising on quality for the customer, so continuing to drive value in those areas. It’s extended to the GPO partnership that we created with Walgreens and looking at how can you consolidate opportunities and best thinking there as well. So it continues to evolve for us and the team is doing a great job in finding those opportunities to maximize savings, and we would expect that to be a continued opportunity for us because we keep identifying new innovative ways to ensure that we’re designing for value and maximizing opportunities to be more efficient.
On the sort of the OG&A side of things, that’s across a number of different areas as well. So it would include using technology and automation to reduce shrink and waste in the business, to improve on some of those activities in the store and our operations that are very manual and don’t really maximize the value that our great associates can deliver for customers. So taking that non-value-added workout wherever we can to allow our associates to focus on the customer. It includes automating our ordering and production planning type processes.
One of the big ones, of course, this year that we think would expect to be a tailwind into next year as well for every dollar that we can capture this year would be taking cost out of our digital cost to serve. So we’ve invested significant labor over the years in building that digital ecosystem, and we’d expect to continue to grow that business, of course. But if we can take out — if we can improve efficiency on that $10 billion digital business, it creates not just a saving on the next new sale, but it creates a saving on that baseline $10 billion business as well.
And then finally, I would say we’ve taken the opportunity to use things like the learning through COVID on things like administrative costs and what are the areas you can actually work more efficiently and operate in more of a hybrid environment to take cost out of the model as well. So I hope that gives you an idea of the way it’s kind of really become embedded more in the business, and we certainly would expect as part of our overall TSR growth — TSR growth model to be continuing to take costs to be able to fund new investments in our average hourly rate for associates to be able to invest in pricing and value for the customer, while at the same time growing shareholder returns.
W. Rodney McMullen — Chairman and Chief Executive Officer
Robby, the only other thing I would add to Gary’s comments and it’s implied throughout Gary’s comments, but we have done a lot of people changes and talent changes, both in terms of recruiting people from within the Company, but external as well, outside of the industry that have skills that were different than traditional in our industry, which has been a huge help in both areas for us to think about things in new ways and for people to approach things in new ways as well.
Robby Ohmes — Bank of America Global Research — Analyst
That’s great. That’s really helpful. And one really quick follow-up question, if I may. With the changes you’re making on the sourcing side and with own brands, what is happening with total SKUs versus national brands SKUs versus owned brands SKUs in your stores? Are they shrinking, or some growing? Can you give us any color on that?
W. Rodney McMullen — Chairman and Chief Executive Officer
If you look at before COVID, the number of SKUs would be lower now than before just because it’s — you don’t have as much change time and things like that. There are selective areas where some of the national players haven’t reintroduced some of the variety that we are introducing some of that variety in our own brands. And we introduced over 200 new SKUs in the quarter, and we would have an aggressive pipeline going forward. But overall, if you look at — there’s still continued SKU growth in natural organics, plant-based areas like that. And you — and if you think about like paper tows and paper goods and things like that, you would see fewer SKUs just because the customers move to purchasing bigger-sized packages.
Robby Ohmes — Bank of America Global Research — Analyst
Got it. Really helpful. Thanks so much.
W. Rodney McMullen — Chairman and Chief Executive Officer
Thanks, Robby.
Operator
The next question is from Greg Badishkanian with Wolfe Research. Please go ahead.
Spencer Hanus — Wolfe Research — Analyst
This is Spencer Hanus on for Greg. I just wanted to ask how you’re thinking about the delta between retail and cost inflation in ’22? And then what is the breadth and depth of promotions that you need to hit your long-term topline targets, just given the unique opportunity the industry has had to reset promos over the last 18-plus months here.
