Company Reports

No-moat Albertsons’ fiscal fourth-quarter results reflected the grocery industry’s tough competitive landscape as identical sales growth of 1% underperformed our 2% estimate. Sales ticked up for the quarter primarily due to strength in the firm’s pharmacy business, while its nonperishable and fresh food categories (over 80% of sales) posted a low-single-digit decline. The 28% gross margin (up 20 basis points annually) was impressive at first glance, but gross margin contracted nearly 60 basis points, excluding favorable inventory accounting effects and fuel, amid higher fulfillment costs related to digital orders and an unfavorable sales mix (pharmacy sales typically carry a lower margin). Ongoing investments in digital fulfillment and delivery capabilities also contributed to a 60-basis-point reduction in fourth-quarter adjusted operating margin to 2.5%. We surmise that less-pronounced food inflation has prompted grocery stores’ pricing gains in recent quarters to abate, and we expect promotional activity to increase as stores compete for customer traffic to drive growth. Because Albertsons lacks a durable cost advantage over lower-priced peers like wide-moat Walmart and Costco, we maintain our forecast for weak comparable sales growth and slight operating margin degradation in fiscal 2024. We do not plan to materially alter our $28 fair value estimate and currently view the shares as undervalued.

We raise our fair value estimate on no-moat Albertsons to $28 per share, from $27, primarily due to a slight increase to our stage two growth outlook (we model flat earnings before interest growth compared with a 2% decline previously). We currently view shares as undervalued and credit Albertsons’ management team for prioritizing operational improvements at the store and supply chain level while balancing investments in its digital fulfillment capabilities, helping to drive modest margin expansion in recent years.

No-moat Albertsons, with its network of over 2,200 stores, operates as one of the largest grocery retailers in the United States. After purchasing over 600 Albertsons stores in 2006, Cerberus Capital Management expanded its footprint through its 2013 deal with Supervalu to acquire nearly 900 supermarkets, and just a year later pursued an acquisition of Safeway. Now, with stores spanning across 34 states and a more than $75 billion top line that gives the firm a strong standing with suppliers, Albertsons’ presence in US communities appears well entrenched. We also note that the grocery industry benefits from steady demand as food-at-home spending per capita typically increases at a low-single-digit pace, helping to limit mismatches in industrywide supply and demand and thus providing some stability to Albertsons’ financial outlook.

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 continue to believe that the long-term environment for the grocery sector will feature intense price competition, high customer expectations, and more costly fulfillment (particularly delivery). With wide-moat companies like Walmart and Amazon battling for national supremacy, traditional grocery leader Kroger building a highly automated delivery fulfillment network with Ocado, and the hard discounters boosting their presence, we believe Albertsons will be hard-pressed to defend its returns on invested capital (14% on average in fiscal 2020-22, but only 7% on average in fiscal 2018-19; includes goodwill). Additionally, we are skeptical that Kroger’s proposed acquisition of Albertsons will achieve regulatory approval.

We plan to lower no-moat Albertsons' stand-alone $28 fair value estimate by around $1 per share, after its third-quarter (ending Dec. 2) results continue to highlight intense industry headwinds, which we expect to endure.

We continue to believe that the long-term environment for the grocery sector will feature intense price competition, high customer expectations, and more costly fulfillment (particularly delivery). With wide-moat companies like Walmart and Amazon battling for national supremacy, traditional grocery leader Kroger building a highly automated delivery fulfillment network with Ocado, and the hard discounters boosting their presence, we believe Albertsons will be hard-pressed to defend its returns on invested capital (14% on average in fiscal 2020-22, but only 7% on average in fiscal 2018-19; includes goodwill). Additionally, we are skeptical that Kroger’s proposed acquisition of Albertsons will achieve regulatory approval.

We plan to hold our stand-alone fair value estimate of $28 for Albertsons after its third quarter (ending Sept. 9) results continue to highlight intense industry headwinds, which we expect to endure. On Sept. 8, Albertsons and Kroger announced the latter would divest 413-650 Albertsons stores to competitor C&S to meet regulatory concerns about its proposed acquisition of Albertsons, 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/Albertsons would have a meaningfully larger 4,600-unit footprint.

We remain convinced that the long-term environment for the grocery sector will feature intense price competition, high customer expectations, and more costly fulfillment (particularly delivery). With wide-moat companies like Walmart and Amazon battling for national supremacy, traditional grocery leader Kroger building a highly automated delivery fulfillment network with Ocado, and the hard discounters boosting their presence, we believe Albertsons will be hard-pressed to defend its returns on invested capital (14% on average in fiscal 2020-22, but only 7% on average in fiscal 2018-19; includes goodwill). Additionally, we are skeptical that Kroger’s proposed acquisition of Albertsons will achieve regulatory approval.

