Kroger and Whole Foods are the two giants in the grocery industry; however, their capital structure and financial measures paint vastly different pictures. The liquidity ratios, which measure short term solvency of the company, were calculated for both companies. The current ratio for Kroger was calculated to be .76 compared to a current ratio for Whole Foods of 1.60. At a glance, Whole Foods is more able to pay their short term debt obligations compared to Kroger. In the same vein, Whole Foods has a much higher quick ratio at 1.20 compared to .25 for Kroger. The capital structure of the two companies is the main reason for the distinct differences in the liquidity ratios.
Kroger has financed the company’s expansions with debt; whereas, Whole Foods has financed their expansions with equity. One of the reasons why Whole Foods’ quick ratio is higher than Kroger’s quick ratio is due to inventory management. Whole Foods is an industry leader at inventory management. Whole Foods inventory consists of two-thirds perishable foods, which requires management to have outstanding inventory management to be profitable. Due to the outstanding inventory management of Whole Foods, the quick ratio for the company is higher compared to the much larger Kroger. Activity ratios are a measure of a company’s asset management. When comparing Kroger to Whole Foods, Kroger has a higher total asset turnover and fixed asset turnover compared to Whole Foods.
In fact, Kroger is the industry leader in asset turnover consistently having the highest asset turnover ratios in the industry. The reason for Kroger’s high asset management ratios for total asset turnover and fixed asset turnover is due to sales. Sales are calculated into each ratio. By generating massive sales, Kroger is able to complete with slim profit margins due to exploiting economies of scale. Whole Foods dominates Kroger with two of the activity ratios: inventory turnover and days sales in inventory. Inventory turnover for Whole Foods is 19.84 times per year compared to 14.45 times per year for Kroger. Days sales in inventory for Whole Foods is 18.39 compared to 25.24 for Kroger.
The catalyst for Whole Foods superior performance in inventory turnover and days sales in inventory is due to three reasons: efficient inventory management, high traffic in stores, and the nature of the organic market. Due to the nature of the organic market, Whole Foods has had to become extremely efficient as inventory management. The organic market is characterized by: fresh fruits and vegetables, inventory mix that is more perishable than traditional grocery stores, and shorter shelf life of products. Because the organic market is dominated by fresh foods as opposed to pre-packaged foods, Whole Foods customers are more likely to visit the grocery store multiple times per week compared to Kroger customers.
Due to this, Whole Foods is more able to control inventory and generate higher inventory turnover compared to Kroger. An analysis of the leverage ratios of Whole Foods and Kroger illustrates the impact of a company’s capital structure on leverage ratios. Whole Foods had a lower Debt Ratio (.282), Long Term Debt Ratio (.0147) and Long-term Debt to Equity Ratio (.01) compared to Kroger, which had a Debt Ratio of .83, Long Term Debt Ratio of .41, and Long-term Deb to Equity Ratio of .01. The reason for Whole Foods having substantially lower leverage ratios is due to the capital structure of Whole Foods. Whole Foods capital structure consists of little to no debt. At the present time, Whole Foods’ capital structure is made up of 99.3% equity and .7% debt. In contrast, Kroger’s capital structure consists of 57.3% debt and 42.7% equity.
By having little to no debt, Whole Foods is able to maintain lower leverage ratio numbers compared to Kroger, which is more dependent on debt to fund expansion. The corporate strategies of Whole Foods and Kroger make a tremendous impact on the profitability ratios. Whole Foods strategy involves opening high-end grocery stores in upscale locations, offering organics foods and specialty items, providing a more enjoyable shopping experience for shoppers, and selling more expensive grocery items than traditional grocery stores. By comparison, Kroger’s strategy is to offer price reduction on grocery items, compete based on price which reduces profit margins, and offer a high-end shopping experience with low prices on staples. Due to the strategies of both companies, the profitability ratios are affected.
By competing on price, Kroger has lower net income and higher sales. Lower net income and higher sales shrinks profit margins and gross margins. On the other hand, Whole Foods specialty food items are priced at a premium; therefore, net income is larger compared to sales. A larger net income results in a higher profit margin and higher gross margin. The corporate capital structure factors into two of the profitability ratios for Whole Foods and Kroger. Due to having a capital structure that is essentially all equity, Whole Foods has much lower return on equity than Kroger, which has a capital structure that is a mixture of debt and equity.
The diversified capital structure of Kroger accounts for the higher Return on Equity compared to Whole Foods. The Return on Invested Capital is the same for Whole Foods and Kroger at 13% for each company. The Return on Invested Capital takes into consideration both debt and equity, which allows for a more accurate comparison of the two companies. Many of the ratios for Whole Foods and Kroger have been affected by the capital structure of the two companies. By taking into consideration by side of the capital structure, debt and equity, the two companies have a return on invested capital that is essentially the same.