Analysts Weigh in on Kroger's Purchase of Harris Teeter

CINCINNATI — The agreement by Kroger Co. here to acquire Harris Teeter Supermarkets puts the company in a strong position to grow in the Carolinas and Mid-Atlantic, analysts said last week.

“We continue to view Harris Teeter as a well-positioned, high-end banner in attractive markets for growth, including the Carolinas and greater Washington [including Baltimore], as well as a good cultural fit for Kroger,” said Andrew Wolf, a Boston-based analyst with BB&T Capital Markets.

Wolf just a few days prior to the acquisition had published a report called “Should Kroger Acquire Harris Teeter?” in which he speculated that such an agreement “would be a good deal for Kroger” given Harris Teeter’s strong history of performance.

The $2.5 billion price — $49.38 per share, plus the assumption of $100 million in debt — was at the low end of what Wolf had expected Harris Teeter to fetch. He suggested that other potential strategic bidders, such as Lakeland, Fla.-based Publix Super Markets, had dropped out of the bidding.

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Meredith Adler, an analyst with Barclays Capital, New York, said she thought the price was “reasonable.”

“We think this is a very good acquisition for Kroger, given the quality of the asset and its operations in high-growth markets,” she said in a report.

Harris Teeter, based in Matthews, N.C., had disclosed earlier this year that it was seeking strategic alternatives, after being contacted by investment firms. Kroger had indicated during the past year that while it remained cautious when evaluating acquisition opportunities, it was considering entering new markets.

If the acquisition is completed — pending shareholder approval — it would be the largest acquisition in 15 years for Kroger.

Kroger said Harris Teeter’s strong position in growing markets made it a compelling target.

“Harris Teeter is located in the exciting, high growth mid-Atlantic and Southeastern U.S. markets. Their store footprint is highly complementary to Kroger’s,” said Michael Schlottman, Kroger’s chief financial officer, in a conference call with analysts on Tuesday. “They share our customer-centric approach to everything we do — from store format and merchandising to disciplined execution across the organization.”

Read more: Kroger CEO David Dillon discusses the acquisition in his Power 50 profile.

Acquiring Harris Teeter allows it to enter new markets like Charlotte, N.C., and Washington, D.C., at less cost than moving in organically through new-store development, Schlottman explained.

Neil Stern, managing partner, McMillanDoolittle, Chicago, said that regardless of whether the purchase price for the 212-store chain was appropriate, “it appears to make a lot of sense.”

“It starts with geography, and what it essentially does is that it gives Kroger very strong access to the Carolinas, and maybe even more significantly, moving into northern Virginia and Maryland,” Stern explained. “As big as Kroger is, they don’t have a presence in the Northeast, and they didn’t have strong presence in the Carolinas.”

Perhaps as important as the geographic fit, however, is the fact that Harris Teeter has a long history of sales growth and profitability, and a strong management team, he said.

“I think the reason they did this one has more to do with quality. It is the quality of the acquisition, not the numbers or the geography. Harris Teeter runs a very successful format.

He said he sees several opportunities for Kroger to leverage its strengths to boost Harris Teeter’s performance even further, including through its buying power; its strength in private label, both as a retailer and manufacturer; and in its data analytics, through its DunnhumbyUSA joint venture.

Read more: Kroger Adds New Divisions in South

While private label and the V.I.C. loyalty program are both current strengths at Harris Teeter, Stern explained, Kroger brings more resources and scale to those areas.

He also noted there “could be cross-pollenization” of some of Harris Teeter’s strengths, such as its perishables merchandising, into Kroger, particularly its more upscale Fresh Fare stores.

Kroger said it did not anticipate closing any stores, but noted that the two companies have some “minor overlap” in a handful of markets, including Raleigh, N.C.; Charlottesville and Hampton Roads, Va.; and Nashville, Tenn.

“We are making plans now as to how we will operate in each of these markets over the long term,” Schlottman said.

Harris Teeter operates 138 locations in North Carolina, including 55 in the Charlotte area. It has another 31 locations in the Washington market. Harris Teeter also has several stores in “affluent vacation destinations and university communities,” Schlottman noted.

The acquisition would pit Kroger against Publix in the Charlotte market, where the Lakeland-based operator has recently established a new regional headquarters to guide its expansion there. Publix has begun opening some stores in the region, just across the border in South Carolina, and expects its first North Carolina supermarkets to debut in 2014.

SN Infographic: Harris Teeter by the Numbers

Kroger already competes against Publix in Atlanta and a few other markets in the Southeast.

Although Harris Teeter is non-union and Kroger operates mostly unionized stores, Adler of Barclays noted that she does not anticipate that the Harris Teeter stores — which operate primarily in non-union markets — would become organized.

In the conference call, Kroger also said it was hoping to learn from Harris Teeter’s “click and collect” online shopping strategy.

Kroger is expected to retain the Harris Teeter name and said it also planned to retain certain “key” management personnel.

Stern of McMillanDoolittle noted that from early indications it appears that Kroger is making the right moves to preserve the qualities that have made Harris Teeter excel.

“You don’t see the red flags we’ve seen with other deals in the past,” he said.

Kroger said it expects net accretion to earnings per diluted share in the range of 6 cents to 9 cents in the first full year after the merger, excluding transition and transaction expenses. It also said it expects about $40 million to $50 million in annual cost synergies over the next three to four years.

The merger is subject to regulatory approval. The transaction also is subject to a Harris Teeter shareholder vote, which will require approval from a majority of the outstanding shares.

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