Regulatory clearance remains uncertain, but a Kroger-Albertsons merger could spark changes across the marketplace
Just when you thought brick-and-mortar was out of the grocery retail spotlight, the Kroger-Albertsons merger deal dragged it right back in. 칓ģ§ė øģ¬ģ“ķø
E-commerce has grabbed much of the grocery industryās attention in recent years, especially since the pandemic. But the biggest U.S. supermarket merger ever ā in which Kroger is acquiring Albertsons ā has turned the conversation back to physical stores.
The Kroger Cos. and Albertsons Cos. have a lot of them. The joining of the first- and second-largest U.S. supermarket retailers would create a truly national operator with 4,996 stores, 66 distribution centers, 52 manufacturing plants and 2,015 fuel centers in 48 states and the District of Columbia. The merged company also would be the fifth-largest pharmacy retailer, with 3,972 pharmacies. On the dollars side, Kroger and Albertsons generated a combined $210 billion in revenue and $3.3 billion in net earnings in fiscal 2021.
Among the largest players in the grocery retail channel by total sales, Kroger-Albertsons would vault into the No. 3 spot over Costco Wholesale, which would be a distant No. 4 with 2021 sales of $141.4 billion. Only Walmart ($466.8 billion) and Amazon ($279.8 billion) would be bigger in overall sales. By store count, Kroger-Albertsons (4,996 stores) would remain at No. 8 but challenge Walmart (5,342 stores) for the No. 7 slot. ģģ ķ칓ģ§ė øģ¬ģ“ķø
Including supermarket retailers only, Kroger-Albertsons would nearly quadruple the sales of Ahold Delhaize USA, the next-largest player with $53.7 billion in fiscal 2021. By supermarket count, the merged entity would more than double No. 4 Loblaw Cos. (2,437), No. 5 Aldi U.S. (2,200) and No. 6 Ahold Delhaize USA (2,048).
Like other business sectors, grocery retail is abuzz with rumors and speculation about mergers and acquisitions. Yet the Kroger-Albertsons announcement, which came in mid-October, seemed to catch many in the industry by surprise.
āFor Kroger, theyāve been kind of eager to get into M&A for some time now,ā said CFRA Research analyst Arun Sundaram. āThey have a really clean balance sheet, lots of cash and a little debt. I just didnāt think that they would pursue an acquisition this large. A very bold acquisition, a risky acquisition, and one that looks like it will take a lot of time and work in order to get the required regulatory approval.ā
Kroger-Albertsons would become only the second grocery retailer, behind Walmart, to hold double-digit market share (before store divestitures). BofA Securities analyst Robert Ohmes pegged U.S. grocery market share for Kroger-Albertsons at mid- to high teens (pre-divestitures), compared with roughly 25% for Walmart (30% including Samās Club) and 9% for Costco at a distant third.
Cincinnati-based Kroger clearly sees itself on the same playing field as Walmart and Amazon, according to Sundaram.
āThis [merger] is going to create a much larger grocery giant,ā he said. āIt would make Kroger a more formidable competitor to Walmart and Amazon. Amazon currently has relatively low market share, but itās rapidly growing and investing in the grocery space. So for Kroger, they needed to do something to remain a top competitor, especially since companies like Walmart and Amazon have other aspects of their business that are very high-margin and fast-growing, whereas Kroger doesnāt really have that and is more of a traditional supermarketer. I think this was a move to really declare that theyāre going to be fighting along the same lines as a Walmart and an Amazon.ā 칓ģ§ė øģ¬ģ“ķø ģ¶ģ²
The merger transaction
Under the deal, Kroger plans to acquire all outstanding shares of Albertsonsā common and preferred stock for about $34.10 per share. The total value of the transaction includes the assumption of roughly $4.7 billion of Albertsonsā net debt. Plans call for Krogerās Rodney McMullen and Gary Millerchip to continue as chairman and CEO and chief financial officer, respectively, of the combined company.
In connection with the transaction, Boise, Idaho-based Albertsons was slated to pay its shareholders a special cash dividend of up to $4 billion, or about $6.85 per share, on Nov. 7. At press time, however, that payment was being held up following lawsuits by several states and the District of Columbia.
