Good morning and welcome to The Kroger Company Third Quarter 2019 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Rebekah Manis, Director of Investor Relations. Please go ahead.

Thank you, Gary. Good morning, and thank you for joining us. 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 the business on an ongoing basis is contained in our SEC filings. The Kroger assumes no obligation to update that information. Both our third quarter press release and our prepared remarks for this conference will be available on our website at ir.kroger.com. After our prepared remarks, we look forward to taking your questions. [Operator Instructions] I will now turn the call over to Kroger's Chairman and Chief Executive Officer, Rodney McMullen.

Thank you, Rebekah. Good morning, everyone, and thank you for joining us today. With me to review Kroger's third quarter 2019 results is Chief Financial Officer Gary Millerchip. I would like to thank those of you who were able to attend our investor conference last month where we shared our progress on Restock Kroger. We believe that Restock Kroger is the right framework to reposition our business to create value for all of our stakeholders. It provides us with a clear purpose and our vision to serve America through food inspiration and uplift. It focuses us on redefining the customer experience, identifying the partners who will help us deliver customer value today and in the future and putting the right talent and teams in place to focus on growth in our supermarket business and our alternative profit businesses. We are proud of the progress we have made, and we've learned from the challenges we've experienced. We are on track with a stable and growing supermarket business as a result of our customer obsession, renewed intensity around operational excellence and continued investment in seamless. We are growing our supermarket business by focusing on 3 levers to drive identical sales: fresh, power brands and data and personalization. And we continue to build a seamless ecosystem that is available, relevant and accessible for our customers. All of this combined to generate positive results in the third quarter. We continued to grow identical sales, reduce costs and deliver strong free cash flow. We had a broad-based identical sales improvement. 15 of our divisions had increasing supermarket identical sales without fuel compared to the second quarter. We delivered a slightly improved FIFO gross margin, excluding fuel and pharmacy. Headwinds in pharmacy were offset by strong fuel performance during the quarter. We are on track to…

Thanks, Rodney, and good morning, everyone. I want to echo Rodney and thank those of you who were able to attend or view the Investor Day webcast last month. As we shared in New York, our model for a strong and durable retail supermarket business begins with the customer and our obsession with increasing customer loyalty. We believe that our intensified focus on execution and continued improvements in the value and experience we deliver for our customers is driving increased identical sales across our store and digital ecosystem. To drive sustainable sales growth for the long term, we will continue to invest in areas of the business that are important to the customer. This includes ongoing investments in talent, price, digital and store experience, with an even greater emphasis on fresh, Our Brands and personalization. We are demonstrating through the first 3 quarters of the year we are being very deliberate in balancing these investments with disciplined execution of cost savings that simplify our business. Our supermarket business and the traffic and data this generates serves as the foundation from which we are able to drive higher growth in our asset-light, margin-rich alternative profit businesses that we continue to expect to accelerate our results. We expect our model to deliver improved operating results over time and continued strong free cash flow, and we expect this to translate into a consistently strong and attractive total shareholder return through EPS growth driven by sustained net earnings growth and the return of cash to shareholders via share repurchase, plus a growing dividend over time. Now I'd like to share third quarter results. For the quarter, we delivered an adjusted EPS of $0.47 per diluted share. As noted in this morning's press release, that includes a $0.03 out-of-period charge that I will share more…

Thanks, Gary. As I shared when we first began the call, we believe that Restock Kroger is the right framework to reposition our business and create value for all of our stakeholders. We are on track with a stable and growing grocery business as a result of our customer obsession, renewed intensity around operational excellence and continued development of our seamless ecosystem. Our focus on the fundamentals generated positive results in our supermarket business in the third quarter, which gives us strong momentum heading into the holiday season. Now we look forward to your questions.

[Operator Instructions] The first question is from Edward Kelly with Wells Fargo.

