Analysts: Kroger likely to see only near-term lift from Berkshire Hathaway stake

Berkshire Hathaway acquisition of a nearly $550 million stake in The Kroger Co. did little to brighten financial analysts’ outlook for the competitively squeezed supermarket giant.

Led by legendary investor Warren Buffett, Berkshire Hathaway on Feb. 14 filed a 13F form with the Securities and Exchange Commission reporting the purchase of more than 18.9 million shares in Kroger for $549.1 million.

The transaction made the Omaha, Neb.-based investment firm the seventh-largest institutional holder of Kroger shares, with a 2.37% interest. The only holders with at least a 5% stake are Vanguard Group (8.63%), BlackRock (7.24%) and State Street (5.05%).

Kroger’s stock price saw a brief lift in after-hours trading when the news emerged late Friday heading into the President’s Day weekend, and the momentum appeared to continue on Tuesday. Kroger shares closed on Feb. 14 at $28.23 and opened this morning at $29.80. As of late-day trading on Feb. 18, the price stood at $29.83.

While analysts said it’s hard to dispute the longtime, successful track record of Buffett — known as the “Oracle of Omaha” — and the shot in the arm it gives Kroger investors, they expressed uncertainty about the rationale behind Berkshire’s Kroger play, given the Cincinnati-based company’s difficult position in the grocery retail arena.

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“Obviously, it’s a big vote of confidence in Kroger, the management team and its strategy,” said analyst Rupesh Parikh of Oppenheimer & Co. “We don’t know if it’s Warren Buffett or some of the other portfolio managers that made this investment. But it’s a clear positive to have Warren Buffett involved, and it definitely helps the stock from a support perspective.”

Though Berkshire’s backing looks to be a plus in the short term, Kroger’s long-term picture hasn’t changed, according to Jefferies analyst Christopher Mandeville.

“We hate to be on the opposite side of a debate with Berkshire Hathaway, but that's where we find ourselves as the company has taken a 2.4% Kroger stake,” Mandeville wrote in a research note Tuesday. “While advantaged versus many, we fail to see Kroger’s long-term appeal, as it's losing share to most scaled peers, its online fulfillment/pricing strategy concerns us and ROIC [return on invested capital] continues to deteriorate. That said, with Omaha in its corner and recent media coverage of Amazon’s new grocery concept proving unexciting, near-term sentiment clearly improves.”

In his report, Mandeville and his team at Jefferies noted that Kroger has been losing market share to other major grocers since mid-2016, and the company’s ROIC had declined 400 basis points over the last five years. He also said Kroger has taken a “high-cost/risk approach to online fulfillment,” opting for a centralized fulfillment center (CFC) model to fill online grocery orders via its partnership with U.K.-based Ocado. A recent deep-drive analysis by Jefferies concluded that Kroger’s CFC investment could end up as “a multiyear mistake,” explaining that it will be couple of years before the first Ocado CFC opens, and the potential returns remain questionable on a total capital commitment of over $1 billion for 20 facilities.

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“Moreover, food for thought: If Mr. Buffett had truly appreciated the [Kroger] business model, why didn't he simply use a fraction of Berkshire Hathaway’s mountainous $128 billion cash pile to buy the company outright?” Mandeville said in the research note.

Berkshire Hathaway’s involvement doesn’t change the challenges facing Kroger, noted analyst Matt Siler of R5 Capital.

“Even Berkshire, our research suggests, will be hard-pressed to change the very difficult competitive situation for Kroger. On Friday after the close, Berkshire filed a 13F indicating a stake of just over $500 million in Kroger. The stock popped a little over 6% after hours,” Siler explained in a research note Tuesday. “While we have great respect for Berkshire, its track record in consumables is mixed (Kraft recently and Walmart a few years ago). We see most of the risk to the upside on Kroger more around events, including selling real estate or some form of M&A, as our research strongly points to continued business pressures.”

Kroger continues to feel pressure from thinning pharmacy reimbursements and other grocery retailers, notably Walmart, Aldi, Lidl and Amazon, which debuted the first store of a reported new supermarket chain in the works, according to Siler.

“Indeed, core areas of the company's business appear to face pressure and have for some time, including pharmacy, fresh, as well as the center of the store (heading online) and private-label margins due to heightened competition from Aldi and Lidl and Walmart’s reaction to these hard discounters,” he said of Kroger. “We continue to strongly urge investors to avoid the space and take the opportunity to sell Kroger on any strength.”

Still, Amazon’s new grocery store in Woodland Hills, Calif., “lacks excitement/newness” and might not be as big of a threat to Kroger and other major grocery retail players as initially believed, according to Jefferies’ Mandeville.

“Bloomberg recently reported on Amazon’s first of many planned conventional grocery stores across the country, where images shown looked boringly similar to that of a typical Whole Foods Market,” he said in his report. The store exhibited no cashierless Amazon Go technology, offered “your typical” center-of-store and meat/seafood service counters, had a “heavy influence” of prepared food and in-store dining, and featured space for online pickup orders, he reported.

“Much to our disappointment, though, the images provided no evidence of automation for the picking process, which would suggest that Amazon will continue to utilize store associates to aggregate online orders,” Mandeville wrote. “If this is the model that the online giant intends on rolling out, then we're far less concerned by the level of disruption Amazon brings to the grocery world.”