āThereās a lot of strategic merit to the combination,ā Oppenheimer analyst Rupesh Parikh said, noting that the merger would give Kroger national scale. āIt would make a much more formidable competitor to other large players like Walmart, Amazon and Target. From a longer-term perspective, employees would be better-positioned; it could mean more job opportunities. Consumers could see lower prices, as Krogerās historical track record is that they do pass through lower prices. And from a shareholder perspective, this deal could be 15% to 20% earnings accretion by year four and 30%-plus free cash-flow accretion. I think itās a win-win all around for all key stakeholders.ā
For Albertsons, the merger deal culminates a āreview of potential strategic alternativesā that its board of directors initiated in February. The effort reflected Albertsonsā concern that its business was being undervalued versus those of competitors ā including Kroger. Previously owned by an investment group led by private-equity firm Cerberus Capital Management, Albertsons went public in June 2020 following an initial public offering. Cerberus still holds an approximately 29% stake in the retailer.
āIn my mind, Albertsons was an undervalued company. So we believe Kroger got a good deal here,ā said analyst Scott Mushkin, principal of R5 Capital.
Sizing up the store geography
To help pave the way for Federal Trade Commission and other federal and state regulatory approvals of the merger, Kroger and Albertsons plan to form an Albertsons Cos. subsidiary dubbed SpinCo. This entity would be spun off to Albertsons shareholders immediately before the transactionās closing and operate as a stand-alone public company. The two retailers would determine which stores would become part of SpinCo. In announcing the merger, they estimated that SpinCo would comprise 100 to 375 stores.
Mushkin noted that the merger deal sets a store divestiture ceiling of 650, at which point the companies could re-evaluate the transaction. In a research note, R5 Capital estimated potential store divestitures at 550 for the regulatory green light and said that figure implies that Western divisions likely would be sold.
āIs 350 [stores divested] the number? We donāt think so. Basically, we think itās around 500. Thatās still well below 650,ā Mushkin said. āAnd then the question is, are there buyers for divisions or multiple divisions? We think the answer is yes.ā
Store overlap for Kroger and Albertsons appears heaviest in Southern California, Chicago, the Pacific Northwest, eastern Texas (Dallas and Houston), Denver, Phoenix and the greater Washington, D.C., area, according to BofAās Ohmes.
Indeed, from the middle of the country moving west, Kroger and Albertsons have significant conflicts in store locations. R5 Capital reported that the proximity of stores between the two retailers jumps when the radius is extended from 1 mile to 3 miles. For example, the report showed that in seven markets, the percentage of Albertsons stores in Chicago with at least one Kroger location increases from 2.79% within 1 mile to 14.53% within 3 miles. The trend is similar in other markets: Denver (30.95% 1 mile, 90.48% 3 miles), Las Vegas (28.57% 1 mile, 95.24% 3 miles), Phoenix (22.08% 1 mile, 89.61% 3 miles), Portland (29.69% 1 mile, 81.25% 3 miles), San Diego (19.72% 1 mile, 76.06% 3 miles) and Seattle (40.78% 1 mile, 87.38% 3 miles).
āWhen I saw the estimated store divestitures, 100 to 375, my first thought was that seems kind of low, given that the two companies have a combined store base of around 5,000. So itās a pretty small percentage,ā CFRAās Sundaram said. āIf you look at where they have a lot of concentration, itās really in the Midwest and West Coast. So it seems like this number could be higher than 375. Thatās kind of the consensus of what Iāve been hearing from investors and other analysts.ā
The Kroger Co.ās family of store banners includes Kroger, Ralphs, Dillons, Smithās, King Soopers, Fryās, QFC, City Market, Owenās, Jay C, Pay Less, Bakerās, Gerbes, Harris Teeter, Pick Nā Save, Metro Market, Marianoās, Fred Meyer, and Food 4 Less/Foods Co., all within 35 states. Albertsons Cos.ā store base includes such banners as Albertsons, Safeway, Vons, Jewel-Osco, Shawās, Acme, Tom Thumb, Randalls, United Supermarkets, Pavilions, Star Market, Haggen, Carrs, Kings Food Markets and Balducciās Food Lovers Market, all across 34 states and the District of Columbia.
