Analysts see benefits for Sprouts in Albertsons merger

Sprouts Farmers Market stands to gain from the buying power of Albertsons Cos. if the two companies were to consummate the merger they are reported to have discussed, according to analysts.

Both Sprouts and Albertsons purchase product from wholesaler KeHE Foods, and combining the two contracts could result in savings of about $50 million annually, according to Karen Short, an analyst at Barclays Capital.

Albertsons recently signed a long-term supply agreement for natural and organic product with KeHE, while Sprouts’ agreement with KeHE expires next spring, she said.

A potential merger, which was reported last week to have been in the very early stages of discussion, could also shave overhead costs by a combined $100 million, estimated Short (left). Additional savings, she said, could be gleaned in produce procurement and private label manufacturing.

The companies have not commented on merger talks.

Although some analysts questioned whether the fast-growing, independent Sprouts would want to be absorbed by a traditional supermarket retailer like Albertsons, Short said Albertsons’ decentralized management structure could be attractive to Sprouts.

“We believe this potential combination makes sense because we believe the cultures of each firm are aligned and believe the synergies gained by Albertsons in a merger scenario would almost equal the reverse synergies gained by Sprouts,” said Short in a report on the potential merger.

Kelly Bania (left), an analyst with BMO Capital Markets, characterized Albertsons’ reported interest in Sprouts as “opportunistic,” given the smaller retailer’s recent struggles amid a prolonged deflationary environment. She noted that other retailers, including Whole Foods Market and Kroger Co., could also be interested in acquiring Sprouts, particularly if its stock price dips again.

Sprouts’ shares had fallen to all-time lows below $18 until about two days before Bloomberg reported that the company was in talks with Albertsons. The share price quickly shot up to near $23.

Scott Mushkin (left), an analyst at Wolfe Research, said he believes Sprouts would not be best served by a merger with Albertsons, given the challenges Albertsons faces in the current competitive environment. He also said it appears unlikely that Albertsons, which is owned by private equity firm Cerberus Capital Management and other investors, would want to add more debt to its balance sheet.

Cerberus had been planning to spin Albertsons off as a public company following its January 2015 merger with Safeway, but it put the offering on hold because of investor unease in the industry, according to reports. It had planned to sell about 65.3 million shares at $23 to $26 per share, Albertsons said in a 2016 filing with the Securities and Exchange Commission.

In its most recent filing in January, Albertsons reported revenues of about $45.9 billion for the 40-week period through Dec. 3, 2016, and listed about $12.3 billion in debt.

“Albertsons’ owners, we believe, are increasingly driven to find a way to bring Albertsons public in order to reduce debt levels and to create a vehicle for future monetization,” Mushkin said in a report. “Given this situation, adding any leverage without a monetizing event seems unlikely.”

Analysts have speculated that adding the fast-growing Sprouts banner to its portfolio could make Albertsons more appealing as a public offering. Sprouts is considered a strong player in the organic/natural/specialty niche, and seeks to differentiate itself from Whole Foods Market with its competitive pricing, particularly on produce. It has more than doubled in size in the last four years, growing from about $1.8 billion in revenues in 2012 to more than $4 billion in 2016.

Bania of BMO Capital Markets noted that Albertsons and Sprouts have a “relatively high” percentage of stores within close proximity to each other, indicating that a “modest/immaterial” number of stores might need to be divested in order to satisfy regulators if they were to pursue a merger. Eighty-one percent of Sprouts locations are within five miles of an existing Albertsons store, 78% are within three miles, and 39% are within one mile, she said.

Phoenix-based Sprouts, which operates about 260 stores, had 96 locations in California, 40 in Texas and 32 in Arizona, as of Jan. 1. Most of its other stores are scattered throughout the West, with about 20 in the Southeast.

Boise, Idaho-based Albertsons operates 2,327 stores in 35 states, with a heavy concentration in the West.