I just wanted to start with a question on the Q4 outlook. So you have a fairly wide range. That, I guess, implies earnings growth anywhere from sort of like mid-singles all the way up over 20%. One question, I think, that I have related to this is what are the puts and takes around that range? And I know you mentioned fuel, but a second question related to that is that to get to these numbers sort of either way, you need core grocery earnings to improve, and that's despite what is a harder comparison on SNAP and quite frankly recent pressure in grocery. So can you just kind of walk us through those puts and takes and then what you think will drive core grocery earnings to inflect positively in Q4?

Yes. Thanks for the question. I'll cover that. So you're correct, we expect -- as I mentioned in the prepared comments, we are expecting adjusted EPS growth to be in the double digits in the fourth quarter. Obviously, as I mentioned a moment ago, we're assuming and expecting identical sales growth to be in the range in the quarter, continuing the sort of trend that we saw in Q3, but there will be some SNAP headwinds that will bring it down towards the lower end of the range. So that's the kind of core assumption around ID sales for the quarter. We do cycle some investments. In Q4 last year, if you recall that we set up costs around some facilities in D.C. So from a gross margin perspective, we do have some tailwinds that will help the quarter. We also expect to continue to see the cost-saving improvements that we've been accelerating throughout the year as we continue to execute on the $1 billion cost-saving plan. And of course, I think we shared on previous quarters that alternative profit streams tends to be skewed more towards the fourth quarter, predominantly because both KPS has a heavy fourth quarter influence on the results and then Media continues to accelerate, and Q4 is always a higher Media quarter as well. So you combine an accelerating rate and the fact that Media is higher in the fourth quarter helps the alternative profit part of the business to continue to grow. In terms of the sort of puts and takes in the quarter that could influence where we finish in the range, on the headwind side, obviously, we have been investing in a new brand launch, and we're obviously spending dollars there in continuing to improve the messaging and translating that into a…

And just a follow-up. It seems like what's new in terms of what we're learning in the guidance this quarter is it -- I guess it seems like there's a $0.03 pharmacy charge that's in the guidance given that it's in your $0.47. Your LIFO charge is going up by $0.04. So that seems to be something that's a bit more unexpected. What's offsetting that to allow you to maintain guidance?

Ed, this is Rodney. Just a couple of comments, and I'll let Gary fill in. Obviously, our identicals continue to improve and strong there. If you look at gross margin without fuel and pharmacy, a slight improvement there. We had great balance between cost improvements and gross investment and it's the continuation of those pieces coming together. So it's really -- the core business continuing to improve and move in the right direction, that's providing the tailwind to offset the $0.03 on the pharmacy that was out-of-a-quarter adjustment and the LIFO as well. I don't know, Gary, anything?

I would completely agree with you, Rodney. I think the key thing for us is that, to your point, that those headwinds, even with those headwinds, if you strip those back in the quarter and look at Q3, underlying EPS and operating profit would have been positive excluding the out-of-period adjustment, as Rodney mentioned. Obviously, ID sales was very positive during the quarter. But we mentioned on the call, we didn't include it in the press release, but the impact of the out-of-period on gross margin rate was 9 basis points. So actually, in the quarter, gross margin rate, even with the pharmacy headwinds that we called out, would have been balanced with OG&A improvements over 15. So we were 24 basis points reported gross margin decline, excluding fuel. Taking out those 9 basis points, you get to the 15 basis points of underlying, if you like, gross margin investment after the -- excluding the onetime -- sorry, the out-of-period adjustment. So when we look at 15 basis points of investment, including pharmacy headwinds that we faced and we achieved 15 basis points of OG&A improvement, we actually feel like the progress that we're seeing in the model has been masked quite a bit in the quarter and we feel very positive about the underlying trends that we're seeing in the business.

The next question is from Judah Frommer with Crédit Suisse.

Maybe first, just following up on fuel. Can you help us with the benefit you're getting from improved sourcing and the sustainability of that relative to just kind of a general step higher in industry profitability and how that's playing out?

