Kroger Seen as Bargain at Cheaper Than 99% of S&P 500: Real M&A

Kroger Seen as Bargain at Cheaper Than 99% of S&P 500
Kroger earned 2.6 cents in operating income for every dollar of sales in the past 12 months, the least among U.S. food retailers with more than $2 billion in market value, according to data compiled by Bloomberg. Photographer: Tom Uhlman/Bloomberg News

For potential acquirers, there may never be a better time to go grocery shopping in the U.S.

Kroger Co., the largest U.S. grocery-store chain, traded last week at an 86 percent discount to its projected sales this fiscal year, leaving it cheaper than 99 percent of companies in the Standard & Poor’s 500 Index, according to data compiled by Bloomberg. The Cincinnati-based company, which lost $4.7 billion in market capitalization during the last recession, was valued at 10.8 times estimated earnings, the lowest level for a U.S. food retailer greater than $2 billion, the data show.

Kroger, which has increased sales in every year since at least 1987 even as Target Corp. and Wal-Mart Stores Inc. grabbed market share from other supermarkets, may now become a target for retailers outside the U.S. or private equity firms, according to Northcoast Research Holdings LLC. Valued at $13.7 billion last week, Kroger could still attract a takeover offer 30 percent above its current price, Point View Wealth Management Inc. said, making it the largest grocery acquisition on record.

“Of the traditional pure-play grocery stores, Kroger is the crown jewel,” David Dietze, president and chief investment strategist at Summit, New Jersey-based Point View, which owns shares of Kroger, said in a telephone interview. “They have a long consistent record of positive same-store sales performance. It’s timely to acquire Kroger because it’s cheap.”

Keith Dailey, a spokesman for Kroger, said the company doesn’t comment on rumor or speculation.

Today’s Trading

Shares of Kroger climbed as much as 1.1 percent today and closed 0.6 percent higher at $24.06 in New York. That was the fifth-biggest gain among 42 companies in the S&P 500 Consumer Staples Index.

Kroger traces its roots back to 1883, when Barney Kroger used his life savings of $372 to open a grocery store in downtown Cincinnati. Since then, the company has grown to more than 2,000 Kroger supermarkets, selling Kroger brand food items such as ice cream, pasta sauce and fruit juice.

The company also operates retailers including the Fred Meyer grocery and department store chain, the Turkey Hill convenience shops and Littman Jewelers.

After losing $4.7 billion in market value during the longest recession since the Great Depression, Kroger has lagged behind a rebound in consumer stocks. Since June 2009, when the 18-month contraction ended, shares of Kroger gained just 4.9 percent through last week, versus a 41 percent advance for the S&P 500 Consumer Staples Index.

Relative Value

While Kroger was able to boost sales through the recession, its profitability declined in each of the past five years as the company lowered prices to compete with discount store chains such as Wal-Mart.

Kroger earned 2.6 cents in operating income for every dollar of sales in the past 12 months, the least among U.S. food retailers with more than $2 billion in market value, according to data compiled by Bloomberg. The supermarket chain also has lower operating margins because it operates gas stations, a less profitable business, according to Charles Cerankosky, a Cleveland-based analyst for Northcoast.

Shares of Kroger last week were valued at 0.14 times estimated sales of $95.8 billion for the year that started this month, according to data compiled by Bloomberg. That was cheaper than 488 of 495 other S&P 500 companies with sales projections from analysts, the data show.

Record Sales

Kroger also traded at 10.8 times projected profit of $1.3 billion for the current fiscal year. That was about half the average for five U.S. food retailers with market capitalizations of more than $2 billion. Both the earnings and sales numbers for this year would be records, the data show.

Food retailers outside the U.S. have bought American grocery chains in the past and some may be interested in acquiring Kroger if they are seeking further investment in the country as Europe’s sovereign debt crisis threatens its economy, Point View’s Dietze said.

Royal Ahold NV, the Dutch company that bought the Stop & Shop chain in 1996, also owns Peapod, the online grocery shopping and delivery service. Tesco Plc, Britain’s largest supermarket company, owns the Fresh & Easy Neighborhood Market chain on the U.S. West Coast. Delhaize Group SA is the owner of Food Lion, Bottom Dollar Food and Hannaford.

While the 17-nation euro region’s gross domestic product will contract 0.5 percent in 2012 and the U.K. will only grow 0.5 percent, according to economists’ estimates compiled by Bloomberg, the U.S.’s GDP will rise 2.3 percent, the data show.

U.S. Economy

America’s economy expanded at a 2.8 percent annual rate in the final three months of last year, the fastest pace since the second quarter of 2010. The jobless rate unexpectedly fell in January to the lowest in three years as payrolls climbed more than forecast, Labor Department figures showed last week.

“The reason I think of a foreign buyer is because Kroger represents a large U.S. franchise in the retail food industry,” Northcoast’s Cerankosky said in a telephone interview. “On a fundamental basis it’s cheap and we very much like the company’s ability to continue to grow market share.”

While Kroger is an attractive business, its size may make buyers hesitant to do a deal that large as the industry faces increasing challenges and competition from unconventional food retailers, according to Edward Kelly, a New York-based analyst at Credit Suisse Group AG.

“Kroger would be too large,” Kelly said in a telephone interview. “It’s a good, well-run company, but it’s in a tough business. There’s a lot of different places that consumers can go to buy food today and the supermarkets are kind of caught in the middle because they’re losing share.”

‘It’s Doable’

Size may not be an issue if private equity were to team up with an overseas grocery chain such as Delhaize or Carrefour SA, the world’s second-largest retailer, Point View’s Dietze said.

A group of buyers could pick and choose which brands and assets they want and private equity could decide to restructure the real estate, he said.

“It’s doable,” Dietze said.

In addition to Delhaize and Carrefour, Ahold may also want to expand its footprint in the U.S. by acquiring Kroger and may see an opportunity to improve profitability, said Michael Holland, chairman and founder of New York-based Holland & Co.

“As bad as things look in the U.S. for the consumer, they look worse in Europe,” Holland, whose firm oversees more than $4 billion in client assets, said in a telephone interview. “It’s possible that an industry participant might have a little bit of an edge simply because they might be able to drive some efficiencies and some cost savings.”

‘Fairly Inexpensive’

Steven Vandenbroeke, a spokesman for Brussels-based Delhaize, didn’t respond to telephone calls or e-mails seeking comment. An e-mailed request to Carrefour’s media relations department also wasn’t returned.

Jochem van de Laarschot, a spokesman for Amsterdam-based Ahold, declined to comment on whether the company has considered a takeover of Kroger.

Kroger may command a 30 percent premium in a takeover, or $31 a share based on last week’s closing price, Dietze said. At that price and assuming its $7.47 billion in net debt, Kroger would be valued at about $25 billion, the largest acquisition of a food retailer on record, data compiled by Bloomberg show.

“A 30 percent premium is definitely reasonable,” Malcolm Polley, who oversees about $1 billion as chief investment officer at Stewart Capital in Indiana, Pennsylvania, said in a telephone interview. “If they’ve already got exposure here, it gives any of the retailers outside of the U.S. the ability to expand their reach. It looks to me it’s in pretty good shape and it’s fairly inexpensive.”

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