D I S C U S S I O N  M A T E R I A L S

The Kroger Co. (KR):

Andrew Boone

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Investment Merits

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Kroger private label brands provide a competitive advantage

Additional fuel centers will increase customer traffic

Best in class super market with most defensive positioning

Superior data management

Improved market share

Buy: Price target of $xx.xx

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Kroger Co. Overview

2 year price history2 year price history

Market characteristicsMarket characteristics

Enterprise value:

Market cap: $13.05bn

52 week high: $25.85 (7/20/11)

52 week low: $20.53 (12/10/10)

Vol.: 3.067mm

Next earnings date: December 1st

Dividend yield: 1.9%

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Kroger Co. accounts for COGS using FIFO

Miscellaneous considerationsMiscellaneous considerations

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The Kroger Co. is…

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StoresStores Different Business LinesDifferent Business Lines

Traditionally cater to customers in a 2.0-2.5 mile radius

At the end of 2010, Kroger had 1,014 fuel centers attached to a supermarket

Kroger operates more than 40 manufacturing plants

361 jewelry stores (149 in stores & 212 in shopping malls)

Product of the 1999 takeover of Fred Meyer Jewelers

Historically, 95% of revenues come from supermarkets

Stores% of

revenueTotal Supermarkets 2,460 94.0%

Combination Food & Drug Store 2,128  Multi-Department Stores 125  Marketplace Stores 61  Price Impact Warehouses 146  

Convenience Stores 784 5.0%Jewelry Stores 361 0.5%Other* N/A 0.5%

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Kroger has historically been…

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StoresStores

Different Business LinesDifferent Business Lines

2007 2008 2009 2010Stores Stores Stores Stores

Total Supermarkets 2,486 2,482 2,468 2,460Combination Food & Drug Store 2,183 2,169 2,143 2,128Multi-Department Stores 123 124 125 125Marketplace Stores 35 43 53 61Price Impact Warehouses 145 146 147 146

Convenience Stores 782 771 777 784Jew elry Stores 394 385 374 361

Combination Food & Drug – Complete supermarket & pharmacy

Multi-Department – Combo store with apparel & food departments

Marketplace – Combo store with additional living and home goods

Price Impact Warehouse – “No frills, low cost” shopping

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Investment Merits

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Kroger private label brands provide a competitive advantage

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7Kroger does a cost analysis for each private label good and manufactures 40% of these products

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Percent of consumers who agreed with the following statements about private label goods (Source: Mintel)

Percent of consumers who agreed with the following statements about private label goods (Source: Mintel)

U.S. private label sales (Source: Mintel)U.S. private label sales (Source: Mintel)

2005A 2006A 2007A 2008A 2009A 2010A 2011A 2012A 2013A 2014A 2015A0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

Sales ($mm)

Annual Growth %

Store brand products are of better quality today than they were five years ago

44.0%

I compare the ingredients listed in store brand products with the name brand versions

42.0%

I would recommend a store brand product 39.0%

I purchase store brand products only because I want to save money – but I’d rather purchase name brands

35.0%

I don’t feel like I’m giving anything up (e.g. flavor, quality, prestige) by using store brands

34.0%

I trust the ingredients of name brand products more than store brand 23.0%

I think it’s worth paying more for name brand products 19.0%

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8Unemployment has shackled consumer spending and will keep consumers watching spending

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US unemployment (source: Bureau of Labor Statistics)US unemployment (source: Bureau of Labor Statistics)

Private label as % of US supermarket sales Jan. 2008-Sept. 2011 (Source: Nielsen, Credit Suisse)

Private label as % of US supermarket sales Jan. 2008-Sept. 2011 (Source: Nielsen, Credit Suisse)

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Three tiered branding structure provides exposures shopping demographics

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Private Selection

• “Best” quality brand• Offers 1,000 Private Selection Items

Banner Brands

• “Better” tier• 13 new categories • Moderation Pillar allows shoppers an easy way to find healthy

items

Value Brand

• “Good” tier• Basic products priced to fit in budgets

27% of grocery sales were from private label goods in 2010, from 2007 numbers of 26%

Private label units sold have increased to 35% of all grocery sales in 2010, from 32% in 2007

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10Kroger manufactures 40% of their own products: vertical structure improves logistics and margins

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LaborLabor Manufacturing facilitiesManufacturing facilities

99.8% of shoppers buy a corporate brand product every 12 weeks

Big K cola received new packaging and added Ralphs as a distribution line

Kroger does a price analysis when deciding whether to manufacture or outsource

18 dairies

10 deli or bakery plants

5 grocery plants

3 beverage plants

2 meat plants

2 cheese plants

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Investment Merits

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Additional fuel centers will increase customer traffic

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12Same store sales have been buoyed by the addition of fuel sales but still have room to grow