It's a combination of really some technology investments that we've made in terms of how to buy fuel and making sure, from a market standpoint, how we're pricing on a daily basis and reacting to what our competitors are doing. So it's the benefit of the way fuel is being bought plus being much more disciplined relative to the market. So it's really the combination of those. In terms of expectations going forward, from a procurement standpoint, we don't believe that's something that will continue to incrementally get better. We do believe it's something that we'll be able to maintain, and it's something that we've reflected in our guidance going forward.

Okay. That's helpful. And then maybe just following up on the Lucky's write-down. I don't think it was that long ago that you guys were citing double-digit IDs at Lucky's and great trends in produce. Maybe just a little bit more on the decision to exit the investment, the write-down of the investment. And is there any commentary on that kind of subchannel of food retail, kind of the specialized fresh-led food retailers and smaller boxes that's causing you to say maybe the traditional larger store fresh-led format is the way to go?

Yes, it really gets back to Gary's comments in the prepared remarks is -- and we talked about at Investor Day, it's really reviewing our whole portfolio of things that we are involved with and working on. And it really -- the amount of investment that it would take for Lucky's to be a meaningful contributor to Kroger overall and the efforts that it would take, we just didn't think it created a good return for the investments that were needed to be made relative to that. So it was really driven by narrowing our focus and the additional requirements to make it something that would be meaningful to Kroger. I don't know, Gary, you've been more on a day-to-day basis involved, anything you want to add?

I don't -- I think you characterized it well, Rodney. I think the only thing maybe to build in the second part of the question, I -- we do believe that as we get better connecting on fresh and continue to evolve the strategy around natural and organic, obviously, we're providing a far more comprehensive level of experience for that customer than ever before and continue to do more of that as we continue to build out the strategy around freshness and connecting with our loyal customers. We do believe that there's still a role for the small format store. I think it's certainly proven. And I think it's still probably to be proven in the industry about what is the right model for a smaller format store and how do you make that economic model work and how do you connect with the customer in a way that drives the right value on those smaller shopping trips as well. So we still believe and continue to look for opportunities. And obviously, our Walgreens pilot continues to provide an opportunity to learn how to continue to build a strategy that has a small format presence in there. But I do think it also demonstrates your comment that it's hard to figure out that small format model and to make it work effectively.

The next question is from Chuck Cerankosky with Northcoast Research.

Been looking at the Thanksgiving sales and how customers were spending, trading up. Can you talk about what that might mean for the Christmas selling season later this month?

Yes. Thanks, Chuck. If you look at quarter-to-date, our identicals would be pretty similar to where we were in the third quarter. The balancing of it is significantly different than the last few years because, obviously, there's 1 less week between Thanksgiving and Christmas. If you look at the way how customers spend their money, we continue to see obviously strong on people trading up, strong performance in wine, cheese, all those types of categories, and we would certainly expect that to continue to stay consistent through Christmas as well. So we really expect the business to continue where it is through Christmas. Obviously, if you look at January of next year, it's really the SNAP cycling, the SNAP impact would affect the kind of the numbers that we've provided for guidance.

Related to customers trading up, is that what you're trying to do when you invest in the customer experience? Prepared food strikes me you're making investments there. But are there other things we should think about?

Yes. It's fascinating because the customer is trading up both in terms of buying bigger package size. So what we find is when people are tied on budgets, they go to smaller package size. So we see people trading up there. We see people trading up to products that's better for you, natural and organic category. Prepared foods would be an area that we see people continuing to trade up for, and it's an area where we've focused a lot of attention on how do we get better. We view it as a huge opportunity to improve from where we are. And it's one of those things where we're just at the beginning part of that journey but certainly see customers very willing to pick up dinner at Kroger but do it with a Home Chef meal or something already prepared.

The next question is from Michael Montani with Evercore ISI.

