Analysts: Kroger Co. (KR) poised for acquisitions

Food giant's earnings expected to jump 40 percent

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The Kroger Co  has the financial capacity to pull off an acquisition worth more than $2 billion, but company officials and industry observers are hinting that smaller bites are more likely.

Kroger is likely to be asked about potential acquisitions in its March 7 conference call to discuss fourth quarter earnings.

Nineteen analysts surveyed by Yahoo! Finance are expecting a 12.3 percent increase in revenue to $24.04 billion, compared to one year ago. Earnings are expected to increase 40 percent to $0.69 per share.

Some analysts have commented on Kroger's acquisition potential as a positive indicator for future growth.

"In a backdrop ideal for (mergers and acquisitions, Kroger) has one of the cleanest balance sheets of the traditional grocers," wrote Goldman Sachs analyst Stephen Grambling, in a Feb. 11 report.  " On our estimates, Kroger has approximately $2.3 billion in borrowing power that could be utilized for a potential acquisition."

In the last several weeks, the Cincinnati-based grocery chain has been frequently mentioned as a potential buyer in media reports about the Harris Teeter grocery chain in Charlotte, N.C. and the bankruptcy auction of the bread and snack-food lines of Hostess Brands Inc. Beyond media reports, Wall Street analysts have been speculating about acquisition scenarios involving Kroger, including Jewel Osco stores in Illinois, Sweetbay stores in Florida and a possible entry into New England by picking up troubled assets now operating under the Hannaford and Shaw's banners.

Kroger declined to comment.

But CEO David Dillon discussed the company's appetite for acquisitions in a conference call with analysts last October, when he announced that Kroger would increase its capital spending by $200 million per year. He said Kroger would spend at least some of the money to "identify new markets" and "expand the footprint of the company."

Dillon said the company was not necessarily opposed to a "transformational" deal like the $12.8 billion acquisition of Fred Meyer in 1999, which added talent and new geographic territories that made Kroger the nation's largest traditional grocer. But he added that such deals require "the right combination of assets, the right combination of people and the right pricing position."

He also said the company hasn't changed its approach to acquisitions.

"Generally speaking, the things that have worked the best for us are some fill-in acquisitions that go into existing markets that allow us to extend that market. Those have actually worked quite well and that's what we've done most of," Dillon said.

Beyond that, the company has said little about its acquisition strategy.

"I'm hoping they shed more light on it Thursday," said Alida Destrempe, a Columbus-based analyst for Kantar Retail, a consultancy owned by WPP, one of the world's largest marketing firms.

Destrempe surveyed members of Kantar's grocery team for potential Kroger acquisitions. Two of the most intriguing scenarios would involve Kroger's return to Florida and its first-ever run on the grocery market in New England.

"The fact that Delhaize just closed down 33 Sweetbay stores in Florida opens up an opportunity for Kroger to easily enter Florida," Destrempe wrote in an email to WCPO Digital. "Remodeling a store is not as expensive as building from the ground up. Florida might give Kroger the opportunity to expand its coverage and compete against new competitors of whom Kroger can easily ‘beat' by its low price position and knowledge of shoppers."
In New England, the Kantar Retail team suggests there could be an expansion opportunity in Vermont, New Hampshire and Maine.

"Hannaford is clearly going to be impacted by the restructuring and recent announcements made at Delhaize (i.e. laying off staff and failing to invest)," Destrempe wrote. "With Shaw's also in trouble, it might be possible that Kroger would consider a New England entry in the northern tier and it is not totally impossible Delhaize would divest Hannaford, which would certainly raise more cash than 30 Sweetbays would. Hannaford is a better base for Kroger than Shaw's would be."

The Kantar team also identified the Jewel-Osco chain as a potential buying opportunity for Kroger, an idea endorsed by Goldman Sachs analyst Stephen Grambling and Karen Short from BMO Capital Markets.
Short said the private equity firm "Cerberus recently acquired five banners from Supervalu, and we believe Cerberus plans to sell some of these assets. We believe Kroger would be a bidder for Jewel-Osco – at the right price – so we believe Kroger would probably prefer to maintain financial flexibility in the near term until plans for Jewel are finalized."

Grambling said such a deal would bolster Kroger's market share in Chicago.

"Kroger management has consistently indicated that it prefers to acquire high-quality banners with strong management teams that it can partner with," Grambling wrote. "While much of the consolidation and closings are due to stores being under distress, there are select

cases where banners still have very strong share in key markets for Kroger."

One deal that would allow Kroger to improve market share in states where it already competes is Harris Teeter. A Feb. 20 report by BMO's Short said Kroger has the most overlap with Harris Teeter in Virginia and South Carolina, where Kroger operates a combined 72 stores and Harris Teeter has 52. But Short does not see Kroger as the most likely suitor for the upscale grocery chain, partly because Wall Street expects a high purchase price.

Although it's not officially for sale, Charlotte-based Harris Teeter has said that it hired J.P. Morgan to evaluate recent bids by private-equity firms. The stock closed at $43.71 Friday. Some analysts think buyers would have to pay more than $50 per share, or $2.5 billion, to get the deal done. Short and other analysts regard Kroger as a disciplined buyer, not prone to overpaying. Many see the Dutch chain, Ahold, as a more likely winning bidder, if Harris Teeter is ultimately sold.

"Kroger is predominantly a union operator," Short wrote in a Feb. 20 report. "Harris Teeter is non-union. We believe there could be some risk Kroger would face pressure to unionize some of the stores and this would alter the economics."

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