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Supermarket and fuel center unitsSupermarket and fuel center units

2007 2008 2009 20100

500

1,000

1,500

2,000

2,500

3,000

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

28.0%

31.5%

36.2%

41.2% Total su-permarkets

Attached fuel centers

Percent of supermar-kets with fuel centers

Fuel provides virtually no margins but as gas prices remain high, it drives consumers to take advantage of the Kroger’s low fuel prices and shop for groceries at the store

Kroger loyalty points allow shoppers to gain further discounts as they spend more dollars on grocery sales - $100 spent on groceries allow for a $.10 discount per gallon of gas

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Same Store Sales show Kroger continuing to win

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Same Store Sales (Source: Factset)Same Store Sales (Source: Factset)

Percent of stores with attached fuel centers (Wal-Mart and SuperValu do not disclose fuel center count)

Percent of stores with attached fuel centers (Wal-Mart and SuperValu do not disclose fuel center count)

2008 2009 201015.0%20.0%25.0%30.0%35.0%40.0%45.0%50.0%55.0%60.0%65.0%70.0%

KrogerSafewayCostco

2006 2007 2008 2009 2010

(8.0%)

(6.0%)

(4.0%)

(2.0%)

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

KrogerSafewaySuperValuWal-MartCostco

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Investment Merits

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Best in class super market with most defensive positioning

Superior data management

Improved market share

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Exclusive DunnHumbyUSA partnership allows Kroger insights into consumer trends

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Customer Loyalty Card ProgramCustomer Loyalty Card Program

50% of US households have a Kroger loyalty card

90% of purchases at stores use a loyalty card

Base capital projects on feedback received from DunnHumby to ensure that Kroger remains client focused

“We’ve been doing this for, I don’t know, I guess six years now and if you look at the trend over time, we’ve had tremendous improvement in terms of being able to engage with the customer in a way that they appreciate and need better and better. And it’s something that every quarter we get better but we’re constantly working with dunnhumby and our merchandising teams to figure out how to even get better from where we are.”- Kroger Management Team (2011 Q2 earnings call)

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16Superior market share allows for superior economies of scale and lower prices that continues to drive consumers to Kroger units

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Weighted Average Market Share (Source: Metro Market Studies)Weighted Average Market Share (Source: Metro Market Studies)

Kroger Safeway Supervalu (Excluding Save-A-Lot)

15.0%

18.0%

21.0%

24.0%

27.0%

30.0%

Average basket size for Kroger is 14% lower than Safeway, 18% below Harris Tweeter, and only 6% more expensive than

Wal-Mart*

*Source: Wall St. Research

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Discounted Cash Flow (avg of two methods $27.03)

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Discount Rate12.5% 11.5% 10.5% 10.0% 9.5% 8.5% 7.5% 6.5%

1.5% $12.02 $15.12 $18.95 $21.22 $23.79 $30.07 $38.54 $50.482.0% $13.41 $16.85 $21.14 $23.70 $26.63 $33.88 $43.86 $58.412.5% $14.94 $18.76 $23.60 $26.52 $29.87 $38.32 $50.26 $68.313.0% $16.63 $20.91 $26.38 $29.73 $33.61 $43.57 $58.07 $81.043.5% $18.51 $23.32 $29.57 $33.44 $37.98 $49.87 $67.84 $98.014.0% $20.61 $26.06 $33.24 $37.77 $43.14 $57.57 $80.40 $121.784.5% $22.98 $29.18 $37.53 $42.88 $49.34 $67.19 $97.15 $157.42

Term

inal

Gro

wth

Term

inal

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Discount Rate12.5% 11.5% 10.5% 10.0% 9.5% 8.5% 7.5% 6.5%

4.50x $16.09 $17.67 $19.36 $20.25 $21.16 $23.10 $25.17 $27.384.75x $17.25 $18.90 $20.66 $21.59 $22.55 $24.57 $26.73 $29.055.00x $18.40 $20.12 $21.96 $22.93 $23.93 $26.04 $28.30 $30.725.25x $19.55 $21.35 $23.27 $24.27 $25.32 $27.52 $29.87 $32.395.50x $20.71 $22.57 $24.57 $25.62 $26.70 $28.99 $31.44 $34.065.75x $21.86 $23.80 $25.87 $26.96 $28.09 $30.46 $33.00 $35.736.00x $23.01 $25.02 $27.17 $28.30 $29.47 $31.93 $34.57 $37.40

AssumptionsGrowth 4.0% Gross margin 75.4% OG&A step $550.0 CapEx as % of sales 2.6%

Depreciation as % of beginning assets 11.8%

Tax 33.0% Shares 597.1

PerpetuitySum 25,046.2 Debt 6,962.0 Cash 643.0 Pension Underfunding 973.0 Equity Value 17,754.2 Price per share $29.73

