Retail and grocery industry observers are now asking themselves, what will Kroger (NYSE: KR) buy next? This question is being raised because the Cincinnati-based grocery giant took a pass on The Fresh Market (NASDAQ: TFM).
It is easy to see why Kroger said no; the specialty grocer had a market capitalization of $1.332 billion and an enterprise value of $1.297 billion on March 15, 2016, yet it reported a TTM revenue of just $1.818 billion on October 31, 2015. That means Kroger would have spent around $1.3 billion to get $1.818 billion in revenue, which does not seem like a good return on investment.
Why Kroger Bought Roundy’s and Not the Fresh Market
This violates the pattern set by Kroger’s last acquisition; that of Wisconsin-based grocer Roundy’s, in November 2015. In that deal, Kroger spent $800 million to buy a publicly traded grocer that reported around $4 billion in revenue in June 2015. Kroger added $4 billion in revenue for $800 million, which is a great deal.
A quick comparison of Fresh and Roundy’s will show us what Kroger is looking for in acquisitions. Here are some of the attributes Roundy’s has that Fresh lacks:
- Roundy’s controls around 39% of the grocery market in a major American city: Milwaukee; Fresh is very much a niche player in most of the regions it operates in.
- Roundy’s operations are geographically compact; its stores are in Chicagoland and Wisconsin and adjacent to Kroger’s Midwest home base. The Fresh Market’s operations are geographically far flung and somewhat illogical; some of its stores are in Massachusetts, two or three states away from the nearest Kroger.
- Roundy’s is a traditional grocer that operates in-store pharmacies and amenities similar to those at Kroger. That means it can be easily folded into existing Kroger operations.
- Roundy’s owns four very strong grocery brands: Mariano’s, Copps, Pick N’ Save and Metro Market. Kroger likes to purchase strong grocery brands with great reputations in a market, such as Harris Teeter and King Soopers. Fresh has a very weak brand with a small share of the grocery market.
If we want to identify Kroger’s next acquisition target, we need to look for a supermarket operator that displays some of the same attributes as Roundy’s; that is, a low-priced operator of traditional grocery stores with strong brands and a large market share in urban areas.
Supervalu: A Likely Kroger Acquisition Target
There is such a grocery operator out there right now; it’s Supervalu (NYSE: SVU). There are several very good reasons why Kroger would be interested in Supervalu, including:
- Supervalu is very cheap. It had a market capitalization of $1.489 billion on March 15, 2016, yet it generates a lot of revenue; the company reported $17.87 billion in revenue on November 30, 2015.
- Supervalu is undervalued. It was trading at $5.605 a share on March 15, 2016, yet it had an enterprise value of $3.908 billion.
- Supervalu owns five supermarket brands: Cub Foods, Farm Fresh in Virginia, Hornbacher’s in Minnesota and North Dakota, Shop ‘N Save in St. Louis and Central Illinois, and Shoppers in Maryland, the District of Columbia and Northern Virginia.
- Some of these brands, including Farm Fresh in Hampton Roads, Virginia, and Hornbacher’s in Fargo, North Dakota, and Moorehead, Minnesota, are dominant in their markets.
- Many of the Supervalu operations are adjacent to Kroger’s existing operations. Shoppers and Farm Fresh operate in Virginia, where Kroger has a growing presence, and Shop ‘N Save operates in Central Illinois.
- Buying Supervalu would get Kroger into new markets, including Baltimore, St. Louis, the Twin Cities, Minnesota and North Dakota.
- The existing Supervalu stores are similar to the ones Kroger already operates. They are big grocery stores with pharmacies.
- Kroger has taken over Supervalu operations before. King Soopers took over some of the old Cub Food locations when that chain pulled out of Denver for example.
Why Kroger Might Say No to Supervalu
So Supervalu has a lot to offer Kroger, but it has some real drawbacks as well. In addition to the supermarket brands, Supervalu runs a company that services independent grocery stores, which is a shrinking business. It also operates 1,300 franchised discount stores under the Save a Lot brand. Save a Lot is a bottom-feeding discount grocer similar to Aldi.
A strong possibility is that Kroger would buy Supervalu simply to get its supermarket operations then sell the rest of the operations to somebody else. A strong contender would be the privately-held German company Aldi Sud, which operates the Aldi discount grocery stores in parts of the United States.
Why Supervalu Will Soon Be for Sale
One thing is for certain: Supervalu is a company with a lot of problems that could soon be facing the death spiral. The latest set of financial numbers I could find for it (those from November 31, 2015) are pretty dismal.
Some of the troubles at Supervalu include the following:
- A net income of just $165 million
- A profit margin of .83%
- A free cash flow of -$100 million
- $554 million in cash from operations
- $134 million in cash and short-term investments.
It looks as if Supervalu is not generating enough cash to sustain its operations, much like Roundy’s and the Fresh Market. That means this company could soon be for sale because it is very close to collapse.
One has to wonder, would Kroger buy it or simply buy some of the assets of all or some of the supermarket brands it owns? A Kroger play for Supervalu is a strong possibility simply because the company is extremely cheap right now. Expect to see something happen at Supervalu this year, possibly a Kroger acquisition.