Novice Investing - Marrying Kroger

Date: Monday 13th 2008f October 2008 06:17:52 PM

Marrying Kroger - 08/07/2006

By: Novice Investing Staff

Back on October 2005, we speculated whether Kroger Inc. (KR) will be the suitor for grocery chain Albertson. Both are in the grocery business and the need for consolidation was there as the threat from Walmart was looming. The price tag for Albertson at the time was $ 17.2 Billion (including debt), which gives it a price earning ratio of 34. Also, at the time, Kroger held around $ 1 Billion in cash equivalents. Therefore, most of the purchase will be financed by debt or stocks, which made it even undesirable since Kroger stock was valued at much lower than a Price Earning (P/E) ratio of less than 20.

Kroger did not buy Albertson, which we feel is a wise decision. Albertson was being bought by Supervalu supermarket chain and private equity firm Cerberus. We did not know how the purchase turns out for Supervalu but Kroger might be better off marrying someone else. Several candidates came to mind.

Whole Foods Market Inc. (WFMI). Whole Foods has a major growth cycle ahead. It has successfully capitalized on the growing trend on organic food to excel in this special niche of grocery. Kroger can acquire Whole Foods for about $ 7.5 Billion, which is less than half of Albertson's price tag. Whole Food is richly valued however, producing an annual earning of 'only' $ 136 Million on year 2005. This brings the P/E value closer to 55. We believe that Whole Foods is a better acquisition than Albertson for one thing; Growth. Albertson is in a commoditized part of the grocery business with a P/E of 34. We'd rather stick with Whole Foods which instills a better growth prospect despite the slightly higher price.

Rite Aid Corp. (RAD). The number three drug store had been struggling for years. Acquiring Rite Aid will diversify Kroger's earning stream more compared to the Albertson's purchase. Acquiring Rite Aid will give Kroger a huge demographic play where the demand of pharmaceutical drug is expected to remain strong for years ahead. While Rite Aid has a lot of problems operationally, it can be acquired for less than $ 5 Billion including debt. For the past several years, the company had been able to cut its debt load from $ 5 Billion in the year 2000s to $ 2.4 Billion now. It is still high but the progress is there.

Sysco Corp. (SYY). Now, acquiring Sysco is a far fetched thought but it is doable if Kroger is really serious about acquisition. Sysco is valued at $ 18 Billion assuming debt and it is one of the nation's largest food distributor. Kroger's market capitalization is almost equal to that of Sysco thus the acquisition might be a leveraged move. However, the positive side is Sysco's operations. With annual earning of $ 950 Million , Sysco is one of the cheapest acquisition for Kroger. (P/E of 19). With Sysco acquisition, Kroger will also diversify its revenue stream more than Albertson's purchase.

There are many possible acquisition partners for Kroger Inc. (KR). Albertson was not the only game in town and we have just shown you several possibilities. While it is not definite, Kroger needs to consolidate and grow bigger to compete with Walmart's mighty hand. Let's hope it chooses the right partner for that.

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Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding Kroger Inc. (KR) or any other securities.

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