Shares of retail giant Target Corporation (NYSE:TGT) and grocery giant Kroger Co (NYSE:KR) rallied in early Friday morning trade after Fast Company reported that the two are in merger talks. Target stock rose a few percentage points on the news. Kroger stock rose as much as 8%.
But both stocks have pared gains as CNBC has reported that its inside source says there is “no truth” to the Fast Company article.
So are the two companies in merger talks? Or is this all just smoke and mirrors?
Tough to tell. M&A is always tricky. Especially when the M&A involves two very big companies like Target and Kroger.
But tax reform does open a lot of cash for American companies, and there have been a healthy number of M&A deals thus far in 2018. Target stock and Kroger also have a common enemy in Amazon.com, Inc. (NASDAQ:AMZN), and teaming up could help them more appropriately deal with that enemy at scale. Both companies are aggressively pushing their private-label businesses. Both companies are investing big into delivery.
There are a lot of potential synergies here. And both stocks are pretty cheap.
Overall, I think this merger makes a ton of sense. Here’s a deeper look.
Why Target and Kroger Should Combine Forces
The biggest thing here is that Target and Kroger have a common enemy in Amazon. And Amazon, with its recent entry into physical grocery through the Whole Foods Market acquisition and its aggressive ambitions in offline retail, is only growing as a threat.
In fact, Amazon has done nothing but grow as a threat over the past several years. While sales at Target and Kroger have limped along over the past several years, Amazon’s sales have essentially doubled over the past three years.
Here’s the problem over the next five years: the more Amazon grows, the more it rubs elbows with competitors. At $200 billion in revenues for Amazon, its clearly possible for Target and Kroger to post positive comparable sales growth alongside a red-hot Amazon. But if Amazon gets to $400 or $500 billion in revenues, will it still be possible for Target and Kroger to comp positive?
It is far less likely.
Unless the two combine forces.
Target’s weak point is grocery. They’ve been unable to effectively scale that business. Kroger’s strength is grocery. Despite Whole Foods getting an Amazon-inspired makeover, Kroger is still posting positive comparable sales growth.
Meanwhile, Kroger’s weak point is delivery. They’ve had success with programs like ClickList, but the company has struggled with a true grocery delivery program. Delivery is quickly turning into Target’s strength. The company is reporting robust e-commerce sales growth, and just acquired same-day delivery company Shipt.
Clearly, there are synergies here. Kroger can help Target build out its grocery business, while Target can help Kroger build out its delivery business. Moreover, both companies are aggressively pushing their private-label businesses, so the combined Target-Kroger company would have a huge moat in the form of one of the biggest private-label businesses in the world.
Overall, this merger makes a ton of sense. The two companies don’t need each other, but they could really benefit from working closely with one another. Plus, both stocks are pretty cheap (KR stock trades at less than 12-times forward earnings, while Target stock trades at 13-times forward earnings). So if big-time market gaining synergies do kick in, then this merger could yield handsome results for shareholders of both companies.
Bottom Line for Target Stock
I personally own both stocks. They’re cheap, and materially undervalued considering their healthy (but not robust) long-term growth prospects.
The current M&A chatter makes me even more confident in my holdings. I think the two could and should combine forces, and create an omni-channel retail giant that more adequately rivals Amazon.
As of this writing, Luke Lango was long TGT, KR and AMZN.
