On October 14, 2022, two of the largest American grocery store operators, Kroger and Albertsons, announced that they reached a deal whereby Kroger would acquire Albertsons at a valuation of approximately $20B. The deal is widely viewed as one of the most important deals in the history of the U.S. grocery industry because each of the companies is a sizeable operation in its own right. Kroger is the largest grocery-specific retailer in the United States and Albertsons is the second largest. According to the Wall Street Journal, the combined company would rank as the largest grocery-specific retailer in the US with a 13% market share of total U.S. grocery sales. This would rank second only to Walmart in U.S. grocery sales.
Investors are still analyzing this deal and working to understand what it means for the grocery retail industry, the commercial real estate industry, and the secondary tenants that lease space in retail centers with a Kroger or Albertsons presence. In this article we will explore some of the key points of this deal and discuss the impact on various industry participants. By the end of this article, we will provide an understanding of how this development will shape the future of the grocery industry as well as the sector of the commercial real estate industry that calls these companies tenants.
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An overview of the Kroger/Albertsons Merger
Let’s take a look at some of the most important facts and figures behind the deal to help readers understand the magnitude and far-reaching implications.
The deal by the numbers
We’ll start by understanding some of the key points and statistics of this mega deal.
- As reported by the Wall Street Journal, the combined companies will generate $812B in combined annual revenue, according to an estimate by market research firm IBISWorld.
- The companies collectively employ more than 710,000 workers and operate about 5,000 stores.
- Like many deals of this size, it will take time to be completely finalized. The companies have reported that they believe the transaction could take up to two years to complete, and it could take four years for the two companies to fully combine their operations.
- At the time of this writing, the plan is for the companies to keep the names and branding of their respective stores unchanged.
Why is Kroger interested in merging with Albertsons?
Kroger and Albertsons are both successful grocery retailers, so why would they want to join forces?
It turns out that there are a few good reasons. First, the grocery retail business is a lower-margin business than many others. For example, Kroger generated an operating profit margin of 2.5% in 2021. Compare this against the 40% operating margin achieved by technology behemoth Meta Platforms, Inc. during the same time period, and it becomes clear that success in the grocery retail business is about inventory turnover and operational efficiency.
By joining forces, Kroger’s management team believes that they can gain bargaining power over suppliers to get volume discounts. The management team also hopes to benefit from gaining stores in cities and towns where they didn’t have many in the past. The combined company could benefit from a large logistics network of distributors and suppliers.
Finally, in today’s retail environment, the companies that have the most customer data are at an advantage because they can market more effectively and engage with potential customers in a more personalized way.
The deal might grab the attention of regulators
One of the most interesting things about this deal is that it may end up going through a lengthy review by the Federal Trade Commission (FTC). The FTC is a federal regulatory body that is typically in charge of reviewing mergers and acquisitions to guard against antitrust or anticompetitive practices.
As mentioned earlier, this deal will create the largest grocery-specific retailer in the U.S. and will trail only Walmart in grocery market share (22% vs. 13% according to the Wall Street Journal article referenced previously). The FTC will probably review the deal and consider whether it will create a company with so much scale that other grocers will have difficulty competing.
The FTC often looks to see how heavily concentrated a combined entity will be in different areas of the country. They also tend to look at how many other grocery retailers are present in those areas. Ultimately, the regulator has the option to hold up the deal or require the companies to sell stores in certain areas of the country. It will be some time before we know whether the deal will face any serious regulatory hurdles.
Does this merger benefit Grocery-Anchored CRE owners?
When a commercial real estate investor purchases a property, they are also assuming the tenants in place at the time of closing. With a deal like this, the big question for investors like us who are in the grocery-anchored retail space is how will this deal affect our properties and our profitability? We have a few thoughts on this.
One of the most important parts of the due diligence process when buying a commercial property is analyzing the credit profile of the tenants in leasing space there. We often ask questions like “Do existing property tenants have strong financial statements?’ and “Is there a risk that they will go out of business or struggle to earn enough to make rent payments?” This merger is no different, but the reality is that it offers many key benefits to grocery-anchored CRE owners and investors.
