Kroger: Looking Decent Despite Albertsons Deal Uncertainty (NYSE:KR)

Shares of Kroger (NYSE:KR) have seen above-average interest as of late as the company of course announced its intention to acquire Albertsons (ACI) in October, a deal which triggered some controversy from various angles.

At the time of the deal announcement, I looked at the deal in this article, concluding that appeal was emerging after shares had taken a haircut in response to the deal announcement.

A Quick Retake

Shares of Kroger fell 7%, down some three dollars to $43, when the company announced its intention to acquire Albertsons. The $24.6 billion deal is huge, certainly as a full price has been paid, uncertainty will remain for a while and leverage will be taken on during an uncertain period of time.

The deal was a bit complicated as Albertsons aimed to pay out a huge dividend to its shareholders in anticipation of the deal closing, somewhat of a strange structure. Moreover, Kroger estimated that some 100 to 375 stores would be needed to be divested in order to get regulatory approval for the deal.

The transaction is set to make Kroger a more formidable competitor versus its market leader Walmart (WMT), with the added scale expected to deliver on a billion in synergies in year four, albeit that closing of the deal was only seen in 2024 with much time needed to get regulatory clearance.

With the deal, Kroger will add $72 billion in sales and some 2,200 stores, creating a pro forma business generating $210 billion in sales, $11.6 billion in EBITDA and $3.3 billion in net earnings.

Kroger has seen a very strong performance coming out of the pandemic, as it actually held onto the higher sales and earnings posted in the pandemic year 2020. The company earned $3.68 per share in 2021, while guiding for modest earnings growth to $3.80 per share in 2022. Investors were welcoming the solid momentum, sending shares to a high around $60 in April of this year.

Concerns on slower growth, inflation and higher interest rates made that shares fell to the $45 mark in the summer. The company has been faring quite well despite a rapidly changing environment. After all, the company hiked the earnings guidance to $4 per share on the back of the raging inflation.

Given the all-cash $24.6 billion deal for Albertson, pro forma net debt would rise to $37 billion, supported by $7.2 billion in EBITDA from Kroger in 2021 and $4.4 billion from Albertsons that year, translating into a 3.2 times leverage ratio. Retained earnings ahead of the deal closing as well as synergies should lower leverage ratios going forward.

Leverage is a bit on the high side, yet with shares trading at just 10-11 times earnings, multiples look quite compelling, as I picked up a few shares at $43 in mid-October, a potential successful integration and deal could drive further accretion down the road.

And Now?

Since October, shares have done well as the market apparently priced in its appreciation of the deal. Shares rose to the $50 mark by the turn of December, but by now have fallen back to $44 and change, leaving me with minimal earnings on my position.

The intermediate share price peak at the start of December came as the company posted third quarter results, a solid quarter. Identical sales rose 6.9%, that is excluding fuel, with total sales up more than 6% to $34 billion and change. The company grew adjusted earnings by ten cents to $0.88 per share albeit that the company incurred some investment losses, hurting GAAP earnings. Net debt had risen to $12.6 billion albeit that adjusted EBITDA has risen to $7.8 billion on a trailing basis, reducing leverage ratios a bit.

With the company dealing with inflation well, the company hiked the full year earnings guidance, now seeing earnings at midpoint of $4.10 per share. Moreover, this makes that relative leverage ratios are coming down ahead of the Albertsons deal, although the deal was only announced post the end of the third quarter of course. Given the debt assumed in this deal, the company will likely be cutting, or halting share buybacks altogether.

In the meantime, political controversy made that a judge blocked the $4 billion dividend payment to current owners of Albertsons on the back of antitrust and consumer protection laws. As scrutiny on the deal has risen, as it will be a wildcard if the deal will close or not, or how big the concessions will have to be made.

Concluding Remark

Truth be told is that, since the deal announcement a little over two months ago, uncertainty on the Albertsons deal has risen. In the meantime, the company has just seen a third quarter earnings report which was decent, but the uncertainty on the deal overhang remains.

With earnings power now seen above $4 per share, and the company handling inflation well, I continue to hold the stock here. Kroger should be doing alright here with or without Albertsons, as Kroger continues to be a solid part of any long-term portfolio.