W. Rodney McMullen — Chairman and Chief Executive Officer
Gary, you want to…
Gary Millerchip — Senior Vice President and Chief Financial Officer
Sure. Yes. Thanks for the question, Spencer. As we mentioned, we’re kind of not really providing sort of an outlook for 2022 at this point around how we think about sales and investments overall. We’ll be doing that for sure as we get to the March meeting and sharing our Q4 results. I think really, I would pivot back to some of the comments that we made earlier around we think very much of it from the perspective of in all operating environments, Kroger has been able to demonstrate our ability to navigate through those situations. And it really comes back to what we were talking about earlier around ensuring that we understand the customer better than anybody using our data targeting our promotional activity and our personalized pricing and of course, where the pricing structure of product starts to change, really ensuring that customers see the value in our own brand products because of the great quality and value that they offer in combination and during times of high inflation and certainly in times of economic challenge, we found that Kroger has performed very well, and we’ve seen customers pivot to some of those opportunities based on the way we can communicate and connect customers with those strategies. So, I think from our perspective, we’re very much managing the business dynamically to ensure that we can deliver for the customer, but at the same time, deliver on our TSR commitments in the way that we talked about earlier in the conversation.
W. Rodney McMullen — Chairman and Chief Executive Officer
On promotions, we would always use our insights because different types of customers react different types of promotions. So we would aggressively use our insights to personalize promotions. A lot of that is one-on-one with a customer either sending an old-fashioned mail — mailing or electronically with e-mail or text or whatever. And it really depends on each customer, and what do they best react to.
Spencer Hanus — Wolfe Research — Analyst
Got it. That’s helpful. And then in the prepared remarks, I think you mentioned that the Ocado facility is performing better than expected, the one in Florida. But could you just provide some more details on the basket size and the repeat orders relative to your targets? And then how are you thinking about the need longer term to build or acquire stores in that market to provide a more complete omni experience down there?
W. Rodney McMullen — Chairman and Chief Executive Officer
On your second question, I’ll answer it first, and you got to walk before you run. So right now, we’re totally focused on making sure that the sheds open strongly, and we continue to maintain outstanding NPS scores, or net promoter scores, with our customers. And I am super proud of our team in Florida and Monroe, both in terms of how they continue to connect with the customer and continue to improve.
If you look at basket size, the basket size continues to grow, and what we expected and what we believe is as the customers begin to trust the experience, begin to have good experiences, we get a higher share of their total spend. And that’s what we’re starting to see. And when you look at, overall in Florida, one of the reasons why we announced the two additional facilities in Florida is, obviously, the connection and the growth that we are achieving. So far, we feel good about the opportunity in Florida. And as everybody knows, the population growth in Florida and the economic growth in Florida is just mind-boggling relative to an awful lot of the country. So it’s an incredible opportunity for all grocery retailers in Florida. Obviously, the offering we have is unique in the market and very proud of what we’re getting done there.
Gary Millerchip — Senior Vice President and Chief Financial Officer
And the repeat usage, Rodney, is higher than we expected [Indecipherable] net promoter score.
W. Rodney McMullen — Chairman and Chief Executive Officer
Yes.
Spencer Hanus — Wolfe Research — Analyst
Great. Thank you so much.
W. Rodney McMullen — Chairman and Chief Executive Officer
Thanks, Spencer.
Operator
The next question is from John Heinbockel with Guggenheim Securities. Please go ahead.
John Heinbockel — Guggenheim Securities — Analyst
Hi, Rodney. Let me start with, if you look at how consumer behavior has evolved over the last couple of years, in terms of what percent of purchases right are done, shelf price versus promo versus [Technical Issues] promo, how has that shifted, right? And if you think about personalized promo, is that as much as 50% or something along those lines of what purchases are occurring? And then the work you’ve done on price perception. How has that trended maybe early days of COVID to where we are today?