This is Antonio Tabet taking over for Mike Montani. I just wanted to ask something on the 4Q comp outlook. You guys are obviously cycling SNAP in January. But I'm curious as to what you're seeing so far now with the whole rebrand going on. And another follow-up to that is with the option of free pickup promotion going on right now until January 1, is there a possibility that, that stays? Or what are you seeing from that so far from the reception of customers?

Yes. If you look at the outlook for the fourth quarter, so far in the quarter, we're tracking pretty similar to where we were in the third quarter. So it's really up until the SNAP period, we really don't see changes there. In terms of the pickup, free pickup option, we really aren't to a point yet of deciding whether to continue it or not. As you know, we've done it in several markets, and we're still early in the analysis. We -- the customer adoption has been stronger -- a little bit stronger than what we were expecting. But it's -- we're still at a point where we don't need to decide that yet in terms of whether we extend it or not.

Just to add, Rodney, so it is literally a few weeks obviously into -- since we announced the promotion. It's interesting. We're seeing a combination of new customers starting to use the service as well as existing loyal Kroger shoppers using the service more frequently as well. So we'll be using all of that data, as you might expect, to really analyze and evaluate. And that's certainly a factor that could also influence how the quarter plays out in terms of sales, which is another reason why we're trying to be clear about sharing the different moving parts that could still affect the quarter.

Okay. That's helpful. And just a quick follow-up on the digital side. You guys grew digital sales 21% this quarter. And just the way we're thinking about it, for the full year, we're thinking somewhere in the range of $5 billion to $5.5 billion digital sales versus 2018 value somewhere around the baseline of $4 billion. So that implies around 31%, 30% year-over-year growth. Is that somewhat reasonable to think of? Or is that an attainable target? Just want to get your color on that.

Yes. If you look at it on a run rate basis, the numbers that you shared would be very consistent with what we see. The other thing I always think is important to remember that I mentioned on our digital business and Yael shared it on a graph is the profitability of that business is maturing as we expect. And if you look at the early adopters on digital, the profitability of that customer was the same as going in store because we get such a higher share of their total spend. And we continue to see that maturity happen as well, which, for us, is something that makes it a sustainable model longer term as well.

Just one thing to add, Rodney, you said in your prepared comments and I mentioned it briefly as well, but I think we shared before that it really is the cycling of the Home Chef merger that caused the absolute percentage growth rate to show a declining trend. The underlying progress that we're seeing in customer engagement through Kroger pickup and delivery continues to be very strong and very consistent in the underlying results that we're seeing beyond the headline number.

Okay. And does that headwind continue to 4Q?

We've cycled that now. So it kind of -- it was partly through Q3, so you have kind of roughly half of it in the -- sorry, partly through Q2, so roughly half of it in the second quarter, and now it's fully cycled through in Q3. I think Yael may have shared, too, at the investor conference that we expect the growth year-over-year going into 2020 to be in that 20% range, consistent with what we shared this quarter.

The next question is from Ken Goldman with JPMorgan.

Rodney, thank you for the update on the quarter-to-date comp. Can you -- I know you probably will say no, you've never done this before. But just given some of the puts and takes for the fourth quarter, could you give us an update on sort of where you stand on your core gross margin quarter-to-date and your fuel margin as well? The reason I'm asking is there does seem to be a little bit of hesitation from some investors on your ability to sort of hit the high end of your guidance range for the fourth quarter. I just wanted to get your thoughts on that.

Yes. The -- I really would just go back to the comments that Gary made before. If you look at the underlying supermarket business, it continues to be strong. Identicals continue to be strong. A very good balance between cost reductions and investments in service and growth. The biggest swing would be the fuel margin. And even internally, the swings can be so much from day-to-day that it's really -- the value of where we are quarter-to-date, I don't think it can change overnight. And I remember the other day being in a market where in the morning, the margins were $0.40. In the afternoon, the margins were $0.15. It's that type of swing. But when you look at overall, it's a great return and it creates a lot of customer loyalty. So -- and then the other piece is SNAP. So I don't know, Gary, if there's any additional insight. But to me, quarter-to-date, fuel margins are just kind of hard because it swings so much.