āThe two largest areas in the U.S. where the companiesā stores do not overlap are Northern California and the Northeast,ā Coresight Research wrote in a report after the merger announcement. āAlbertsons has a significant presence in the Northeast [Acme Markets, Shawās, Star Market], while Kroger does not. However, previously, Kroger announced the construction of [Ocado-automated] online customer fulfillment centers in this region, meaning these CFCs (when operational) could cannibalize store sales. Currently, neither Kroger nor Albertsons have stores in Florida. So, while Kroger has plans to launch two CFCs and spoke distribution centers in the state, there is no risk of overlap or cannibalization.ā
More industry consolidation looming?
If the acquisition of Albertsons is approved, Krogerās market reach via physical stores will grow from 35 states ā mostly in an area stretching from the Great Lakes to the South and Mid-Atlantic, with pockets in the Central U.S., Southern California, Texas, the Pacific Northwest and Arizona ā to 48 states, bringing the grocer into the Northeast and New England while filling out markets in California, Texas, Arizona, the central and upper Midwest and the Pacific Northwest.
That national footprint, besides pressuring existing supermarket players in those market areas, would boost efficiencies of scale and negotiating leverage with CPG suppliers, enabling Kroger to better compete on price with non-supermarket rivals like Walmart, Amazon, Target and Costco, plus discounters like Aldi (now in 38 states), industry observers said.
Krogerās consumer reach also would grow substantially through the addition of Albertsons. Currently, Kroger serves about 64 million households annually, and that number would jump to 85 million with the merger.
āFor example, with retail media, this allows their advertisers to reach markets that Kroger is not in today,ā said Parikh. āSo, for example, Kroger doesnāt have a Boston presence. If Proctor & Gamble came to Kroger and wanted to reach consumers in that market, they couldnāt today. But with this combination, now they can reach consumers in the Northeast as well.ā
Having Albertsons in the mix, too, would likely fortify Krogerās efforts to extend its online reach. Under a 4.5-year-old partnership with U.K. e-grocery specialist Ocado Group, Kroger plans to roll out about 20 large, automated CFCs across the U.S. So far, 17 CFCs have been announced, and six are open. Eleven of 12 announced supporting spoke sites, automated by Ocado, are also operational. Importantly, the CFCs and spokes will give Kroger entry to markets where it now lacks stores, including Florida, Oklahoma, northeastern Ohio and Pennsylvania, and the Northeast. The addition of Albertsonsā online customers would raise the probability of success for the Ocado network.
āIf Ocado continues to work out well and you have a national footprint, then theoretically you can have more density with these facilities,ā explained Parikh. āYou can have Krogerās and Albertsonsā volume in the same geographies going into these centers, and they can ramp up faster.ā
Such marketplace power could spur other large supermarket players to act with M&A deals of their own, if the Kroger-Albertsons merger does indeed go through, industry observers and analysts said.
With a wider swath of territory from coast to coast, the combined company would present a much bigger competitive challenge to operators like Ahold Delhaize USA (East Coast), Publix (Southeast), H-E-B (Texas), Hy-Vee (Midwest) and Wakefern/ShopRite (Northeast, Mid-Atlantic), Wegmans (Northeast, Mid-Atlantic), Giant Eagle (Rust Belt, Mid-Atlantic), Southeastern Grocers (Southeast) and WinCo Foods (West).
Along with those larger players possibly seeking acquisitions, smaller supermarket retailers also could potentially join together in mergers Ć la Price Chopper/Market 32 and Tops Friendly Markets (forming Northeast Grocery Inc.) and Raleyās and Bashasā (forming The Raleyās Cos.).
āWeāve been thinking that weād see more consolidation in the food retail space for some time now. We thought it would be larger grocery chains swiping up local or regional chains. I didnāt think weād see national grocery companies like this merge,ā Sundaram said. āBut I certainly think weāll see more of the larger grocery chains acquiring some of the smaller ones and independents. One of the biggest reasons is that these smaller grocery chains and independents donāt necessarily have the scale to compete with the larger ones ā especially in e-commerce, which is now more important than ever in food retail. Itās really hard to make online grocery profitable. Even the larger companies are struggling to make that profitable.ā
The SpinCo company to be formed under the Kroger-Albertsons transaction also might present an acquisition opportunity for a regional or smaller supermarket operator, depending which stores become part of that entity. Mushkin pointed to the Kroger-Albertsons store overlap in the West.
