Potential Kroger-Albertsons Combination Would Add Scale, but Draw Regulatory Scrutiny

Neither our $49.50 per share valuation of narrow-moat Kroger (KR) nor our $28.50 per share valuation of no-moat Albertsons (ACI) will change in light of media reports 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 WMT and Amazon AMZN, we suspect overlap between the two chains’ footprints in many markets may lead regulators to scrutinize a transaction closely.

We have long held that local market scale, cost leverage (particularly in omnichannel fulfillment, analytics, procurement, distribution, and advertising), own brand portfolios, and data generated from loyalty programs can help grocers fend off rivals in an intensely competitive industry. We believe Kroger stands well above other American pure-play grocers, with leading analytics, private-label, and omnichannel presences, while Albertsons is a step behind on all fronts. Whether Kroger could extend its advantages to Albertsons depends to a large degree on the extent to which regulators force divestitures in certain markets, as both companies are rivals in many regions.

Before the speculation, Kroger traded at roughly 11 times consensus fiscal 2022 earnings (or an enterprise value of 6 times adjusted consensus EBITDA; consensus as calculated by FactSet), while Albertsons traded at around 9 times earnings (enterprise value/adjusted consensus EBITDA of 5). If Albertsons were valued at a similar multiple as Kroger in an acquisition, its shareholders would receive a roughly 30% premium. However, we believe the price would depend on an assessment of the potential divestitures required, which could drive the premium meaningfully lower.