3 Possible Future Acquisitions For The Kroger Co

  • Acquiring a portion of Ahold NV's US business to gain entry into the North-eastern United States.
  • Acquiring SuperValu's Independent Grocer or Discount Retail divisions.
  • Further investment in or a complete acquisition of Lucky's Market.

Earlier this year, The Kroger Co. (NYSE:KR) was actively considering purchasing The Fresh Market, a chain of 184 specialty and organic stores spread throughout the United States. Following The Fresh Market's (NSDQ:TFM) eventual acquisition by a consortium of private equity funds, Kroger is now likely seeking a new company to acquire. Below I'll discuss three businesses that would work well as a part of the Kroger family. For full disclosure, I do own stock in Kroger but not in any of the potential acquisition targets mentioned below.

For a quick background to readers that do not follow retail stocks, in 2012 Kroger began executing a fill-in market strategy to increase square footage and store penetration in new and existing markets. The fill in strategy included new store openings, increasing square footage of existing locations and acquisitions. In the past four years, Kroger has acquired Harris Teeter's, Roundy's, Hiller's, and others. Acquisitions are a key strategy for Kroger's growth.

The map below shows the locations of all supermarkets in the Kroger Family as of January 2015. The stores below include Fred Meyer, Kroger, Dillon's, Jay-C, etc.

Kroger Family of Stores - 2015

US business of Ahold NV

As shown in the map above, Kroger has no supermarkets in the North-eastern United States. The company also does not have any international operations.

Ahold NV, a global supermarket operator headquartered in the Netherlands, owns the Giant-Carlisle, Giant-Landover and Stop & Shop stores in the US along with the PeaPod delivery service. Ahold's other operations are primarily in the Netherlands along with a minor presence in Germany and Portugal.

On June 24, 2015, Ahold NV announced it would merge with international retailer Delhaize Group. Delhaize's operations include stores in the United States (Food Lion), Europe (primarily Belgium) and Asia.

Below is the current geographic foot print for Ahold - Delhaize.

  1. Giant-Landover: 169 stores throughout Delaware, Maryland, Virginia, and Washington, D.C.
  2. Giant-Carlisle: 180 stores throughout Pennsylvania, Maryland, Virginia and West Virginia.
  3. Stop & Shop: 442 stores in New Jersey, New York, Massachusetts and Rhode Island.
  4. Food Lion: 1,100 stores primarily in the Southeastern United States.

A complete acquisition of Ahold - Delhaize's US operations is unlikely as there is a significant overlap between existing Kroger and Food Lion stores. Additionally, the cost and complexity of a complete acquisition would be too high. Kroger may try to acquire the Stop & Shop franchise to gain entry in the northeastern United States where it currently has no presence. Though I do not view a Stop & Shop acquisition as likely to occur, it does work well with Kroger's fill-in strategy.

SuperValu Independent Grocer and Discount Retail

Investors in SuperValu had a rough experience the past 12 months; SuperValu's stock price has fallen nearly 50% since May 2015. While the company is not currently at risk of delisting or bankruptcy, it's depressed valuation ($1.25 Billion) may make it an attractive acquisition target.

SuperValu 1 Year Stock Price

SuperValu consists of three businesses:

  1. 194 traditional supermarket stores in Illinois, Maryland, Minnesota, Missouri, North Dakota, Virginia and Washington DC.
  2. 1,334 discount retail stores with the Save-A-Lot banner located throughout the entire United States.
  3. Grocery distribution to 1,900 independently owned and operated grocers

For fiscal year 2015, the gross profit and revenue composition were:

  1. Traditional retail: 27% of sales, 55% of gross profit
  2. Discount retail: 26% of sales, 29% of gross profit
  3. Grocery distribution: 46% of sales, 16% of gross profit

The traditional SuperValu supermarkets (Cub Foods, Farm Fresh, Hornbackers, Shop N'Save, etc) operate in markets where Kroger currently has a sizable presence. As this segment provides 50% of SuperValu's gross profit, the company is unlikely to divest it. The geographic overlap to existing Kroger locations also makes an acquisition of SuperValu's supermarkets unlikely.

The discount retail division includes company-owned stores and franchised operations. As stated in last quarter's investor call, Kroger is experimenting with discount retail through the Ruler banner. Kroger has no experience with franchised operations and is unlikely to be interested in acquiring all Save-A-Lot locations. If Kroger is successful with it's Ruler pilot in discount retail, the company may be interested in acquiring Save-A-Lot stores that are company owned and rebrand them into Ruler. Kroger can gain immediate entry into new geographies for discount retail and SuperValu can raise cash to buy back it's stock at a depressed price.

SuperValu's grocery distribution division is the least profitable business but still may be an attractive acquisition. SuperValu distributes many of its private label products to small independent stores throughout the United States. Kroger's superior performance  among retailers is partly driven by its strength in private label products. Acquiring SuperValue's distribution business can provide Kroger an additional sales channel for its private label products.

If SuperValu's stock price continues to decline, Kroger may very well pickup an entire division of the company or select assets within a division. Acquiring company owned Save-A-Lot stores seems to be the top option if the Ruler experiment succeeds.

Lucky's Market

On April 1st, Kroger announced it made a significant investment into Lucky's Market; a chain of 17 natural and organic stores spread throughout the United States. No financial terms of the investment were disclosed.

Lucky's Market would be a good fit for the Kroger company with their focus on natural and organic food. Kroger's Simple Truth brand, a line of organic and natural products, generates sales of over $1 billion annually. Acquiring Lucky's Market would provide another sales channel for Simple Truth and other Kroger private labels. Private labels that are currently sold by Lucky's Market could also be made available through Kroger supermarkets.

In last quarter's investor call, Kroger CEO Rodney McMullen stated that the company is experimenting with a new retail outlet called Main + Vine; a Seattle store focused on health eating. If the Main + Vine pilot is successful, acquiring Lucky's Markets would immediately provide Kroger 17 new stores to rebrand as Main + Vine. The customer base of Lucky's and Main + Vine is similar so the rebranding should be simple. Since Lucky's Markets only operate 17 stores, the cost and complexity of an acquisition would be very low.

Conclusion

Predicting Kroger's next acquisition is difficult; outside a few insiders, no one knows which business the company will acquire next. Of the three potential targets discussed above, Lucky's Market seems the most likely based on the existing investment, small size and focus on organic and natural food.

SuperValu may not be interested in parting with either their Independent Grocer division or their Discount Retail stores. Ahold-Delhaize may be attempting to create a national supermarket operation to compete with Kroger and Wal-Mart. As Kroger completes the integration of Mariano's and Roundy's, the company is likely on the hunt for its next target. That target may well be Lucky's Market.

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Comments on this article and KR stock

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ray.saudlach
bullish
Good article; you're the top kroger story on Google Finance right now.

I think Kroger will try to pick up select assets from SuperValu. Maybe a few stores here and there esp in Northeast where real estate is expensive.
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SingleSoul1976
neutral
Kroger should have bought super valu with a stock for stock merger & then sold of any division it didn't want..Then kroger could do more mergers with less debt & have more free cash flow..Kroger probaly wont do that any ways..
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Do share this awesome post