āIf you wanted to become a regional grocer on the West Coast and that was your aim, or if you didnāt have any West Coast exposure and you wanted some, you could make that happen,ā he said.
Regulatory outlook
Kroger and Albertsons said they expect the merger transaction to close in early 2024, pending regulatory approval and other customary closing conditions, including clearance under the Hart-Scott-Rodino Antitrust Improvements Act. Grocery industry observers and analysts, though, have said the process could take up to two years.
In addition to the planned creation of SpinCo for store divestitures, Kroger has taken a number of actions that improve its regulatory prospects for the deal. For example, the company said in announcing the merger that, post-close, it would invest $500 million to lower grocery prices, $1.3 billion to upgrade Albertsons Cos. stores and $1 billion to raise worker wages and benefits.
Following recent virtual meetings between Oppenheimer and Kroger management, Parikh emphasized that the supermarket giant has done its homework.
āClearly, thereās overlap in certain markets ā the Pacific Northwest, Southern California, Chicago, Denver,ā he said. āBut Kroger and Albertsons and their shareholders have done a lot of work on this. Theyāve hired the lawyers to look at the deal. And we were with Kroger management; they are highly confident of this deal getting the regulatory approvals.ā
A fly in the ointment could be political and labor opposition to the merger, especially in an environment where high inflation has elevated food prices and grocery workers continue to battle challenges since the pandemic.
Just days after the dealās announcement, U.S. Sens. Amy Klobuchar (D., Minn.), chair of the Senate Judiciary Subcommittee on Competition Policy, Antitrust and Consumer Rights, and ranking member Mike Lee (R., Utah) said their subcommittee will convene a panel in November to address the Kroger-Albertsons transaction. At press time, the hearing hadnāt yet been scheduled.
United Food and Commercial Workers and lawmakers such as U.S. Sens. Bernie Sanders (I., Vt.) and Elizabeth Warren (D., Mass.) also have come out against the merger, contending that a combination of two huge players would squeeze smaller competitors, raise grocery prices, lead to job cuts and reduce union workersā leverage at the bargaining table. Albertsonsā planned $4 billion special dividend has also been a lightning rod for criticism from politicians, labor, and state attorneys general, who say the payment could hamper Albertsons and shouldnāt be on the table until a full antitrust review of the merger is completed.
The Kroger-Albertsons deal also presents a litmus test for the Biden administration, which has espoused a stronger consumer-protection stance in terms of mergers-and-acquisitions oversight. And in a letter to the FTC, Klobuchar and other lawmakers urged the FTC to exercise more scrutiny in its market-by-market analysis of a potential Kroger-Albertsons combination than the commission did in reviewing the 2015 Albertsons-Safeway merger.
āThe Federal Trade Commission under the current administration has publicly articulated a more pro-consumer, stronger oversight posture,ā Christine Bartholomew, a State University of New York at Buffalo law professor and antitrust scholar, said in commentary on the Kroger-Albertsons agreement. āIts position on this merger will be the first real test of whether the FTC plans to align its words and regulatory actions.ā
CFRA, based on research by its Washington Analysis policy team, gives a 75% chance that the FTC will block the Kroger-Albertsons merger, Sundaram reported.
āProbably the next big question is, if they do go and block the merger, will [Kroger-Albertsons] try to keep fighting and appealing it or will they just walk away?ā he said. āBut the big reason why we think thereās a 75% chance the FTC will block the merger is the current FTC Chair Lina Khan. Sheās recently expressed concerns about the impact of grocery store mergers.ā
However, R5 Capital sees a path for the deal to get done, citing concentrated overlap in key markets, the likelihood of potential buyers for stores or divisions, and the opportunity for organized labor (both Kroger and Albertsons are union shops) to play āa very constructive role in helping come to a suitable agreement with a buyer, Kroger and the government.ā
āWe look at it a bit differently. In our minds, thereās a path to getting this done probably much more quickly than is realized,ā Mushkin said. āIf Kroger is realistic and said, āOK, letās go to the union, letās get a buyer or two lined up, and letās go to the FTC together, hand in hand, and say hereās the plan and this is why itās good for consumers,āā he explained, āthen I think you can get it through pretty quickly.ā