Company Reports

Although Kroger operates over 2,700 stores and its top line eclipses $150 billion, we have stripped the grocer of its narrow moat rating as we no longer believe it has a durable competitive edge. The industry is highly competitive, with a virtual absence of customer switching costs, so we think food retailers tend to compete primarily on price. While Kroger’s national footprint likely results in strong relationships with its suppliers—the company is the third-largest domestic grocer with about 7% share, according to Euromonitor—we fail to see how national scale translates into a substantial cost advantage over lower-priced peers like wide-moat Walmart, wide-moat Costco, and hard discounters such as Aldi. Additionally, we don’t think Kroger’s loyalty membership program, fuel rewards, and in-store pharmacy provide a unique means of driving foot traffic to stores.

With over 2,700 locations across the United States and a portfolio of over 20 different banners, no-moat Kroger is one of the nation’s leading grocery retailers. It built its vast footprint through expansion of its namesake banner along with numerous acquisitions of competing chains, giving it an ingrained presence in many US communities. Considering this, an immense top line (eclipsing $150 billion in fiscal 2023) that brings a strong standing with suppliers, and its loyalty membership program, Kroger’s competitive standing appears enviable at first glance.

As we expected, narrow-moat Kroger adequately navigated disinflationary headwinds and value-seeking consumers in its fiscal fourth quarter. Identical sales (excluding fuel and effects of the terminated Express Scripts agreement) expanded 0.1% after lapping a difficult 6% prior-year comparison. Management said traffic increased as promotions lured consumers back to its stores, and it reaffirmed its commitment to volume growth in fiscal 2024. While top-line results did not come as a surprise to us—full-year identical sales growth of 2.3% was in line with management’s guidance of 2.1%-2.5%—full-year adjusted earnings per share of $4.76 outpaced our $4.52 forecast as margins proved resilient amid favorable private-label penetration and lower supply chain costs.

After reviewing narrow-moat Kroger and no-moat Albertsons' planned merger for over a year, the US Federal Trade Commission ultimately deemed the nearly $25 billion deal anticompetitive and sued on Feb. 26 to block it. We have long held that the merger would face insurmountable regulatory scrutiny, thus to us, the decision was not unexpected. While the timing of future litigation and the ultimate court ruling remain uncertain, we still view the proposed deal as unlikely to close, and we do not plan to alter our $53 and $27 per share fair value estimates for Kroger and Albertsons, respectively.

We find it peculiar that Gary Millerchip has resigned from his role as chief financial officer of narrow-moat Kroger, given that this comes amid a proposed merger with no-moat Albertsons and that he was set to maintain his position with the combined company. This could be a signal that the merger will continue to face regulatory hurdles; the Federal Trade Commission has been reviewing it for over a year. We have long held that the merger would face insurmountable regulatory opposition and that Kroger’s effort to divest Albertsons units to C&S Wholesale Grocers would not be enough to push the deal through, as C&S stands to have 600-750 units while the combined Kroger/Albertsons would have a meaningfully larger 4,600-unit footprint. On the other hand, Millerchip’s decision to move on from Kroger could simply be due to having a more attractive opportunity as the new chief financial officer of Costco, which we believe has a relatively stronger competitive advantage, as signaled by our wide moat rating for the warehouse retailer.

Judging from the muted share price reaction, investors weren’t caught too off-guard by subdued third-quarter results from narrow-moat Kroger, which faced disinflation headwinds and shoppers who continue to seek value, much as wide-moat grocery peer Walmart did. Same-store sales excluding fuel dropped 0.6% as Kroger faced a tough 6.9% comparison, waning food inflation (down 270 basis points from last quarter to the low single digits), and reduced pharmaceutical sales from the terminated Express Scripts deal last December (a 150-basis point headwind). While Kroger continues to gain higher-income households, overall volume was down (unquantified by the company), lagging the growth in inflation. Amid these headwinds, Kroger once again lowered its 2023 same-store sales growth outlook to 0.6%-1% from the low end of prior 1%-2% guidance.

Of the traditional grocers, we believe Kroger's scale, partnerships, private-label fare, and data capabilities uniquely position the company to defend its returns against competition that should intensify as Amazon, mass merchandisers, and hard discounters continue to price aggressively to boost volume. We contend that Kroger still benefits from enduring intangible assets and cost advantages, even if its acquisition of Albertsons is derailed by regulators.

Narrow-moat Kroger shares moved up 3% on news it would divest 413-650 Albertson stores to competitor C&S, to meet regulatory concerns of its proposed acquisition of Albertson, allowing for a potential completion early next year. We still see regulatory uncertainty, though, as C&S stands to have 600-750 units, while the combined Kroger/Albertson would have a meaningfully larger 4,600 unit footprint. Apparently, the market concords with our view, with Albertson trading around $24 per share, below Kroger’s $34 per share cash offer.