MultiplesEquity Value 21,803.4 Debt 6,962.0 Cash 643.0 Pension Underfunding 973.0 Equity Value 14,511.4

Price per share $24.30

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Comparable companies*

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The Kroger Co.Fiscal Enterprise Price / EPS Enterprise Value /

Company Name Period Value LTM FY1 NTM Sales EBIT EBITDA

The Kroger Co. (kr-us) 08/ 2011 19,557.7 11.92 11.74 10.96 0.22x 8.6x 5.0x

Peer Summary AnalysisMean - 73,637.8 12.07 12.49 12.00 0.36x 11.1x 15.9x

Median - 21,472.6 11.96 11.39 10.61 0.32x 10.7x 9.0x

Peer Universe (4 comps)

Costco Wholesale Corp. (COST) 04/ 2011 32,074.6 25.38 21.03 20.70 0.38x 13.5x 10.0xSUPERVALU, Inc. (SVU) 06/ 2011 8,384.8 (1.05) 6.15 6.09 0.23x - 40.9xWal-Mart Stores, Inc. (WMT) 07/ 2011 243,221.2 11.64 12.22 11.49 0.57x 10.7x 8.0xSafeway, Inc. (SWY-US) 06/ 2011 10,870.7 12.29 10.57 9.73 0.26x 9.2x 4.7x

Source: Factset

*Downloaded 10/10/2011

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Supervalu (SVU)

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GoodGood The bad – Heavily leveredThe bad – Heavily levered

Cheap (6.1x NTM EPS)

$1.87bn goodwill impairment made numbers seem much worse at a superficial level

Has experience improving margins, however this may be due to a smaller reinvestment in stores – they halved CapEx from FY2009 yet developed 132 new stores in FY2011

Pension planPension plan

Plan assets are as of February 26th, 2011 - S&P 500 is down 9.5% over this time frame

A 25bps reduction in the discount rate would increase pension expense by $10mm

Discount rate derived by AA corporate

Plan at Feb. 27, 2010Total pension assets $1,896.0

Total PBO 2,663.0

Underfunded status (767.0)

Discount rate 6.0% Expected return on assets 7.8% % in equities 53.5% % in P/E & real estate 10.8% % in fixed income 35.6%

SVU SWY KR

Debt 5,553.0 4,490.0 7,662.0

LTM Interest 535.0 286.8 449.0

EBITDA 1,833.0 2,366.0 3,716.0

EBIT 894.0 1177.6 2,200.0

Debt/EBITDA

3.0x 1.9x 2.1x

EBIT/Interest

1.7x 4.1x 4.9x

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Safeway (SWY)

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The Good – Safeway has produced superior margins

The Good – Safeway has produced superior margins The bad – Heavily leveredThe bad – Heavily levered

The Bad – Safeway has been consistently produced disappointing identical store salesThe Bad – Safeway has been consistently produced disappointing identical store sales

Safeway trades at 12.3x LTM EPS (11.9x KR) and at 9.7x NTM EPS (10.9x KR) and 4.7x EV/EBITDA (5x KR)

Debt to EV is .46x for Safeway (.38x KR)

KR should trade a premium because of their ID sales. While SWY has better margins, I believe the most price conscious shopper is being driven to KR stores (average KR basket is 14% cheaper*)

SWY SVU WMT COST KR

Gross FY028.3%

22.5%

24.7%

12.8%

20.3%

Gross FY-128.6%

22.4%

24.8%

12.7%

21.2%

EBITDA Margin FYO

5.8% 4.9% 7.3% 3.7% 4.5%

EBITDA Margin FY-1

6.4% 5.4% 6.9% 3.6% 4.8%

Q1 20

08

Q2 20

08

Q3 20

08

Q4 20

08

Q1 20

09

Q2 20

09

Q3 20

09

Q4 20

09

Q1 20

10

Q2 20

10

Q3 20

10

Q4 20

10

Q1 20

11

Q2 20

11(5.0%)

(4.0%)

(3.0%)

(2.0%)

(1.0%)

0.0%

1.0%

2.0%

3.0%

2006 2007 2008 2009 2010(8.0%)

(6.0%)

(4.0%)

(2.0%)

0.0%

2.0%

4.0%

6.0%

8.0%

KrogerSafewaySuperValuWal-Mart

*Source: Wall St. Research

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Wal-Mart (WMT)

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The Good – EM growthThe Good – EM growth WMT vs. KRWMT vs. KR

The Bad - We are seeing the maturation of WMT for the US segment – No where else to grow

The Bad - We are seeing the maturation of WMT for the US segment – No where else to grow

Wal-Mart had a massive price roll back last spring that did not effect KR same store sales at all.