W. Rodney McMullen — Chairman and Chief Executive Officer
If you look at customer behavior, I want to broaden it a little bit relative to your question, we continue to see people focus on health. If you look at early in COVID, people were not as focused on health, but they’re definitely back where they’re focused on health in a more aggressive way. All across the board, you see premiumization on what people do. And I always say, I’m a reasonably aggressive shopper in our Murray’s Cheese. Growing up, I would have never had really good cheese. And once you have a really good cheese, it’s hard to go back to what you were used to when before. And what we’re finding is customers when they upgrade and try higher-quality product, they find out they love it and they become loyal to it. If you look at customers in terms of behavior and buying on promotion, it’s been reasonably consistent throughout the pandemic. People stretch their budget where they need to or want to because — and they will splurge in other places, which is one of the things that from a go-to-market standpoint that we really try to help a customer stretch their budget on things that are important to them, so they can splurge on what’s important to them as well.
John Heinbockel — Guggenheim Securities — Analyst
All right. Maybe just a quick one for Gary. You guys now have something on the order of $4 billion to $5 billion right of dry powder in terms of your leverage target. How do you think about that conceptually in terms of timing, in terms of return to shareholders versus strategic M&A? What’s the philosophy there?
Gary Millerchip — Senior Vice President and Chief Financial Officer
Thanks, John. Obviously, we are really proud of the business performance, and that has demonstrated strength in the overall model and the position that we’re in as we said in the prepared comments. I would say, our overall capital allocation strategy is unchanged that we start with where are the opportunities to invest in capital in the business to drive sustainable growth. We’re obviously in a great position around maintaining our investment-grade debt rating, and we’ve been able to make some good progress on chipping away at the pension funding from an overall sort of debt and potential liability there as well. This year, of course, we’ve been very committed to continuing to return cash to shareholders with the $1 billion so far on buybacks and the 17% increase in the dividend that we announced earlier in the year. So I think we’ve been very consistent with that plan so far.
We do think that in the short term, it’s important to maintain some flexibility, recognizing some of the uncertainty in the market that we’ve all talked about that we’re all navigating through at the moment. That being said, within those principles, we do think it’s important, and we’ve been very committed, as you know, as a company, to being very disciplined with cash flow and deploying it to either grow the business or return to shareholders. So as we head towards 2022 and as we move towards the March planning meeting and the business update meeting that Rod shared, we certainly expect to share more color of how we’re thinking about the excess cash and some of the opportunities we’re exploring there.
W. Rodney McMullen — Chairman and Chief Executive Officer
And we would continue to look for things that are the right opportunity for things that add capabilities. So if you think about merging with Home Chef a couple of years ago, it was a capability that we didn’t have on the direct-to-customer meal kits, and we’ve been able to partner with the team there to leverage it back within Kroger as well. So — and I always think it’s important to remind people that we’re not required to do any kind of mergers in order to achieve our TSR of 8% to 11% as well.
John Heinbockel — Guggenheim Securities — Analyst
Thank you.
W. Rodney McMullen — Chairman and Chief Executive Officer
Thanks, John.
Operator
The next question is from Chuck Cerankosky with Northcoast Research. Please go ahead.
Chuck Cerankosky — Northcoast Research — Analyst
Good morning, everyone. Great quarter. Rodney, I think that was you earlier mentioned that you chose to incur some significant costs in the — to bolster the supply chain in the quarter. Can you give us some detail on that and whether they last into next year? And then, I have a follow-up related to that.
W. Rodney McMullen — Chairman and Chief Executive Officer
If you look at the supply chain investments, it was pretty similar to what we did in the second quarter. Now our team has done a nice job of starting to identify some opportunities for efficiency. One of the biggest areas is that we continue to have extra warehouse space. And I guess I hesitate to call it extra warehouse space because we’re actually using the warehouse space. But — and over time, as we feel like things are permanent, you’ll see us do more permanent type warehouse projects to expand capacity rather than using it maybe in a way that’s not as efficient. We would expect to continue to do that in the fourth quarter. As we look out next year, we really are working hard to make sure we stay agile in that area because things continue to change so quickly. And what’s going on with COVID, what’s the COVID variance and things like that. So we really are making the decisions on an agile basis and it’s one of the learnings that we’ve had early on in the pandemic. and we’ll continue to do that relative to the supply chain as well.
