What Will Kroger Acquire?

There has been a lot of chatter about another big acquisition by Kroger (NYSE: KR) lately, and it is easy to see why. The mega grocer just completed a really great year; in fact, in 2014 its revenue topped the $100 billion mark for the first time.

 

Kroger’s TTM revenue grew by $10.09 billion in 2014, rising from $98.38 billion in January 2014 to $108.47 billion in January 2015. That gave Kroger a quarterly year to year revenue growth rate of 8.55%. It provided investors with a dividend yield of 0.97% and a return on equity of 33.37%.

Much of that growth was driven by the acquisition of the very profitable Harris Teeter supermarket chain, which operates in the Mid-Atlantic states. It was also driven by a very healthy supermarket segment; Kroger reported that its sales without fuel grew by 6% in the fourth quarter of 2014 and its same store supermarket sales grew by 5.2%.

Things Look Good for Supermarkets

What’s more, the near future is looking really bright for the supermarket business. Low rates of inflation and falling gas prices are giving consumers more money to spend on groceries. The U.S. Energy Department expects the average gasoline price this summer will be around $2.45 a gallon, and that the average American household will spend $700 less on gasoline this summer, The New York Times reported—meaning the average household will have $700 more in disposable income.

That will benefit Kroger in another important way because the company will be able to expand its deep discounting of fuel, which drives more customers to its stores. Kroger’s rewards card program gives customers discounts on fuel based on the amount of groceries that they buy.

Acquiring another supermarket chain would make sense for Kroger at this time because it has the cash to make an acquisition. Kroger’s Chief Financial Officer, Mike Schlotman, thinks the company could complete a big deal without hurting its credit rating, The Cincinnati Business Courier reported.

There’s another reason why Kroger might want an acquisition: despite its size, Kroger still has not managed to penetrate some of America’s major grocery markets. The nation’s largest grocer is still absent from two of the nation’s three largest cities: New York and Chicago. Kroger also has only one supermarket in the nation’s third most populous state, Florida, and no operations in the country’s fourth most populous state, New York.

Companies Kroger Might Acquire

If Kroger wants to see major growth in 2015 that rivals 2014, it’ll need to make another acquisition. The question is, what chains would Kroger think of acquiring?

One strong possibility that has gotten a lot of speculation is Rite Aid (NYSE: RAD), America’s third largest drugstore operator, because of its low stock price, $8.84 a share on April 8, 2015. Despite its low price, Rite Aid has some attractive assets, including 4,572 drug stores and growing revenues.

Buying Rite Aid could help Kroger get into markets like Chicago and New York State and position Kroger to compete with Walmart’s new Neighborhood Markets. Rite Aid would fit in well with Kroger, which is a major player in the pharmacy business. Kroger filled 164 million prescriptions in 2014, and it also operates a mail order pharmacy called Postal Prescription Services. Kroger Rite Aid stores could also be a good outlet for some of Kroger’s products.

Beyond Rite Aid, there are a couple of other chains Kroger might go after. First there’s Supervalu (NYSE: SVU). Like Rite Aid, Supervalu is very cheap; its stock was trading at $11.78 a share on April 8, 2015. Supervalu had a market cap of $3.064 billion and an enterprise value of $5.588 billion on the same day.

Supervalu operates five grocery store chains in seven states: Cub Foods, Farm Fresh, Hornbachers, Shop ‘n Save and Shoppers. Some of these hold the number one and two shares in the markets they operate in.

A Supervalu acquisition would get Kroger into two major metropolitan areas it does not serve: Minneapolis/St. Paul (where Cub Foods operates) and St. Louis, where Shop ‘n Save is based. The Shoppers and Farm Fresh stores in Washington, D.C., Baltimore, and Virginia would fit in nicely with the Harris Teeter operation.

One interesting possibility is that Kroger might try to buy Supervalu’s traditional retail stores while selling off its other operations. Some of Supervalu’s other operations, such as Save-a-Lot, a franchised deep discount grocery chain, might not fit in well with Kroger. Supervalu is also a major distributor of foods to other grocery stores.

Another company that has generated Kroger acquisition speculation is the private Winn-Dixie Stores Inc., which operates 485 stores in the South. Acquiring Winn-Dixie would give Kroger a major presence in Florida, one of the nation’s fastest growing states, and such metropolitan areas as Orlando, Tampa, Jacksonville, and Miami.

Another company that would fit in well with Kroger would be the privately held Meijer, which operates 200 very profitable supercenters in Michigan, Illinois, Indiana, and Kentucky. Meijer’s standard business model is similar to Kroger’s marketplace concept, and Meijer sells some Kroger-branded products, including Fred Meyer. Like Harris Teeter, Meijer is a well-respected regional chain.

Buying Meijer would get Kroger into the Chicago region and into Wisconsin, a state where it does not operate. Meijer is planning to open four stores in the Milwaukee area this year. Meijer would also add a lot of money to Kroger’s bottom line; it had revenues of $15 billion in 2014. The problems with its acquisition are that Meijer would be an expensive acquisition and that the Meijer family, which still runs the chain, shows no sign of wanting to sell.

A dark horse acquisition would be Sprouts Farmers Market (NASDAQ: SFM), the deep discount organic grocer. Sprouts is growing fast, but it would be a small and manageable acquisition with an enterprise value of $5.552 billion and a market cap of $5.368 billion. Sprouts’ revenue is also growing dramatically; it reported a quarterly year to year revenue growth rate of 20.77% on Dec. 31, 2014. Buying Sprouts would give Kroger a stronger position in the fast-growing organic sector.

My take is that Kroger is most likely to make a big acquisition outside the grocery business unless it can get a major grocer that would expand its geographic reach. The most logical acquisition for Kroger outside the grocery business would be Rite Aid. Even if it does not make an acquisition, Kroger is still a great value investment because of its profits.

Disclosure: Your friendly neighborhood blogger owns shares of Kroger and has no plans to sell them any time soon.