Kroger and Albertsons Merge in $25bn Deal to form US Supermarket Giant
Deal Overview
Acquirer: Kroger (NYSE: KR)
Target: Albertsons (NYSE: ACI)
Total Transaction Size: $25bn
Sector: Technology: US Retail
Close Date: Early 2024
Acquirer Advisors: CITI Group, Wells Fargo Securities
Target Advisors: Goldman Sachs & Co, Credit Suisse
On October 14th, 2022, the board of directors for both grocery giants unanimously approved the acquisition of Albertsons by Kroger with the deal likely to materialise in early 2024. A very ambitious goal has been set by Kroger which hopes the merger will bring them closer to the market share of Walmart, the largest retailer in the United States, who brought in US$459.51bn worth of sales in 2021 alone.
Kroger is set to acquire all the outstanding shares of Albertsons common and preferred stock at $34.10 per share (US$24.6bn), along with a special cash dividend of up to US$4bn to its shareholders.
With its goals to become an industry leader Kroger-Albertsons has set itself milestones in delivery quality, value and choice to the 85 million households it provides for. A strong emphasis on logistics with optimised supply chains leads to a broader and fresher supply of goods at an affordable price. As well as enhancing existing loyalty programs to offer a more streamlined ecosystem for customers to increase retention.
Following the announcement of the acquisition of Albertsons, Kroger’s share price fell sharply from $48.36 to $41.32 on the 17th of October as investors were sceptical about Kroger’s claims that the deal would cut prices. The stock has slowly climbed its way back up to $48.83 but it’s still shy of its high $62.78 high earlier in the year after the Q1 revenues exceeded expectations.
There is still worry surrounding the deal, namely the US$4bn dividend pay-out which has been criticised for being too hasty and should be put off until a full antitrust review takes place. The congressional hearing for this is due to take place where Kroger CEO Rodney McMullen and Albertsons’ top executive, Vivek Sankaran, will face questions about the deal.
Kroger Overview
Kroger was established in Cincinnati, Ohio in 1883, and since its inception has grown to over 2,850 stores across America, with 2,721 supermarkets and 129 jewellers as of Q2 2022. The company employs over 420,000 people, which is set to grow as new employment opportunities open following the merger. Kroger’s largest market share is in the Online Grocery Sales industry, accounting for approximately 18.5% of total industry revenue.
Kroger’s revenue has been steadily increasing YOY with its biggest jump being seen in 2021, boasting revenues of US$132.49bn, an increase of almost US$10bn from 2020.
Albertsons Overview
Established in Boise, Idaho in 1939 and backed by the private equity group Cerberus Capital, Albertsons boasts a less-diverse list of offerings compared to Kroger. Albertsons solely focuses on the supermarket aspect, with over 2,250 stores offering general grocery shopping along with bakery, deli and pharmacies located within their establishments.
Like Kroger, Albertsons has experienced strong growth with consistent revenue growth YOY, growing from US$62.45bn in 2020 to US$69.69bn in 2021 which remains less than half the size of Kroger. The strength of Albertsons was that most of its stores are in the Midwest and west coast of the US whilst Kroger primarily operates in the northeast and the east coast making the acquisition one that makes perfect sense when it comes to the geographical spread of the stores across the US. This rings especially true when considering Walmart has a strong presence across the entirety of the country.
US Supermarket Industry Overview
The supermarket & grocery industry will always be lucrative, especially in a country of over 331 million people. As population increases and indicators such as purchasing power parity (PPP) grow, a direct conversion to higher growth rates within various industries can be observed. PPP grew almost 6% from 2021 to 2022 which roughly correlates to the supermarket industry growth during the same timeframe.
The market size has grown to US$811.5bn in 2022 leaving the supermarket & grocery industries just shy of the top ten industries by revenue in the US but if growth rates don’t stagnate, we can expect supermarkets to make an appearance on that list in the next five years.
Within the supermarket industry, Walmart unsurprisingly leads the pack with a massive 21.3% market share as of Q1 2022. Kroger is a distant second on the list at 10.2% whilst Albertsons sits fourth with 5.8%. Following the acquisition, Kroger, and Albertsons would have a projected market share of 16%, making the goal of de-throning Walmart as the market leader in groceries a difficult, but much more achievable task.
M&A activity in the sector has been on the back burner for 2022, with only 226 deals announced – a 34% drop compared to 202. As inflation and interest rates continue to rise, so will unemployment, bringing a decrease in discretionary spending from the average citizen. This turbulent macro-environment is difficult to predict however, great demand for ESG presents an opportunity for those brands that are socially conscious and focus on sustainability. Kroger is one of these, with its annual ESG report for 2022 highlighting its plans to build a more equitable and sustainable food system as well as its bid to increase workforce diversity and fight food insecurity.
Valuation Analysis
We analysed the intrinsic value of Albertsons Companies Inc using The Sparks DCF Model.
Our WACC was calculated as 5.57%. With interest rates in the US on the rise, we estimated the risk-free rate at 9% (inflation for October 2022 + 1%), Albertsons Beta was 0.33, and the Cost of Debt was 3.4%.
What we found interesting was the high percentage of debt that makes up Albertson's capital structure. With roughly 56% of the capital structure being debt and a debt-to-equity ratio of 1.28, Albertsons has positioned itself with little room for error. While the global economy moves into uncertain territory, and inflation still being a real issue, the cost of debt for Albertsons will increase significantly.
Our DCF model yielded an intrinsic value of $29.05 per share, a 14.8% discount to the final acquisition price of $34.10 that Kroger will pay. We used a range of analyst consensus estimates to build our model (Revenue Growth etc) to ensure maximum accuracy.
SWOT Analysis & Conclusion
All considered this merger would create a US retail behemoth which could severely impact the prices and quality of products for consumers. “There is no reason to allow two of the biggest supermarket chains in the country to merge — especially with food prices already soaring,” said Sarah Miller, executive director of the American Economic Liberties Project, a consumer group. “With 60 per cent of grocery sales concentrated among just five national chains, a Kroger-Albertsons deal would squeeze consumers already struggling to afford food, crush workers fighting for fair wages, and destroy independent, community stores. This merger is a cut-and-dry case of monopoly power, and enforcers should block it.”
I hope you enjoyed the article!
See you next month,
Andre & Roman
Disclaimer
This communication is for informational and educational purposes only and should not be taken nor used as investment advice, as a personal recommendation, or solicitation to buy or sell any financial instrument. This material has been prepared without considering any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or structured product are not, and should not be taken as, a reliable indicator of future performance. I assume no liability as to the accuracy or completeness of the content of this publication.