Is Kroger (KR) a Smart Bet Amid Largest Retail Merger Ever?

The Kroger Co. (KR), a leading food and drug retailer, seeks to close its $24.60 billion deal to acquire Albertsons Companies. As previously reported, Kroger and Albertsons entered a definitive agreement to merge in October last year, aiming to expand customer reach and enhance proximity to deliver fresh and affordable food to nearly 85 million households with a premier omnichannel experience.

“As a combined entity, we will be better positioned to advance Kroger’s successful go-to-market strategy by providing an incredible seamless shopping experience, expanding Our Brands portfolio, and delivering personalized value and savings. We believe this transaction will lead to faster and more profitable growth and generate greater returns for our shareholders,” said Rodney McMullen, Chairman and CEO of Kroger.

The new update in this deal is that Kroger disclosed the company had “certified substantial compliance” with the Federal Trade Commission (FTC) as of November 15. This move means that the antitrust regulator FTC would decide whether to approve or fight one of the largest retail mergers ever by December 15.

“We continue to work cooperatively with the FTC in its review of the transaction,” McMullen told Wall Street analysts during a conference call on Thursday, November 30. “This step keeps us on track to close our proposed merger with Albertsons in early 2024,” he added.

Now, let’s discuss some of the factors that could influence KR’s performance in the near term:

Update on “Leading with Fresh and Accelerating with Digital” Strategy

Kroger updated investors on how its “Leading with Fresh and Accelerating with Digital” strategy positions it for long-term sustainable growth. The company accelerated the Fresh Produce Initiative with a total of 2,053 stores currently certified.

On October 2, KR launched Kroger® Mercado, a Hispanic-inspired brand added to the Our Brands’ portfolio with products exclusively sold at Kroger Family of Stores. Kroger® Mercado’s expansive assortment offers more than 50 products, including items like fresh meat, snacks, sides, desserts, beverages, and more.

Also, in September, the grocery retailer announced its commitment to making more local products available to its customers following its proposed merger with Albertsons. After the close, the combined company will increase the number of local products in its stores by 10%, equating to at least 30 new local products in each store.

The company made significant progress in accelerating its digital strategy. During the third quarter, Kroger’s delivery sales grew by 20% compared to last year’s quarter, driven by the strength of Kroger Boost and Customer Fulfillment Centers. Also, it increased digitally engaged households by 13% from a year ago.

Digitally engaged householders are extremely valuable to KR’s model as they are loyal, spend approximately three times more, and accelerate growth in alternative profit businesses.

Upbeat Last Reported Financials

For the third quarter ended on November 4, 2023, KR reported sales of $33.96 billion, surpassing analysts’ estimate of $33.90 billion. Its gross margin was 22% of sales for the quarter. The FIFO gross margin, excluding fuel, grew three basis points compared to the same period of 2022. Its operating profit increased 8.4% year-over-year to $912 million.

The grocery retailer’s net earnings before income tax expense were $851 million, an increase of 61.8% from the prior year’s quarter. Also, adjusted net earnings attributable to KR rose 8.6% year-over-year to $698 million. The company posted an adjusted EPS of $0.95, compared to the consensus estimate of $0.92, and up 8% year-over-year.

KR achieved a strong adjusted free cash flow, leading to a net total debt to adjusted EBITDA ratio of 1.40 on a rolling four-quarter basis.  As of November 5, 2023, Kroger’s cash totaled $254 million, compared to $241 million as of November 4, 2022. The company’s current liabilities reduced to $16.79 billion, compared to 17.74 billion as of November 4, 2022.

Regarding its outstanding financial performance, KR’s Chairman and CEO, Rodney McMullen, commented, “Kroger’s third quarter results highlight the strength and diversity of our business model in a challenged operating environment, as strong fuel performance and growth in our alternative profit businesses supported continued adjusted net earnings per diluted share growth.”

“As consumer spending tightens, we are focused on providing customers with exceptional value. By maintaining our long-term commitment to lower prices, personalized promotions and rewards, we are growing households and increasing loyalty, positioning Kroger for sustainable future growth,” he added.

