Are we on the verge of a new grocery landscape?

Just when you thought brick-and-mortar was out of the grocery retail spotlight, the Kroger-Albertsons merger deal dragged it right back in.

E-commerce has grabbed much of the grocery industry’s attention in recent years, especially since the pandemic. But the biggest U.S. supermarket merger ever — in which Kroger is acquiring Albertsons — has turned the conversation back to physical stores.

The Kroger Cos. and Albertsons Cos. have a lot of them. The joining of the first- and second-largest U.S. supermarket retailers would create a truly national operator with 4,996 stores, 66 distribution centers, 52 manufacturing plants and 2,015 fuel centers in 48 states and the District of Columbia. The merged company also would be the fifth-largest pharmacy retailer, with 3,972 pharmacies. On the dollars side, Kroger and Albertsons generated a combined $210 billion in revenue and $3.3 billion in net earnings in fiscal 2021.

Among the largest players in the grocery retail channel by total sales, Kroger-Albertsons would vault into the No. 3 spot over Costco Wholesale, which would be a distant No. 4 with 2021 sales of $141.4 billion. Only Walmart ($466.8 billion) and Amazon ($279.8 billion) would be bigger in overall sales. By store count, Kroger-Albertsons (4,996 stores) would remain at No. 8 but challenge Walmart (5,342 stores) for the No. 7 slot.

Albertsons’ strengths in the fresh department will complement Kroger’s fresh offerings.

Including supermarket retailers only, Kroger-Albertsons would nearly quadruple the sales of Ahold Delhaize USA, the next-largest player with $53.7 billion in fiscal 2021. By supermarket count, the merged entity would more than double No. 4 Loblaw Cos. (2,437), No. 5 Aldi U.S. (2,200) and No. 6 Ahold Delhaize USA (2,048).

Like other business sectors, grocery retail is abuzz with rumors and speculation about mergers and acquisitions. Yet the Kroger-Albertsons announcement, which came in mid-October, seemed to catch many in the industry by surprise.

“For Kroger, they’ve been kind of eager to get into M&A for some time now,” said CFRA Research analyst Arun Sundaram. “They have a really clean balance sheet, lots of cash and a little debt. I just didn’t think that they would pursue an acquisition this large. A very bold acquisition, a risky acquisition, and one that looks like it will take a lot of time and work in order to get the required regulatory approval.”

Kroger-Albertsons would become only the second grocery retailer, behind Walmart, to hold double-digit market share (before store divestitures). BofA Securities analyst Robert Ohmes pegged U.S. grocery market share for Kroger-Albertsons at mid- to high teens (pre-divestitures), compared with roughly 25% for Walmart (30% including Sam’s Club) and 9% for Costco at a distant third.

Cincinnati-based Kroger clearly sees itself on the same playing field as Walmart and Amazon, according to Sundaram.

Kroger has been improving freshness through its End to End Fresh initiative and would bring that to the table for Albertsons Cos. stores.

“This [merger] is going to create a much larger grocery giant,” he said. “It would make Kroger a more formidable competitor to Walmart and Amazon. Amazon currently has relatively low market share, but it’s rapidly growing and investing in the grocery space. So for Kroger, they needed to do something to remain a top competitor, especially since companies like Walmart and Amazon have other aspects of their business that are very high-margin and fast-growing, whereas Kroger doesn’t really have that and is more of a traditional supermarketer. I think this was a move to really declare that they’re going to be fighting along the same lines as a Walmart and an Amazon.”

The merger transaction

Under the deal, Kroger plans to acquire all outstanding shares of Albertsons’ common and preferred stock for about $34.10 per share. The total value of the transaction includes the assumption of roughly $4.7 billion of Albertsons’ net debt. Plans call for Kroger’s Rodney McMullen and Gary Millerchip to continue as chairman and CEO and chief financial officer, respectively, of the combined company.

In connection with the transaction, Boise, Idaho-based Albertsons was slated to pay its shareholders a special cash dividend of up to $4 billion, or about $6.85 per share, on Nov. 7. At press time, however, that payment was being held up following lawsuits by several states and the District of Columbia.

“There’s a lot of strategic merit to the combination,” Oppenheimer analyst Rupesh Parikh said, noting that the merger would give Kroger national scale. “It would make a much more formidable competitor to other large players like Walmart, Amazon and Target. From a longer-term perspective, employees would be better-positioned; it could mean more job opportunities. Consumers could see lower prices, as Kroger’s historical track record is that they do pass through lower prices. And from a shareholder perspective, this deal could be 15% to 20% earnings accretion by year four and 30%-plus free cash-flow accretion. I think it’s a win-win all around for all key stakeholders.”

For Albertsons, the merger deal culminates a “review of potential strategic alternatives” that its board of directors initiated in February. The effort reflected Albertsons’ concern that its business was being undervalued versus those of competitors — including Kroger. Previously owned by an investment group led by private-equity firm Cerberus Capital Management, Albertsons went public in June 2020 following an initial public offering. Cerberus still holds an approximately 29% stake in the retailer.

