Grocery store giant The Kroger Co. (NYSE: KR) announced Friday a merger with rival Albertsons Companies Inc. (NYSE: ACI) as part of a $24.6 billion deal.
Kroger, the second largest grocery store retail based on its market share, will see its business combine with the fourth largest grocer. The deal has been signed off by the board of directors of both firms and will require regulatory approval.
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Regulators may hesitate to give the green light if the combination of the two grocery giants results in too much power in a region. But Morgan Stanley analyst Simeon Gutman said regulators may require some store divestitures for the deal to pass, according to CNBC.
Assuming that a lengthy review process ultimately results in Kroger acquiring Albertsons, let’s take a look at a few key reasons why this merger is taking place.
Lower food prices
The latest news out of the food and beverage sector has certainly received more than its fair share of coverage with prices up more than 11% year-over-year. Invezz reported on Thursday that inflation is front and center – not only in consumers’ minds but investors as well.
During Kroger’s second quarter earnings call transcript, Kroger CEO Rodney McMullen said the company is “doing everything we can to help our customers stretch their dollars.”
McMullen noted that it is indeed passing along some of the higher food costs to customers. But it is looking for ways to minimize price increases.
Typically, a merger of two giants is done to create superior economies of scale and help drive down costs in new ways. Kroger will leverage Albertsons’ footprint to “invest in lowering prices for customers and expects to reinvest approximately half a billion dollars of cost savings from synergies to reduce prices for customers.”
Kroger’s negative traffic trends needs to be reversed
Kroger seems to have gone through a foot traffic slump. Data from foot traffic analytics firm Placer.ai that was shared with Invezz shows that visits on a year-over-three-year (Yo3Y) were down on average -4.5% each week in 2022. Albertsons, on the other hand, was up.
One would assume that Kroger is in a position where it needs to pay for growth if it can’t do so organically. Kroger (and other legacy chains) has faced increasing pressure from European chains that are typically new to the US market, much like Aldi.
In fact, Aldi was named the fastest-growing grocery chain in the US in 2021 and ranks just behind Kroger as the third largest grocer by store count.
A mega acquisition certainly sends a message to competitors that a new and formidable competitor is expected to emerge once the deal closes. Once all is said and done, Kroger will control 5,000 stores which is double Aldi’s estimated count of 2,500 stores by 2024.
Kroger is switching from defense to offense
Ocado Group (LON:OCDO), a UK-based online supermarket and technology, has been working with Kroger since 2018. Ocado constructs robotically operated warehouses and counts Kroger as its largest client. Ocado stock rose after the Kroger deal was announced which could mark a reversal in recent negative trends that you can read more about here.
According to supply chain, logistics, and transportation expert Brittain Ladd, Kroger’s acquisition is in part motivated by its online ambitions. He wrote in a LinkedIn post that Kroger “deserves to be congratulated for making a BIG move.” While any benefits from the deal will take a few years, he explains:
Kroger will greatly improve Albertsons operations, and leverage the Customer Fulfillment Centers built and operated by the Ocado Group, to fulfill online and Click and Collect orders for Albertsons.
Rather than playing defense and defending its total market share against Aldi and other rivals, perhaps Kroger is now ready to switch to offense. According to Ladd, both companies will save over $500 million across their supply chain networks within the first two years of the merger. This gives Kroger further ammunition to take market share away from Walmart, rather than focusing on defending its position against Aldi.
Ladd argues Walmart needs to “focus even more” on its grocery business, especially in the online channel. While Walmart has tools at its disposal to fight back, including leveraging Alert Innovation, a micro-fulfillment center it recently acquired.
Perhaps Kroger is counting on Walmart being complacent and taking its dominant share for granted.
Final thoughts: a merger that makes sense
There is a lot of logic to Kroger acquiring Albertsons from protecting market share to lowering price and gaining new share. Management expects the deal to close in 2024 and with food inflation showing no signs of easing, Kroger should be in a much better position in the bottom half of the decade than it was in the beginning half.
Investors that want to buy shares in the food and beverage sector should take a good luck at Kroger as it is making the right moves for long-term growth.
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