Yes, I think that's right. And just to put the number into context, I mentioned it briefly earlier, but the rate that we've been trending at year-to-date in that $0.29-ish range, $0.34 was the Q4 rate last year. That $0.05 range can make a $50 million difference in terms of profitability. So -- and obviously, we have a very clear strategy of how we connect with customers on fuel and making sure that we're in line with the market. And so it is one of those areas where it can have a significant impact, and hence why I appreciate it does leave a much wider range than we normally want to, I think, have in place for the fourth quarter, and it's certainly not a lack of confidence in what we're seeing in the underlying core business, but it's just -- with that level of uncertainty out there on something like rates, it's -- we felt it was prudent to leave the range where it is.

I get that. And then my follow-up is, obviously, the government made some changes that are going to take some people in the America off food stamps, and it sounds like there's more of that coming. I'm curious, to what degree does your 2020 guidance factor that as a risk? Because, clearly, I think that if 700,000 or eventually some of the people think it will be closer to 3 million Americans get off food stamps, I can't say that as a positive for you, but I'm curious if there's any way to think about numerically how that might affect you?

Yes. Thanks for the question. Ken, obviously, it's something that we continue to watch very closely. And obviously, it's one of those things that we knew was a potential risk that's out there in the business, and we'll continue to watch it and evaluate. From our perspective, we really try and build the business model around being able to adapt to the circumstances, and we do believe that the model that we're creating and our ability to connect with customers and deliver an overall experience, the personalized pricing offers that we can generate that obviously are -- what we tend to see when customers have less dollars, they'll tend to gravitate more to own brand products, and you'll start to see some behavior shift. But because food is a nondiscretionary spend, usually, the customer is going to make adaptations that they have to, to be able to still buy the groceries that feed the family. So from our perspective, it's certainly something that we contemplate as a risk as we think through how we'll continue to build our model and drive connection with customers. And it's something that we'll continue to adapt as we hear more and learn when and if the changes occur. But obviously, it's one of those things out of our control. And our focus is much more on how do we make sure we win the customer and continue to adapt strategy if some of those things were to hit us as a headwind in 2020.

Yes. Just a couple of additions. Obviously, the overall economy continues to be strong as well, which provides support. And when you look at SNAP, we would be less dependent on SNAP than many of our competitors would be as well.

The next question is from Rupesh Parikh with Oppenheimer.

This is actually Erica Eiler on for Rupesh. Firstly, just wanted to touch on price investments. I think last quarter, you called out, I think it was about 12 basis points of price investment. Just curious if there was a similar level of price investments this quarter.

Yes. I don't think we've typically called out specifically price investments. What I would say in terms of maybe a couple of thoughts, when you think about gross margin and what happened in gross margin during the quarter, the way that -- to sort of break it down, if you like, and I covered a couple of these points earlier, but if you exclude fuel from the results, we had a 24 basis point investment in gross margin, 9 basis points of that related to the out-of-period charge that we shared in the press release this morning, which essentially brings it down to 15 basis points. All of that gross margin headwind was essentially in the health and wellness space between Kroger specialty pharmacy and retail pharmacy. And as Rodney mentioned, our gross margin rate overall improved slightly when you exclude pharmacy from the core business. So another way to say that is through the cost of goods savings that we were able to execute on during the quarter and the alternative profit growth that we were able to achieve during the quarter, which both support improvements in gross margin, we fully offset the continued price investments that we made in the business to drive the continued improvement in ID sales growth. We are continuing to invest in price. As we've shared, I think, at the Investor Day, a lot of our focus this year is on really making sure that we're using our data to drive the price investments in areas that matter most to our customers. And some of those are going to be personalized offers and promotions, but some of it will also be in fuel rewards. And we mentioned in the prepared comments that while the profitability of fuel improved during the quarter, that was offsetting the supermarket business by an 8% growth in the amount of fuel rewards that we paid to customers to incentivize them to continue buying Kroger. So it's a complex model in that sense, but we are continuing to invest in price. We're pleased with the way that customers are reacting to the investments that we're making because it's certainly allowing us as that one component of driving the identical sales growth that we shared in the quarter. But we're being very deliberate in balancing those investments with cost of goods savings and alternative profit growth.