“In my mind, Albertsons was an undervalued company. So we believe Kroger got a good deal here,” said analyst Scott Mushkin, principal of R5 Capital.

Sizing up the store geography

To help pave the way for Federal Trade Commission and other federal and state regulatory approvals of the merger, Kroger and Albertsons plan to form an Albertsons Cos. subsidiary dubbed SpinCo. This entity would be spun off to Albertsons shareholders immediately before the transaction’s closing and operate as a stand-alone public company. The two retailers would determine which stores would become part of SpinCo. In announcing the merger, they estimated that SpinCo would comprise 100 to 375 stores.

Mushkin noted that the merger deal sets a store divestiture ceiling of 650, at which point the companies could re-evaluate the transaction. In a research note, R5 Capital estimated potential store divestitures at 550 for the regulatory green light and said that figure implies that Western divisions likely would be sold.

“Is 350 [stores divested] the number? We don’t think so. Basically, we think it’s around 500. That’s still well below 650,” Mushkin said. “And then the question is, are there buyers for divisions or multiple divisions? We think the answer is yes.”

Store overlap for Kroger and Albertsons appears heaviest in Southern California, Chicago, the Pacific Northwest, eastern Texas (Dallas and Houston), Denver, Phoenix and the greater Washington, D.C., area, according to BofA’s Ohmes.

Indeed, from the middle of the country moving west, Kroger and Albertsons have significant conflicts in store locations. R5 Capital reported that the proximity of stores between the two retailers jumps when the radius is extended from 1 mile to 3 miles. For example, the report showed that in seven markets, the percentage of Albertsons stores in Chicago with at least one Kroger location increases from 2.79% within 1 mile to 14.53% within 3 miles. The trend is similar in other markets: Denver (30.95% 1 mile, 90.48% 3 miles), Las Vegas (28.57% 1 mile, 95.24% 3 miles), Phoenix (22.08% 1 mile, 89.61% 3 miles), Portland (29.69% 1 mile, 81.25% 3 miles), San Diego (19.72% 1 mile, 76.06% 3 miles) and Seattle (40.78% 1 mile, 87.38% 3 miles).

“When I saw the estimated store divestitures, 100 to 375, my first thought was that seems kind of low, given that the two companies have a combined store base of around 5,000. So it’s a pretty small percentage,” CFRA’s Sundaram said. “If you look at where they have a lot of concentration, it’s really in the Midwest and West Coast. So it seems like this number could be higher than 375. That’s kind of the consensus of what I’ve been hearing from investors and other analysts.”

The Kroger Co.’s family of store banners includes Kroger, Ralphs, Dillons, Smith’s, King Soopers, Fry’s, QFC, City Market, Owen’s, Jay C, Pay Less, Baker’s, Gerbes, Harris Teeter, Pick N’ Save, Metro Market, Mariano’s, Fred Meyer, and Food 4 Less/Foods Co., all within 35 states. Albertsons Cos.’ store base includes such banners as Albertsons, Safeway, Vons, Jewel-Osco, Shaw’s, Acme, Tom Thumb, Randalls, United Supermarkets, Pavilions, Star Market, Haggen, Carrs, Kings Food Markets and Balducci’s Food Lovers Market, all across 34 states and the District of Columbia.

The addition of Albertsons banners like Shaw’s and Acme will give Kroger physical stores in the Northeast.

“The two largest areas in the U.S. where the companies’ stores do not overlap are Northern California and the Northeast,” Coresight Research wrote in a report after the merger announcement. “Albertsons has a significant presence in the Northeast [Acme Markets, Shaw’s, Star Market], while Kroger does not. However, previously, Kroger announced the construction of [Ocado-automated] online customer fulfillment centers in this region, meaning these CFCs (when operational) could cannibalize store sales. Currently, neither Kroger nor Albertsons have stores in Florida. So, while Kroger has plans to launch two CFCs and spoke distribution centers in the state, there is no risk of overlap or cannibalization.”

More industry consolidation looming?

If the acquisition of Albertsons is approved, Kroger’s market reach via physical stores will grow from 35 states — mostly in an area stretching from the Great Lakes to the South and Mid-Atlantic, with pockets in the Central U.S., Southern California, Texas, the Pacific Northwest and Arizona — to 48 states, bringing the grocer into the Northeast and New England while filling out markets in California, Texas, Arizona, the central and upper Midwest and the Pacific Northwest.

That national footprint, besides pressuring existing supermarket players in those market areas, would boost efficiencies of scale and negotiating leverage with CPG suppliers, enabling Kroger to better compete on price with non-supermarket rivals like Walmart, Amazon, Target and Costco, plus discounters like Aldi (now in 38 states), industry observers said.

Kroger’s consumer reach also would grow substantially through the addition of Albertsons. Currently, Kroger serves about 64 million households annually, and that number would jump to 85 million with the merger.

“For example, with retail media, this allows their advertisers to reach markets that Kroger is not in today,” said Parikh. “So, for example, Kroger doesn’t have a Boston presence. If Proctor & Gamble came to Kroger and wanted to reach consumers in that market, they couldn’t today. But with this combination, now they can reach consumers in the Northeast as well.”