Same store sales for WMT have not exceeded 1% in 10 consecutive quarters

WMT trades at 8x EV/EBITDA (5x KR) & 11.5x NTM EPS (11x KR). With it’s superior margins & better ID sales it should receive a premium

New sq ft (mm) in FY12

Sub-Saharan Africa 17.2LatAm 13.2Asia 8.2Other 4.3

The international segment accounted for 26.1% of FY2011 net sales

FY2007 FY2008 FY2009 FY2010 FY20113300

3400

3500

3600

3700

3800

3900

0

20

40

60

80

100

120

140

160

180

Stores - End of YearNet Opened Stores

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Risks

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Increased margin pressureIncreased margin pressure Pension ObligationPension Obligation

KR is subject to union labor. SWY, COST and SVU do as well but WMT does not

− KR will renegotiate contracts with workers in California, Memphis and West Virginia over the remainder of 2011

KR has successfully passed along price increases to consumers. However, management specifically chose to contract gross margins. Margin contraction may hamper financial performance

Pension short fall was $973mm at January 29th, 2011

Discount rate was 5.6%. If the discount rate was to be lowered by 1% it would increase PBO by $342mm

Kroger investments more aggressively with their pension assets

Poor performance will squeeze profitability

Similar to SVU but better capitalized

Pension asset allocation 2010

Global equity securities 22.1%Emerging market equity securities 9.4%

Investment grade debt securities 12.2%

High yield debt securities 13.6%

Private equity 6.3%

Hedge funds 23.1%

Real estate 2.4%

Other 10.9%

Higher hurdlesHigher hurdles

KR has experienced higher hurdles due to superior historical numbers

Multiples may contract if past growth is not maintained

Much of the historical growth has been due to KR’s ability to pass through inflationary pressure

A P P E N D I X

Amazon (AMZN):Everyone’s retailer

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Real growth vs. nominal growth

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E 2006 2007 2008 2009 2010(2.0%)

0.0%

2.0%

4.0%

6.0%

8.0%

Nominal Same Store Sales

Real Same Store Sales

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Discounted Cash Flow ($27.03)

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In Millions 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 TVRev $76,148.0 $76,733.0 $82,127.0 $88,548.2 $92,090.1 $95,773.7 $99,604.6 $103,588.8 $107,732.4 $112,041.7 $115,402.9COGS 58,012.0 58,429.0 63,354.0 69,082.2 71,767.4 74,638.1 77,623.6 80,728.5 83,957.7 87,316.0 89,935.5

Gross Margin 18,136.0 18,304.0 18,773.0 19,465.9 20,322.7 21,135.6 21,981.0 22,860.3 23,774.7 24,725.7 25,467.5Gross Margin 23.8% 23.9% 22.9% 22.0% 22.1% 22.1% 22.1% 22.1% 22.1% 22.1% 22.1%

SG&A 14,229.0 14,527.0 14,948.0 15,516.0 16,066.0 16,616.0 17,166.0 17,716.0 18,266.0 18,816.0 19,366.0Depreciation 1,443.0 1,525.0 1,600.0 1,746.0 1,662.3 1,748.3 1,835.5 1,924.1 2,014.5 2,106.9 2,106.9

Operating Profit 2,464.0 2,252.0 2,225.0 2,203.9 2,594.4 2,771.3 2,979.6 3,220.2 3,494.2 3,802.8 3,994.6EBIT Margin 3.2% 2.9% 2.7% 2.5% 2.8% 2.9% 3.0% 3.1% 3.2% 3.4% 3.5%

One time items (12.0) (1,161.0) (43.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0

Tax 717.0 532.0 601.0 658.6 856.2 914.5 983.3 1,062.7 1,153.1 1,254.9 1,318.2

NOPAT 1,735.0 559.0 1,581.0 1,545.3 1,738.3 1,856.8 1,996.3 2,157.5 2,341.1 2,547.9 2,676.4

Working Capital (259.0) 73.0 370.0 (508.0) (83.7) (87.0) (90.5) (94.1) (97.9) (101.8) 0

Depreciation 1,443.0 1,525.0 1,600.0 1,746.0 1,662.3 1,748.3 1,835.5 1,924.1 2,014.5 2,106.9 2,106.9

CapEx (2,149.0) (2,297.0) (1,919.0) (1,634.0) (2,394.3) (2,490.1) (2,589.7) (2,693.3) (2,801.0) (2,913.1) (2,106.9)

Free Cash Flow 770.0 (140.0) 1,632.0 1,149.3 922.5 1,027.9 1,151.6 1,294.2 1,456.7 1,639.9 2,676.4

Present Value Multiplier 0.98 0.85 0.77 0.70 0.64 0.58 0.53 0.5349.1 780.8 790.9 805.5 823.0 842.1 861.8 20,093.1