This blog post is co-authored by Irene Marks and David Mell. Marks is managing director, Retail Finance, Wells Fargo Capital Finance, and Mell is vice president, Consumer & Retail Investment Banking, Wells Fargo Securities.
Like most industries after the financial crisis of 2008, the grocery sector was broadly negatively impacted by macroeconomic factors, as well as increasing competition and changes in consumer behavior.
As a result there was a dramatic slowdown of capital markets activity, with mergers and acquisitions and initial public offerings barely making an appearance. However, over the course of the economic recovery the industry has reacted, with established players altering their go-to-market strategies, new specialized food retail formats emerging and continued rationalization of weaker competitors. This change is providing fodder for the re-emergence of a new wave of M&A and capital markets activity that will change the landscape further.
As consumers increasingly seek value, convenience, and healthy choices, effective supermarket strategies have focused on providing competitive pricing, a seamless shopping experience and enhancing and enlarging perimeter and fresh offerings. To further develop and implement these strategies, supermarkets are returning to M&A, to reap synergies and gain best practices.
Over the last two years the industry has seen a dramatic rise in the volume and dollar value of acquisitions with several landmark transactions, including the reunification of Albertsons, Kroger’s return to large acquisitions with the purchase of Harris Teeter, and the merger of Nash Finch and Spartan Stores. Additional conditions favor further consolidation — relatively attractive sector valuations motivating sellers, record low interest rates, significant cash balances on companies’ balance sheets and shareholders’ demands for growth and efficiencies to drive earnings. Private equity and activist investors have also been increasingly active, often serving as catalysts for sector activity, with a particular focus on high growth differentiated formats or underperforming “value” operations.
The trends underlying the increase in M&A activity have also lead to a resurgence of the IPO market for well-positioned traditional grocers and also the differentiated small-box alternative food retailers. Be it natural and organic, discount/limited-assortment or ethnic, these alternatives are in sync with the new consumer mega trends and such stores are increasingly becoming the “grocer of choice” for many individuals – whether they are the working mother looking for healthy and cost-effective alternatives to feed their families or the young urban professional looking for quick meals on the go. To fuel their growth, these alternative formats are turning to the equity markets, with Natural Grocers by Vitamin Cottage, Fairway, and Sprouts going public in the last two years and rumors of multiple other alternative formats considering IPOs in the future. Growth hungry investors have been incredibly receptive, sending shares soaring well above their initial IPO price, and just like consumers shopping these new formats, demanding more of such offerings from Wall Street.
Helping to finance the increased M&A activity as well as provide capital for growth has been the increasing use of asset-based loans vs. traditional cash flow loans. Asset-based loans have gained in popularity due to several relative advantages:
• They are only limited in size by the size of the collateral base, typically inventory and receivables but also other assets such as real estate, vs. a formula based on cash flow generation;
• Asset-based loans are price competitive and often require lower interest payments than cash flow loans executed for comparable credits;
• Lastly, they will often have far fewer or effectively no financial covenants. Partly as a result of these differences, asset-based loans provide greater relative flexibility when considering debt-financed acquisitions.
With positive industry fundamentals driving overall growth, and changing consumer tastes, the food retailing industry will be forced to continue to adapt. As a result, we believe consolidation and capital markets activity will remain robust well into 2014 as the grocery industry continues to evolve to suit today’s eclectic, diverse, and conscientious consumer.