Albertsons' first quarter (ended June 17) highlighted its ability to navigate well amid an intensifying competitive landscape, which we expect to endure. Having largely accounted for this challenging environment, as reflected in just 2% sales and gross profit growth on average during the next five years, we don’t plan to materially adjust our $28 stand-alone fair value estimate, leaving shares undervalued. Our fair value estimate assumes that the proposed acquisition of Albertsons by Kroger will be blocked by regulators on antitrust grounds given concerns over higher food prices for consumers.

We remain convinced that the long-term environment for the grocery sector will feature intense price competition, high customer expectations, and more costly fulfillment (particularly delivery). With wide-moat companies like Walmart and Amazon battling for national supremacy, traditional grocery leader Kroger building a highly automated delivery fulfillment network with Ocado, and the hard discounters boosting their presence, we believe Albertsons will be hard-pressed to defend its returns on invested capital (14% on average in fiscal 2020-22, but only 7% on average in fiscal 2018-19; includes goodwill). Additionally, we are skeptical that Kroger’s proposed acquisition of Albertsons will achieve regulatory approval.

We remain convinced that the long-term environment for the grocery sector will feature intense price competition, high customer expectations, and more costly fulfillment (particularly delivery). With Walmart battling Amazon for national supremacy, traditional grocery leader Kroger building a highly automated delivery fulfillment network with Ocado, and the hard discounters boosting their presence, we believe Albertsons will be hard-pressed to defend its returns on invested capital (14% on average in fiscal 2020-22, but only 7% on average in fiscal 2018-19; includes goodwill). Additionally, we are skeptical that Kroger’s proposed acquisition of Albertsons will achieve regulatory approval.

Our $29 per share valuation of no-moat Albertsons should not change significantly after it reported fiscal 2022 earnings slightly ahead of our expectations (propelled by 5.6% fourth-quarter identical sales growth). We are encouraged that the company continues to progress in improving efficiency and bolstering its omnichannel capabilities, particularly important as we remain skeptical that its proposed acquisition by narrow-moat Kroger will pass regulatory muster. Our long-term standalone forecast for Albertsons still calls for low-single-digit top-line growth and mid-single-digit adjusted EBITDA margins over the next decade. We believe prevailing sentiment does not adequately credit Albertsons’ ability to improve its private label and omnichannel capabilities independent of Kroger (our valuation is on a standalone basis).

We remain convinced that the long-term environment for the grocery sector will feature intense price competition, high customer expectations, and more costly fulfillment (particularly delivery). With Walmart battling Amazon for national supremacy, traditional grocery leader Kroger building a highly automated delivery fulfillment network with Ocado, and the hard discounters boosting their presence, we believe Albertsons will be hard-pressed to defend its returns on invested capital (14% on average in fiscal 2020-21 but only 7% on average in fiscal 2018-19, including goodwill). Additionally, we are skeptical that Kroger’s proposed acquisition of Albertsons will achieve regulatory approval.

We do not plan to significantly alter our $29 per share valuation of no-moat Albertsons after it announced solid third-quarter (ended Dec. 3) results, including 8% identical sales growth (excluding fuel). Although the firm’s proposed acquisition by narrow-moat Kroger could prove to be a distraction as antitrust scrutiny is likely to be intense, we see a buying opportunity. We believe prevailing sentiment does not adequately credit Albertsons’ ability to improve its private label and omnichannel capabilities independent of Kroger (our valuation is on a standalone basis).

We remain convinced that the long-term environment for the grocery sector will feature intense price competition, high customer expectations, and more costly fulfillment (particularly delivery). With Walmart battling Amazon for national supremacy, traditional grocery leader Kroger building a highly automated delivery fulfillment network with Ocado, and the hard discounters boosting their presence, we believe Albertsons will be hard-pressed to defend its returns on invested capital (14% on average in fiscal 2020-21, but only 7% on average in fiscal 2018-19; includes goodwill). Additionally, we are skeptical that Kroger’s proposed acquisition of Albertsons will pass muster with regulators.

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.

Although the pandemic has provided a financial respite, we remain convinced that the long-term environment for the grocery sector will feature intense price competition, high customer expectations, and more costly fulfillment (particularly delivery). With Walmart battling Amazon for national supremacy, traditional grocery leader Kroger building a highly automated delivery fulfillment network with Ocado, and the hard discounters boosting their presence, we believe Albertsons will be hard-pressed to defend its returns on invested capital (14% on average in fiscal 2020-21, but only 7% on average in fiscal 2018-19; includes goodwill).