Chuck Cerankosky — Northcoast Research — Analyst
Anything on the labor side worth noting? And then also, when you’re talking about the supply chain issues and product outages, is — are you talking about branded versus private label, fresh versus shelf-stable, edible versus non-edible products? I mean, where are you seeing the need to spend the most money and use the most management resources to make sure the shelves are stacked?
W. Rodney McMullen — Chairman and Chief Executive Officer
Yes. If you look at labor, we certainly have partnered with outside companies to supplement our labor resources, especially on the supply chain. If you look at in stocks, they would be more affected on center store. If you look in the fresh departments, we would be in much better shape in most of the fresh departments in terms of in-stock.
Chuck Cerankosky — Northcoast Research — Analyst
All right. Thank you. Good luck for the fourth quarter.
W. Rodney McMullen — Chairman and Chief Executive Officer
Thanks, Chuck. Appreciate it. Take care.
Operator
The next question is from Michael Lasser with UBS. Please go ahead.
Mark Carden — UBS — Analyst
This is Mark Carden on for Michael today. Thanks for taking the questions. As a follow-up to some of the earlier inflation questions, where do price gaps stand today? And what’s the posture on further investments from here? And have competitors been acting as rationally, given just the heightened inflation this time around? Thanks.
W. Rodney McMullen — Chairman and Chief Executive Officer
If you look at — as everybody knows, we go to market as a high low merchant. So we’re aggressive on promotion. We’re aggressively on using promotion. And we feel very good about where we stand relative to price gaps. And if you look at — our strategy has always been to neutralize on price and win on our fresh areas and our friendliness and connection our associates have with our customers. And that continues to work well, and we continue to feel good about where we are relative to the various gaps.
Mark Carden — UBS — Analyst
Great. That’s helpful. And then on Ocado, how integrated is the CFC today with your Cincinnati operations? Has it been integrated and click and collect yet? And then in Florida, who do you think you’re taking the most share from? Thanks.
W. Rodney McMullen — Chairman and Chief Executive Officer
If you look at Florida, I think the growth in the market is so strong that I think every — all boats are rising in Florida. So to say that we’re taking share away from somebody, I really don’t think of it that way because I just think the market is growing so much. If you look at your first part of your question on Monroe, we continue to further integrate it within the store network. And it’s something that literally every single week that goes by, we further integrate to really make it a seamless experience for the customer.
Mark Carden — UBS — Analyst
Great. Thanks so much, and good luck.
W. Rodney McMullen — Chairman and Chief Executive Officer
Thanks, Mark.
Rob Quast — Director of Investor Relations
Thanks for your questions, and that will end our question-and-answer session.
W. Rodney McMullen — Chairman and Chief Executive Officer
As Rob said, thanks for questions. Obviously, thank you for your interest in Kroger. As you know, many of our associates own stock, and we always use the end of this to communicate directly with our associates as well. And as all of us embrace the holiday season, it often becomes a time where we can — a reflection as we set down to enjoy special meals with our loved ones. And as I said earlier, I am just so incredibly proud of our associates across the Kroger family of companies and what we as a team have accomplished this year. Every one of our associates is helping make the holidays brighter and fresher for our customers and more importantly, for that customer and their family.
And it doesn’t matter if you’re making a difference together like our Kroger Health team, who has administrated 8.5 million doses of the COVID-19 vaccine, or as individuals like Donna Greer, a cashier at our store 387 in Collierville, Tennessee, whose unshakable positivity has been an inspiration to many, including the Collierville Herald Independent who just named her Collierville Woman of the Year. We are so proud of Donna and congratulations, Donna. When you look at these, there are just a few examples of our incredible people who bring our vision and values to life each and every day. Our associates are beyond amazing and continue to serve our communities and uplift each other and our customers.
That concludes our call for today. We wish everyone a happy holiday season, Merry Christmas, and encourage you to stay safe. And as always, thank you for your interest in Kroger.
Operator
[Operator Closing Remarks]