Solid Historical Growth

KR’s revenue and EBITDA grew at respective CAGRs of 3.5% and 9.6% over the past five years. Its EBIT increased at a CAGR of 13.9% over the same period. Additionally, the company’s normalized net income rose at a CAGR of 17.9% over the same timeframe.

Furthermore, the company’s total assets and levered cash flow improved at CAGRs of 6% and 14.7% over the same period, respectively.

Full-Year 2023 Guidance

For the rest of the year, the grocery retailer updated its full-year guidance to reflect the impact of near-term economic pressures and food-at-home disinflation. KR expects full-year identical sales without fuel to be in the range of 0.6% to 1.0%, with underlying growth of 2.1%-2.5% after adjusting for the effect of Express Scripts.

KR’s adjusted FIFO operating profit is expected to be $4.9-$5 billion. The company expects its adjusted free cash flow to be in the range of $2.50 to $2.70 billion.

“At the same time, we are confident in our ability to navigate these near-term headwinds and we are raising the lower end of our full-year adjusted net earnings per diluted share guidance range,” said KR’s CFO Gary Millerchip.

Kroger projects its adjusted net earnings per share to be between $4.50 and $4.60, including an estimated benefit from the 53rd week of nearly $0.15.

Favorable Analyst Estimates

Analysts expect KR’s revenue for the fourth quarter to grow 6.3% year-over-year to $37.01 billion. The consensus EPS estimate of $1.14 for the ongoing quarter indicates a 14.8% year-over-year increase. Moreover, the company has surpassed the consensus EPS estimates in each of the trailing four quarters, which is impressive.

For the current fiscal year 2024, Street expects Kroger’s revenue and EPS to grow 1% and 7.7% year-over-year to $149.78 billion and $4.56, respectively.

Impressive Capital Allocation Strategy

KR expects to continue to generate solid free cash flow and remains committed to investing in the business to boost long-term net earnings growth and maintain its current investment-grade debt rating. The company also expects to continue paying its quarterly dividend and increase it over time, subject to board approval.

Kroger paid a dividend of $0.29 per common share in the third quarter, up 11.5% from the dividend declared for the third quarter of 2022. The company pays an annual dividend of $1.16, which translates to a yield of 2.60% at the current share price. Its four-year average dividend yield is 1.97%.

Moreover, the company’s dividend payouts have increased at a CAGR of 17.4% over the past three years. Kroger has raised its dividends for 16 consecutive years.

Discounted Valuation

In terms of forward non-GAAP P/E, KR is currently trading at 9.77x, 44% lower than the industry average of 17.44x. The stock’s forward EV/Sales of 0.33x is 79.8% lower than the industry average of 1.66x. Likewise, its forward EV/EBITDA of 6.36x is 41.8% lower than the industry average of 10.93x.

In addition, the stock’s forward Price/Sales and Price/Cash Flow multiples of 0.21 and 5.11 are favorably lower than the respective industry averages of 1.14 and 13.22.

Bottom Line

Kroger recently reported third-quarter fiscal 2023 results, wherein the top and bottom lines beat analysts’ estimates. The company’s solid third-quarter results reflect the strength and diversity of its business model in a challenging operating environment.

Further, the consistent progress in its “Leading with Fresh and Accelerating with Digital” strategy positions the retailer for robust long-term growth. KR is confident in its ability to navigate near-term headwinds and has raised the lower end of its full-year adjusted EPS guidance range. It also remains committed to delivering attractive and sustainable returns to shareholders.

Moreover, KR approaches the finish line on acquiring grocery chain Albertsons, as the $24.60 billion deal hits the major milestone with Kroger disclosing the company had “certified substantial compliance” with the FTC. By law, this triggers a 30-day timeline in which the anti-trust regulator must accept the deal or sue to block it by December 15.

The potential Kroger-Albertsons merger will accelerate KR’s go-to-market strategy and position the combined company as a premier omnichannel food retailer, delivering quality, value, convenience, and choice to customers. Also, it will strengthen Kroger’s value creation model to boost profitability and enhance shareholder returns.

As KR nears its proposed merger with Albertsons, it could present an attractive investment opportunity.