Of the traditional grocers, we believe Kroger's scale, partnerships, private-label fare, and data capabilities uniquely position it to defend its returns against a competitive onslaught that should intensify as Amazon, mass merchandisers, and hard discounters price aggressively to boost volume. Thus, we contend that Kroger still benefits from enduring intangible assets and cost advantages (even if its acquisition of Albertsons is derailed by regulators).

Despite inflation’s grip on consumer spending habits, narrow-moat Kroger’s first-quarter sales results tracked largely in line with our fiscal 2023 expectations, with profitability better than anticipated. As such, we plan to raise our $54 fair value estimate by a low-single-digit percentage, leaving shares trading at a discount, particularly after a post-print mid-single-digit dip in share price. Although Kroger faces challenges in a price-competitive grocery landscape, we believe investors underestimate the firm’s ability to resonate with consumers through its dynamic private-label offerings and data-driven promotional capabilities, while utilizing scale to extract efficiencies to invest in price. These features underpin the brand asset and cost advantage we see for Kroger.

Of the traditional grocers, we believe Kroger's scale, partnerships, and data capabilities uniquely position it to defend its returns against a competitive onslaught that should intensify as Amazon, mass merchandisers, and hard discounters price aggressively to boost volume. Thus, we contend that Kroger still benefits from enduring intangible assets and cost advantages (even if its acquisition of Albertsons is derailed by regulators).

Of the traditional grocers, we believe Kroger is uniquely positioned to defend its returns against a competitive onslaught that should intensify as Amazon, mass merchandisers, and hard discounters price aggressively to boost volume. Industry factors are diminishing its competitive standing, but we contend that Kroger still benefits from enduring intangible assets and cost advantages (even if its acquisition of Albertsons is derailed by regulators).

We plan to raise our $52 fair value estimate for narrow-moat Kroger by a mid-single-digit percentage after its fiscal 2022 results. We view shares as attractive, even after a similar rise following the results.

Of the traditional grocers, we believe Kroger is uniquely positioned to defend its returns against a competitive onslaught that should intensify as Amazon, mass merchandisers, and hard discounters price aggressively to boost volume. Industry factors are diminishing its competitive standing, but we contend that Kroger still benefits from enduring intangible assets and cost advantages (even if its acquisition of Albertsons is derailed by regulators).

Our $49.50 per share valuation of narrow-moat Kroger should not change much after it announced third-quarter results, with solid performance amid continuing high inflation. Our long-term forecast still includes low-single-digit revenue growth and adjusted operating margins on average over the next decade, and we continue to suggest that investors should seek a greater margin of safety before building a position.

Our $28.50 per share valuation of no-moat Albertsons should rise by a low- to mid-single-digit percentage, reflecting the time value of money and solid second-quarter earnings (including 7% identical sales growth) that has it tracking ahead of our full-year estimates (3.5% expansion). Our long-term forecast (low-single-digit percentage revenue growth, mid-single-digit percentage adjusted EBITDA margin) and valuation reflect Albertsons’ prospects on a standalone basis, as we believe the firm’s combination with narrow-moat Kroger will garner regulatory resistance, with divestitures potentially insufficient to garner approval. We still suggest prospective investors await a greater margin of safety.

While we see the merits of Kroger’s cash offer to acquire Albertsons for an estimated total of $34.10 per share, we are skeptical that regulators will approve the deal. So, we are leaving our fair value estimates in place: $28.50 for Albertsons and $49.50 for Kroger.

Neither our $49.50 per share valuation of narrow-moat Kroger nor our $28.50 per share valuation of no-moat Albertsons will change in light of rumors that they are considering a merger, as we await more concrete information before incorporating a deal into our analyses (shares of the former are roughly flat and the latter up around 10% in the wake of the report). While we believe a combination between the two largest pure-play grocers in the United States would create scale benefits (and associated cost and purchasing leverage) that would help fend off burgeoning omnichannel titans Walmart and Amazon, we suspect overlap between the two chains’ footprints in many markets may lead regulators to scrutinize a transaction closely.

Of the traditional grocers, we believe Kroger is uniquely positioned to defend its returns against a competitive onslaught that should intensify as Amazon, mass merchandisers, and hard discounters price aggressively to boost volume. Industry factors are diminishing its competitive standing, but we contend that Kroger still benefits from enduring intangible assets and cost advantages.

Similar to the trading reaction, our $48 per share valuation of narrow-moat Kroger should rise by a mid-single-digit percentage after the firm announced second-quarter earnings that leave it trending ahead of our full-year targets. The results (including 5.8% identical sales growth, excluding fuel; period ended Aug. 13) were underpinned by its broad portfolio, including its strong private-label offerings, which we believe contribute to its competitive advantages. We still expect low-single-digit revenue growth and adjusted operating margins on average over the next decade, but with the shares trading near our valuation, we suggest investors seek a greater margin of safety before building a position.