Kroger Co. (KR) posted lower-than-expected operating earnings on Tuesday as sharp price cuts hurt profit margins, sending shares of the nation's top grocer down 5 percent.

Although discounting fueled a welcome rise in sales, analysts expressed concern that Kroger (search) may not be reducing costs fast enough to mitigate the effect of price cuts on the bottom line.

"The key to the stock going forward is finding cost savings to offset margin investments," said Jason Whitmer, an analyst at FTN Midwest Research.

Kroger posted an operating profit of 28 cents a share for the fourth quarter, ended Jan. 29, 7 cents below the average forecast among analysts polled by Reuters Estimates.

Its net loss widened to $675.9 million, or 93 cents a share, from a loss of $337.4 million, or 45 cents a share, a year earlier.

The latest results included a charge of $884 million, or $1.21 a share, to write down the value of its underperforming Ralphs (search) and Food 4 Less (search) supermarket divisions, which operate about 450 stores in Southern California.

Kroger's push to hold its prices close to those of leading discounter Wal-Mart Stores Inc. (WMT) has been driving a sales rebound, particularly in Southern California, a key market.

Rodney McMullen, Kroger vice chairman, told analysts in a conference call the grocer may have gone overboard with discounting in the fourth quarter.

"Frankly, we were more aggressive on pricing than we had planned. We are not happy with these results," said McMullen.

Kroger, he said, will try to rely less on costly promotions in the new year by focusing on reducing labor costs and clamping down on losses caused by theft and spoilage.

In the fourth quarter, Kroger negotiated new labor contracts covering 3,200 employees in Las Vegas and the San Francisco Bay area without a work stoppage.

McMullen said there were opportunities to cut health-care and pension costs when Kroger negotiates contracts this year covering workers across the country, from Roanoke, Virginia, to Portland, Oregon.

Chief Executive David Dillon said, "We are really focused hard on non-price initiatives to improve sales, to take some of the pressure off of the margins."

He forecast the current quarter will be "the most challenging in terms of sales and earnings comparisons to the prior year," but said full-year operating profit would likely exceed the 2004 operating profit of $1.16 a share.

Analysts' average profit forecast for the current year is $1.28 a share, according to Reuters Estimates. Forecasts range from $1.09 to $1.40 a share.

Kroger, based in Cincinnati, said fourth-quarter sales rose 5.1 percent to $13.7 billion. Sales at supermarkets open at least four full quarters, excluding gasoline sales, rose 1.8 percent. The grocer operated 2,532 stores in 32 states at the end of the quarter.

Kroger shares were down 94 cents to $16.78 in afternoon trade on the New York Stock Exchange, suffering their steepest one-day percentage drop in nearly a year.