Yes. The other thing that helped gross -- our shrink improved for the ninth consecutive quarter and warehousing and transportation costs improved as well.

Okay. That's helpful. And then you briefly mentioned the prepared food opportunity. Could you maybe talk a little bit more about your vision behind the recently announced ClusterTruck partnership? And does this at all impact how you're thinking about Home Chef?

I'll start with the end of your question first. It doesn't affect us how we look at Home Chef at all. And if you think about our overall strategy on trying to serve the customer anything they want, anytime they want, anywhere they want, as you know, about half of food is food already prepared where people spend their money. And our market share there is significantly less than on the traditional supermarket business. And we really view that it will be a combination of Home Chef, something physical in stores in terms of meals ready to heat, ready to eat. And ClusterTruck is one of those where we think it's an addition to that overall ecosystem. Obviously, they have incredibly good technology. It's made to order quickly. And they will be able to leverage -- and we're doing -- it's obviously on a test basis, they'll be able to leverage some of our physical assets to be able to scale as well. So it's really an additional piece in terms of how do we get the customers what they want, when they want it, the way they want it. And it's just an overall part of the overall ecosystem. And we just see the opportunity on food that's already prepared is a massive opportunity.

The next question is from Michael Lasser with UBS.

So you said you've been encouraged by some of the early learnings from your expansion of the free digital pickup initiative. Can you give us a sense for how that initiative has impacted the P&L? So is the financial performance in line with what you expected?

Thanks for the question. Just recall, again, it is really early days in the journey with the promotion because we literally launched it a few weeks ago. And obviously, part of the modeling that you would expect us to do as we understand customer behavior is to look at -- as Kroger does on everything that we do, look at the longitudinal behavior with the customer and not just the individual transaction but how does that change the level of engagement with the customer, and that's going to need to happen over a longer period of time, as Rodney mentioned earlier. Certainly, the early encouraging signs are, as I mentioned, we're starting to see new customers experience the service and start to engage in Kroger pickup that haven't before. We're also seeing existing Kroger pickup customers start to increase the frequency with which they use pickup service. And so a lot of the financial modeling that we will do will really be looking at those metrics over a longer period of time and saying, how does that play out in terms of the value it creates and how does it drive loyalty. And then, of course, as we talked a little bit about at the investor conference, we'll look at that in the context of the investments that we're making in the business and how does customer value this part of the experience versus other ways in which we're creating value across price investments, across fuel discounts and obviously through the experience that we're offering in the store. So it's a pretty complex area. And certainly, we'll look at it over a longer period of time. We're seeing kind of the type of behavior we have expected to see, and it's certainly been positive. But it's really going to be a longer period of time before we could really evaluate the way in which it impacts the model with the customer.

And just to clarify, Gary, you have assumed that in your 2020 guidance that you've provided, the test will be limited to 2019 so it will not continue into 2020 at this point. And then I have a quick follow-up.

We haven't really gotten into specifics around what our pricing strategy will be in 2020. As we talked about, obviously, I would think about it more much as you think back to the chart that I shared at the investor meeting in New York and how we're balancing the investments that we're making in the cost savings in the business. So we certainly have a clear view of how much we believe we want to invest in the business next year and how that will be supported by the $1 billion of cost savings that we're expecting. So if we were going to see the value in pickup driving more value in our model, it would be because either we expect it to drive higher sales and support the investment or we believe it would be a better way to invest the dollars that we think are important to driving value for the customer in 2020.