Kroger is an industry-leading credit profile
For owners of grocery-anchored retail centers, Kroger is considered one of the strongest credit profiles in the country. They are a sought-after tenant because they are financially strong and have one of the best grocery operations in the industry.
We expect the credit profile of the combined companies to become even stronger once the deal closes. The Albertsons business will effectively have the backing of Kroger’s financial strength, and the combined company could be able to negotiate more aggressively with suppliers to lower costs. There might also be efficiencies gained on the logistics side of the business if the combined entity is able to consolidate distribution centers to serve both Kroger and Albertsons stores.
Overall, commercial real estate investors will probably come out of this merger having more confidence in the new entity’s profitability, durability, and ability to generate cash flow in good and bad economic conditions. Kroger and Albertsons are two of the largest tenants in our sector of the commercial real estate industry, and the combination reinforces the strength and commitment of brick-and-mortar grocers. We believe this is great for long-term investors who want to grow their wealth through the success of our tenants and the retail centers they lease space in.
Expanding operations requires more commercial space
One of the hot topics in our industry is the shift in consumer shopping habits brought on by the COVID-19 pandemic. The pandemic encouraged consumers across the country to shift to online shopping and led many people to try curbside pickup for the first time. We have found that some anchor tenants require additional leased square footage to support these pickup orders. This has been a benefit to landlords in our sector over the last couple of years.
As we’ll discuss in more detail later in this article, the Kroger management team has made it clear that they intend to continue investing in technology to allow more consumers to order more goods online. This means that the company has to either a) have the ability to make last-mile deliveries in any given community and b) has to have the space to allow customers to complete curbside pickup orders.
Both trends are positive developments for our business because they often require the anchor tenant to lease additional space. Anytime a landlord can lease additional space to their most creditworthy tenant under a long-term lease, the more value and stability they add to their property. We expect to see more of this once the Kroger-Albertsons deal closes.
Successful anchor tenants benefit secondary tenants
Another reason that we look for strong anchor tenants in the deals we underwrite is because they can drive significant traffic to the retail center, which helps the secondary tenants in a major way.
Kroger and Albertsons are part of a group of retailers that were viewed as essential throughout the COVID-19 pandemic, and are known in the commercial real estate industry as tenants that draw consistent, repeat foot traffic from customers. These customers often visit other stores in the retail center while they are onsite. This creates a halo effect where the secondary tenants benefit from being located near a strong anchor. Retail centers with strong anchors typically attract secondary tenants with above average credit profiles, which is a meaningful benefit to commercial real estate investors.
Post-merger, we expect this dynamic to continue. In fact, if the combined entity is successful in deploying the technology, which we’ll discuss later in the article, they may very well be able to draw additional foot traffic to the retail centers they inhabit. We believe that the merger has the potential to benefit secondary tenants in the retail centers where Kroger and Albertsons stores will remain.
What to expect in the future
The Kroger management team has been clear that one of their main objectives is to use the scale of a combined entity to make investments in technology. In the grocery business, rolling out a technology platform across a larger base of stores, distribution centers, customers, etc., can really make the platform more successful and more cost-effective.
Having the financial resources necessary to roll out technology initiatives is an important step toward continued growth. With every passing year, more consumers are expecting their grocery retailer to offer online shopping, fast deliveries, and pickup options. The grocery retailers that can meet this growing need stand to benefit. Their growth also stands to benefit the secondary tenants in the retail center as more traffic can be accommodated when consumers are split between in-store shopping and pickup.
Owners of grocery-anchored retail centers who have space available for growing anchor tenants to lease should see strong demand going forward. There is perhaps no better scenario for a landlord than receiving a call from a tenant with one of the strongest credit profiles in the industry to request additional space in a center. We expect that the combination of Kroger and Albertsons will lead to more of these calls in the coming years.
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