Why Kroger Should Acquire The Fresh Market

  • Kroger and Fresh Market have a minimal geographical overlap in store foot prints.
  • Acquiring Fresh Market will expand outlets for Kroger's private label products.
  •  Strong synergies between Fresh Market and Vitacost.com will help Kroger.

Late last week Reuters reported that Kroger (NYSE:KR) and a competing group of private equity firms are in second round discussions to purchase The Fresh Market (NASDAQ:TFM), a chain of organic and specialty food stores. While there is no certainty that Kroger's bid will prevail, a successful acquisition of Fresh Market will strengthen Kroger's geographic footprint, sales of high-margin private label products and it's e-commerce store Vitacost.

Geographic Footprints

Kroger has no presence in the northeastern part of the United States. Kroger's presence is primarily focused on the West Coast, Mid West and southeast of the United States. 18% of the United States population lives between Pennsylvania and Maine, and is not currently served by Kroger stores (including Harris Teeter's, Dillon's, Fred Meyers, etc).

Kroger Family

 

Fresh Market currently has 184 locations throughout the United States.

A basic comparison of geographical footprints between Kroger and Fresh Market shows:

  • 45 Fresh Market locations in Florida where Kroger only has one store.
  • 18 Fresh Market locations in the Northeast where Kroger has zero stores.
  • 5 Fresh Market locations in Oklahoma, Wisconsin and Iowa where Kroger has zero stores.

More than 33% of Fresh Market locations operate in states where Kroger has no presence or an extremely small (1 store) presence. A deeper analysis using zip codes and population is needed to see the total overlap between Kroger and Fresh Market. However, it's quite evident that by acquiring Fresh Market, Kroger gains a presence into Florida, the northeastern United States and numerous other states where they currently do not operate. More than one-third of the stores they acquire will be in no way competing with their existing locations.

Private Label Sales Channel

Kroger's recent outperformance in the market is partly due to their strength in private label products. According to former Safeway CEO Steven Burd, when a retailer sells a private label product its gross margin is 35% versus a 25% gross margin for other products. Companies with high gross margins can potentially deliver high profits.

Kroger's strength in private label sales is showcased with Simple Truth and HemisFares. Simple Truth is now the largest natural foods brand in the world. Kroger sells more natural and organic products than Whole Foods. 10% of Kroger's $108 billion in annual revenue is from natural and organic products. HemisFares is Kroger's newest private label product for foodie customers and is so popular the company is straining to meet demand.

Fresh Market's stores, similar to Whole Foods', offer primarily organic and specialty products. Fresh Market also offers numerous private label organic and natural food products. The acquisition of Fresh Market will create another outlet for Kroger to offer it's popular private label organic products like Simple Truth and HemisFares. Strong private label products from Fresh Market can also be sold at Kroger locations. This cross-selling of private label products will increase gross margins and lead to higher profits.

Vitacost.com Synergies Will Aid Kroger

Twenty months ago, in June 2014, Kroger purchased online retailer Vitacost.com for $280 Million. Through its e-commerce store, Vitacost sells numerous nutritional supplements as well as natural household and beauty products. Fresh Market sells similar products through its 184 physical stores.

Similar to the synergies for private label products between physical locations for Kroger and Fresh Market, Kroger can realize numerous synergies between Vitacost and Fresh Market. With a successful acquisition, Kroger can offer Fresh Market's nutritional supplements, household and beauty products on Vitacost's e-commerce store.

A stronger e-Commerce business for Vitacost will help Kroger compete with Walmart (NYSE:WMT) and possibly, to some extent, Amazon (NASDAQ:AMZN).

Conclusion

A successful acquisition of Fresh Market will offer Kroger an expansion in its geographic footprint, provide cross-selling opportunities for high-margin private label products and strong synergies to expand it's Vitacost e-commerce store. Purchased for the right price, Fresh Market will enable Kroger to better compete with Whole Foods in the organic and natural products space and Walmart and may be Amazon in e-commerce.

Contrarian View

Over the past 36 months, Kroger has made numerous acquisitions. The company purchased Harris Teeter's, Roundy's and seven Hiller Market stores in Detroit. An acquisition of Fresh Market will add almost 200 additional stores for the company to integrate.

Fresh Market currently has a market capitalization of $1 billion. Kroger currently has a capitalization ratio of 65% and $274 million in cash. Acquiring Fresh Market will require Kroger to increase its debt burden. This may weigh down future dividend growth and share buybacks.

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Comments on this article and KR stock

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ray.saudlach
bullish
If Kroger does purchase Fresh Market, Whole Foods may be in some deep trouble.

Kroger seems like a runaway train right now that just can't be slowed down.
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cw_45
neutral
I hope Kroger acquires Fresh Market, then they can fire the absolutely useless Human Resource staff and get some people who can solve difficult employee problems. Then they can get rid of the poster child for incompetent store management at the Hendersonville, NC store.
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