That's helpful. My follow-up question is, Rodney, you've seen some pretty good momentum in your ID sales. There's probably a variety of factors that are contributing to that, including a healthier overall environment, being further away from some of the disruptive changes that you've made and better execution in the business. If you had to rank those factors and maybe any others in order of importance and magnitude that they've contributed to driving this improvement, how would you do that?

Yes. The -- great question, Michael. We would really view those as pretty equal. The other thing that we would add on top of that is really using personalization and data to be more specific for each customer individually. So like on -- the example I gave on fuel rewards, but it would be true for offers more than just fuel rewards, but really personalizing it to each household individually. And it's really all of those -- we would call it, the sum of all parts. It's all of that together that's creating and improving the momentum. It's not just one single thing.

The next question is from Simeon Gutman with Morgan Stanley.

This is Josh Kamboj on for Simeon. So sales trends are improving and the grocery gross margin increased slightly in the quarter. How sustainable do you think that combination is in the near term? And then more broadly, what changes in the competitive landscape would you need to see to undergo a deeper round of price investments over the next 3 years than what's currently embedded in your plan?

Yes. Thanks for the question. I think on the first part of the question, I would kind of draw back again to what we talked about at the investor conference. The way we think about the model going forward is, certainly, we're going to continue to invest in price. We're going to continue to invest in the customer experience because the long-term sustainable growth in loyalty, we think that's critical to our plan. What we're doing very deliberately is being very disciplined in how we're managing costs within the business, both cost of goods savings but also OG&A cost efficiency, which obviously was strong during the quarter. And then alternative profit streams continues to accelerate and obviously offset the gross margin investments that we're making as well. So I think we look at it much more of an overall ecosystem, if you like, is how do we use food as the foundation for customer loyalty, which drives the traffic. And then fuel obviously builds on that in terms of causing customers to shop more frequently. And then you think about the health and wellness business and alternative profit streams layering on together to create this overall ecosystem that drives customer loyalty and drives total profitability of the customer. And the way we think about it is how do we pull those levers together in a way that allows us to continue to invest and build loyalty. And we're using the different dynamics there around alternative profit and cost savings to be able to continue to invest. I think when we look at the market, certainly, obviously, there's always high competition. We expect that to continue. We always assume that within our model. And we feel very good about the plans that we're implementing around driving costs out and continue to grow alternative profit that we can make the investments that we need to, to be able to continue to grow customer loyalty.

Yes. I'd only add a couple of things. One, and Gary briefly mentioned it, if you look at continuing to learn to improve the customer experience, that provides support and ongoing support because we still -- we've made good progress, but we still see opportunities to get better. The one area that I've been pleasantly surprised, as you know, we've been able to -- in 2018, we were able to take over $1 billion of costs out. We're on track to exceed that again incrementally in 2019, and we have plans to do that in 2020 as well. We continue to see good opportunity to take costs out. And when you look at all those -- both those pieces together and the free cash flow of the business is what gives us confidence and comfort in the comment that Gary shared at the investor meeting of TSR of 8% to 11% per year.

That's helpful. And then in general, maybe you could just quickly touch on your price gaps versus some of your key competitors. Have they been widening or narrowing? And are you pretty happy with where they sit at the moment?

Yes. One of the things that we always think it's important, we're comfortable where we are, but it's always important to remember that customers decide where to shop based on freshness of departments, and we shared with you that our customer feedback on fresh is better than our big box competitors. We also have tons of personalized offers where a customer gets value, both in terms of individual mailings, individual e-mails and fuel. So it's all of those pieces together, and we feel good about where we -- our gap is.

And the last question will be from Robbie Ohmes with Bank of America.

Just 2 follow-ups. Just the first on the LIFO increase, can you maybe just -- you mentioned procuring better, but LIFO is coming in higher than expected. I think in the press release, you guys called out grocery and dairy inflation. Is this all commodity driven? Or are CPG companies pushing through price increases? And then also, could you tell us what the inflation component of IDs was to the third quarter? So maybe just paint us a picture of what exactly is going on between all those things.

