Deal Talks (KR, ACI)
According to numerous reports, Kroger and Albertsons are in discussions about a merger. Kroger would reportedly offer an all-cash deal for its smaller rival. A merger would combine numerous banners, nearly 5,000 stores, and result in 15-16% of U.S. grocery market share.
Albertsons reports FQ2 results on Tuesday and we are above consensus expectations on SSS and EPS. We expected an update about the company’s strategic review with the share lock-up expiration next week. We considered a sale-leaseback and share repurchase plan as the most likely outcome of the review. However, higher interest rates make sale-leasebacks less attractive.
Position Monitor Changes (COST, KR, ACI, LANC)
Costco (COST) is added to our Best Idea Long list. The shift to at-home food consumption and generational high inflationary pressures have been tailwinds to the business. The concern has been when the trends reverse, but we see Costco continuing to gain share of wallet. Costco historically has positive absolute returns in each quad. Costco’s largest outperformance vs. the market is in Quad 4. See our separate note for further details and our Black Book invite.
Lancaster Colony (LANC) moves one spot higher on the Long list. The rapidly decelerating PPI for fats and oils is an unequivocal positive for its most inflationary input. The new capacity expansion nearing completion will accelerate new business wins, leading to organic volume gains as pricing led sales growth fades. The company’s visibility in the growth of its Marzetti dressing and sauce business is underestimated with nearly half of last year’s growth from Chick Fil A alone.
Albertsons (ACI) is moved lower on our Best Idea Short list. A formalized offer from Kroger could be at higher prices and still be accretive. However, we do not expect a merger to be completed. Anti-trust regulators have prevented other mergers in the food sector including Sysco and U.S. Food’s merger in 2015. Walgreens was unable to acquire Rite Aid in 2015 after regulators said it would be anti-competitive. Three years later Albertsons was prevented from acquiring Rite Aid. In 2020, King Cullen and Stop & Shop had to call off their merger after two years of talks with regulators. Regulators did not consider increased openings from hard discounters like Lidl as competition.
We put high odds on the following:
- The DOJ and FTC will be very sensitive to any corporate merger that may lead to higher food prices for consumers.
- Regulators are not likely to consider many food retailers outside of traditional supermarkets as competitors including warehouse clubs, online only chains, and dollar stores.
- The federal government will demand significant divestments of stores in markets in which both Kroger and Albertsons currently compete including Chicago, Los Angeles, Washington D.C., Arizona, Oregon, Texas, Colorado, etc.
- The merger will have to receive the blessing of numerous unions which will demand increased compensation, benefits, and payments to pensions.
- Through it all the federal government is likely to contest the merger in such a manner that it will ultimately not be completed.
- With elevated food inflation a merger of grocers is simply going to attract an aggressive review by anti-trust regulators. It could also make a convenient target for food inflation by politicians who have already blamed Big Meat and Putin for higher prices.
Kroger (KR) is moved off our Best Idea Short list to our Short Bias list. Kroger’s shares have underperformed the S&P 500 and the XLP since our last grocery sector presentation. Our long-term expectations for share loss and the return of competitive intensity have not changed, but we are navigating around near-term sentiment and expectations. We remain short leaning, but are looking to re-short the shares when expectations are higher for sales growth, lower for margin contraction, and details around the proposed tie-up are announced.
Our updated position monitor:
September CPI (GO)
The headline CPI increased 0.4% in September from August and 8.2% YOY. Food at home inflation increased 13.0% YOY in September, decelerating from 13.5% in August. September snapped the 15-month consecutive streak of accelerating inflation. The two-year average still accelerated 50bps to 8.7%. Of the food and beverage categories, cereal & bakery products, meats, dairy, alcoholic beverages, coffee, and the other food category had sequential deceleration in September. Food at home prices accelerated 50bps sequentially to 8.5% YOY. The deceleration in food prices is notable on a rate-of-change basis, but 13% will hardly feel like a relief to consumers. Consumers still have to continue to make changes to their spending behaviors. WMT, BJ, COST, and GO are beneficiaries of the spending shift for food consumption.
Sunflowers gone (STKL)
SunOpta announced the sale of its sunflower seed business for $16M. Divesting a non-core business and narrowing the offering to plant-based foods and beverages better highlight growth and margins. We do not expect a sale of the fruit-based business in the near term, but management reminded investors that they have not changed their strategy to focus on the core businesses.
