The nation’s largest grocery-store chain is about to get even bigger, and that should spell good things for shareholders.
For years now, traditional supermarkets like Kroger and Harris Teeter have been under assault from all sides, with discounters such as Walmart (WMT) and Target (TGT), premium grocers like Whole Foods (WFM), warehouse clubs such as Costco (COST) and — more recently — dollar stores like Family Dollar (FDO) and Dollar General (DG) all impinging on their turf.
That means taking market share and effecting economies of scale has become ever more critical not just to increasing sales and margins — but to survival.
Recall that about this time last year, SuperValu (SVU) — then the nation’s third-largest supermarket chain — put itself up for sale. But none of its rivals were interested in purchasing the cash-hemorrhaging business, and SVU’s banner retail operations were eventually sold to a private-equity group.
By buying Harris Teeter — which had $4.5 billion in revenue last year — Kroger adds 212 higher-end (read: higher-margin) stores to its already impressive base. It also deepens the company’s presence up the east coast from Florida to Delaware. Once the deal is done, Kroger will boast 2,631 supermarkets in 34 states and the District of Columbia.
It’s Kroger’s biggest acquisition since it bought Fred Meyer for about $13 billion and assumed debt back in 1999 — a lifetime ago — and it looks like a canny move.
The market certainly likes it. Usually shares of an acquiring company fall when it announces a big deal, but Kroger’s stock spiked as much as 2.8% after the opening bell.
It’s easy to see why. Touted cost savings — also known as synergies — are usually overstated when deals are announced, but the estimated savings of $40 million to $50 million over the next three to four years should be achievable in this kind of horizontal expansion.
Furthermore, Harris Teeter will help boost Kroger’s margins. Those savings and margin expansion help explain how Kroger expects the deal to add between 6 cents a 9 cents a share to earnings a year after the deal closes.
True, Kroger is paying cash for Harris Teeter — and assuming $100 million in debt — but it’s always runs a fairly levered balance sheet because it generates ample cash flow to support it (especially in this low interest-rate environment.)
Plus, Kroger is striking at a time when business is good — and accelerating. The company kicked off 2013 in encouraging fashion after a strong 2012. For the most recent quarter, earnings beat Wall Street estimates by 4 cents a share and management raised its full-year outlook.
As Hilliard Lyons analyst Jeffrey Thomison wrote in a recent note to clients:
“Kroger continues to maintain strong market share positions in the majority of its markets, as supported by its 38-quarter streak of positive identical supermarket sales. We expect the current year to produce further gains in identical supermarket sales, easing gross margin pressure, and steady operating margin.”
The addition of Harris Teeter only strengthens the market-share-and-margin part of the investment thesis — and that should only help Kroger continue to outperform the competition.
As of this writing, Dan Burrows didn’t hold positions in any of the aforementioned securities.