Sure. Thanks for the question, Robbie. Yes, it's an interesting question around LIFO and inflation because -- I'll maybe answer the 2 questions slightly differently. From an inflation point of view, as you know, we've shared before, we were assuming inflation in the range of 0% to 1% in the year. I would say it's trending slightly above that range. Actually, for Q3, I wouldn't say it's materially different than it was in Q2. There are a couple of categories like produce went slightly down and meat went slightly up, but nothing that would have been dramatic in terms of the overall change in inflation. So just slightly ahead of that 1% assumption that we had during the year. And actually, even though our LIFO charge forecasted increasing, we haven't really seen a dramatic change in the overall inflation rate across the categories. Everything I just said now I should probably caveat excludes fuel and pharmacy because those 2 obviously tend to have a different trajectory versus most of the food categories. Interesting -- with LIFO, it is a one data point in time at the end of the year that we follow to support the accounting rules that are in place around making that LIFO adjustment. With the data point that we used in the third quarter caused us to, in following that process, believe that we should increase the rate and based on what it's telling us, that's why we called out the forecast is expected to be a headwind for the year. Of course, it's a noncash item, and it doesn't really impact the underlying performance of the business. But it will impact the earnings for the year based on the trend that we're seeing right now. But I wouldn't say it's a reflection of a major change in what we're seeing in inflation. And obviously, we've shared before, when we see price increases, generally speaking, we'll be pushing back on them based on our knowledge of our own brand products and managing those. But where we are seeing them, we're generally looking to pass them on to the customer where it makes sense in those markets.

And just my other follow-up question. Just on fuel rewards, so you're expecting the CPG profitability of fuel kind of -- it sounds like flatten out next year. But it sounds like you're also going to be pushing harder, if I understood it, to kind of drive IDs more using the fuel rewards program. Just how should we think about that? And has there been a change in the responsiveness to fuel rewards that's got you interested in pulling that lever a little harder to drive IDs and penetrate loyalty more?

Yes. It really is an important part of our overall connection rewards on -- back to our customers for them shopping with us. I would say part of it is just continuing to learn new approaches that connect with the customer. So over the last, really, 6 to 12 months, we've been doing a lot of different types of tests and learns, trying to identify additional approaches that connect well with the customer. And it's really some of those are working, so we continue to scale that. How much we scale will really be driven by the degree of customer connection and how much does it drive the business. But customers still love an incredible great value for fuel. And we have so many convenient fuel locations. It really works out well for our customers and for our business as well.

And just, Rodney, how should we think about -- if you do keep growing it at 8% year-over-year, how will you fund that in 2020 if you're not going to be growing the profitability of your fuel business at the same rate?

Yes. Well, when we talk about fuel cents per gallon, we do not reduce that for any rewards at all. That doesn't show up there in terms of our internal financials. If you look at the overall guidance that we gave for 2020, we would be reflecting what we expect and plan to do on fuel rewards. But it really gets back to Gary's comment in terms of by -- improving identicals by this much, these type of process changes and getting costs out, what type of capacity does that give us to invest in service and price. And we would look at fuel rewards as part of that price investment because that's how our customers look at it. Thanks, Robbie. We really appreciate everybody joining us today. And as always, thank you for your questions. Hopefully, you can get the sense from Gary and my comments that our underlying business results continue to be strong. Identicals continue to move in the right direction. We had good balance on investing in growth and cost improvements, and the free cash flow of the business continued to be strong, which positions us to get into a position of being able to buy stock back as well. So when you look at it overall in the quarter, feel very good about the underlying results and where we're headed. As you know, before I end today's call, I always like to share a few final comments that's directed at our associates and how we live our purpose every day. Last week, I was visiting with store associates in our Collierville Kroger in Memphis. And a customer approached me when I was walking into the store, and he just wanted to share why he shops at Kroger. And he said -- first of all, I…

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