Does Roundy’s Really Add Value to Kroger?

The management team at Kroger (NYSE: KR) certainly knows what a bargain looks like and how to take advantage of one. They demonstrated this by buying Roundy’s (NYSE: RNDY), a small Wisconsin-based supermarket operator, for around $800 million last week.

The Roundy’s acquisition is a bargain for Kroger because of everything the supermarket giant got for its $800 million. Some of Roundy’s attributes include:

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  • A presence in Chicago, the nation’s third largest metropolitan area, something Kroger so far has lacked. Roundy’s well-loved subsidiary, Mariano’s, operates around 34 stores in Chicagoland. This means that Kroger now has operations in two of America’s three largest cities, Los Angeles and Chicago, although it still has no presence in the nation’s largest metro area, New York City.

 

 

  • More expertise and presence in the lucrative and growing urban and upscale grocery markets. Mariano’s competes directly with Whole Foods Market (NASDAQ: WFM) in Chicago. It has been able to hold its own with that chain by offering a wide selection of fresh and organic products and such amenities as instore pianists and an executive chef on staff. The Chicago Tribune reported that Kroger plans to adopt some of Roundy’s best practices.

 

 

  • Entry into another major urban area, Milwaukee, where Roundy’s is based.

 

 

  • A 39% share of the Milwaukee-area grocery market.

 

 

  • A presence in another state where it had no operations: Wisconsin. This means Kroger now operates in 35 states.

 

 

  • Around $4 billion in additional revenue. Roundy’s reported a TTM revenue figure of $4.03 billion on June 30, 2015. This would increase Kroger’s revenue to $112.53 billion from $108.78 billion.

 

 

  • Impressive revenue growth. Roundy’s revenue grew from $3.49 billion in June 2014 to $4.03 billion a year later—an increase of around $540 million in a year.

 

 

  • A highly experienced and well-respected management team at Roundy’s. This includes CEO Bob Mariano, who is credited with quickly building one of the most respected new grocery brands of recent years—Mariano’s.

 

 

  • 151 supermarkets in two states.

 

 

  • 101 pharmacies.

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  • Four additional supermarket brands: Mariano’s, Pick ‘n Save, Copps and Metro Market.

 

 

  • Another urban market, Chicago, in which to test its delivery services and online capacities, including click and pull. Click and pull, which Kroger got from Harris Teeter, allows customers to order online and pick the items up at the stores.   

 

  • The potential to expand into other markets in the Upper Midwest, including Madison and Green Bay.

So yes, folks, Roundy’s adds a lot of value to Kroger for a very low price. This is a textbook example of strategic acquisition.

Roundy’s Is Not a Healthy Company

Kroger is inheriting some serious problems at Roundy’s, which is far from a healthy company. The Milwaukee Journal-Sentinel reported that Roundy’s lost $8.6 million in the third quarter of 2015.

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To make matters worse, Roundy’s same store sales fell by 3.6% during the same period. In contrast, Kroger’s same store sales increased by 5.3% during the same period.

Roundy’s has a few other problems, including $646 million in debt and liabilities that exceed its assets. The smaller grocer reported liabilities of $1.192 billion and assets of $1.06 billion on June 30. It also reported a negative profit margin of -.15%.

Even though it is cheap, Roundy’s is far from competitive. Kroger will have to fix a lot of problems at Roundy’s simply to keep its doors open.

Why Roundy’s Is Losing Money and Kroger Is Not

One reason why Roundy’s has not been competitive is that it has been unable to match the prices at aggressive discounters, including Wal-Mart, Costco and the privately-held Meijer, all of which operate in Wisconsin. Meijer has started opening stores in Wisconsin, and it has announced plans to build a distribution center in the state.

Roundy’s simply lacks the sales volume needed for the kind of deep discounting that today’s consumer has come to expect. Kroger has demonstrated that it is a bulk discounter capable of matching and even undercutting prices at Walmart and even dollar stores in recent years. Grocery consultant David Livingston told The Journal-Sentinel that prices at Pick n ’Save could drop by four to five percent when Kroger takes over.

Another reason why smaller grocers like Roundy’s have had a hard time competing is that they lack the resources to offer some of the amenities customers have come to expect, such as gas stations. Much of Kroger’s recent success has been its ability to add such amenities as gas stations, cafes, coffee shops, clinics, gourmet cheese counters, sushi bars and even jewelry shops to its stores.

Buying Roundy’s could allow Kroger to bring its Market Place supercenter concept and gas stations to Wisconsin and possibly into Chicagoland. Meijer, which only operates supercenters, is already familiarizing customers in the area with the concept.

This means that Kroger can make money from Roundy’s brands and locations when the smaller grocer cannot. Kroger has the resources to offer the kinds of discounts and amenities that Roundy’s cannot.

Can Smaller Grocers Survive?

This makes the Roundy’s acquisition look like a fire sale. The smaller grocer effectively sold itself to avoid the death spiral and bankruptcy.

The situation at Roundy’s raises serious questions about the ability of smaller grocers to survive. It also means that there could be more bargains out there for Kroger to take advantage of in the near future. Expect Kroger to gobble up more regional chains over the next few years and enter new markets.

By acquiring Roundy’s, Kroger’s management team has demonstrated that they know how to increase value and market share through strategic acquisition. Expect Kroger to keep adding value as the grocery business consolidates and smaller operators become less competitive.