Having Albertsons in the mix, too, would likely fortify Kroger’s efforts to extend its online reach. Under a 4.5-year-old partnership with U.K. e-grocery specialist Ocado Group, Kroger plans to roll out about 20 large, automated CFCs across the U.S. So far, 17 CFCs have been announced, and six are open. Eleven of 12 announced supporting spoke sites, automated by Ocado, are also operational. Importantly, the CFCs and spokes will give Kroger entry to markets where it now lacks stores, including Florida, Oklahoma, northeastern Ohio and Pennsylvania, and the Northeast. The addition of Albertsons’ online customers would raise the probability of success for the Ocado network.

In some markets, the Ocado CFCs will enable Kroger to serve customers where it lacks brick-and-mortar stores.

“If Ocado continues to work out well and you have a national footprint, then theoretically you can have more density with these facilities,” explained Parikh. “You can have Kroger’s and Albertsons’ volume in the same geographies going into these centers, and they can ramp up faster.”

Such marketplace power could spur other large supermarket players to act with M&A deals of their own, if the Kroger-Albertsons merger does indeed go through, industry observers and analysts said.

With a wider swath of territory from coast to coast, the combined company would present a much bigger competitive challenge to operators like Ahold Delhaize USA (East Coast), Publix (Southeast), H-E-B (Texas), Hy-Vee (Midwest) and Wakefern/ShopRite (Northeast, Mid-Atlantic), Wegmans (Northeast, Mid-Atlantic), Giant Eagle (Rust Belt, Mid-Atlantic), Southeastern Grocers (Southeast) and WinCo Foods (West).

Along with those larger players possibly seeking acquisitions, smaller supermarket retailers also could potentially join together in mergers à la Price Chopper/Market 32 and Tops Friendly Markets (forming Northeast Grocery Inc.) and Raley’s and Bashas’ (forming The Raley’s Cos.).

“We’ve been thinking that we’d see more consolidation in the food retail space for some time now. We thought it would be larger grocery chains swiping up local or regional chains. I didn’t think we’d see national grocery companies like this merge,” Sundaram said. “But I certainly think we’ll see more of the larger grocery chains acquiring some of the smaller ones and independents. One of the biggest reasons is that these smaller grocery chains and independents don’t necessarily have the scale to compete with the larger ones — especially in e-commerce, which is now more important than ever in food retail. It’s really hard to make online grocery profitable. Even the larger companies are struggling to make that profitable.”

The SpinCo company to be formed under the Kroger-Albertsons transaction also might present an acquisition opportunity for a regional or smaller supermarket operator, depending which stores become part of that entity. Mushkin pointed to the Kroger-Albertsons store overlap in the West.

“If you wanted to become a regional grocer on the West Coast and that was your aim, or if you didn’t have any West Coast exposure and you wanted some, you could make that happen,” he said.

Regulatory outlook

Kroger and Albertsons said they expect the merger transaction to close in early 2024, pending regulatory approval and other customary closing conditions, including clearance under the Hart-Scott-Rodino Antitrust Improvements Act. Grocery industry observers and analysts, though, have said the process could take up to two years.

In addition to the planned creation of SpinCo for store divestitures, Kroger has taken a number of actions that improve its regulatory prospects for the deal. For example, the company said in announcing the merger that, post-close, it would invest $500 million to lower grocery prices, $1.3 billion to upgrade Albertsons Cos. stores and $1 billion to raise worker wages and benefits.

Following recent virtual meetings between Oppenheimer and Kroger management, Parikh emphasized that the supermarket giant has done its homework.

“Clearly, there’s overlap in certain markets — the Pacific Northwest, Southern California, Chicago, Denver,” he said. “But Kroger and Albertsons and their shareholders have done a lot of work on this. They’ve hired the lawyers to look at the deal. And we were with Kroger management; they are highly confident of this deal getting the regulatory approvals.”

A fly in the ointment could be political and labor opposition to the merger, especially in an environment where high inflation has elevated food prices and grocery workers continue to battle challenges since the pandemic.

Just days after the deal’s announcement, U.S. Sens. Amy Klobuchar (D., Minn.), chair of the Senate Judiciary Subcommittee on Competition Policy, Antitrust and Consumer Rights, and ranking member Mike Lee (R., Utah) said their subcommittee will convene a panel in November to address the Kroger-Albertsons transaction. At press time, the hearing hadn’t yet been scheduled.

United Food and Commercial Workers and lawmakers such as U.S. Sens. Bernie Sanders (I., Vt.) and Elizabeth Warren (D., Mass.) also have come out against the merger, contending that a combination of two huge players would squeeze smaller competitors, raise grocery prices, lead to job cuts and reduce union workers’ leverage at the bargaining table. Albertsons’ planned $4 billion special dividend has also been a lightning rod for criticism from politicians, labor, and state attorneys general, who say the payment could hamper Albertsons and shouldn’t be on the table until a full antitrust review of the merger is completed.

The Kroger-Albertsons deal also presents a litmus test for the Biden administration, which has espoused a stronger consumer-protection stance in terms of mergers-and-acquisitions oversight. And in a letter to the FTC, Klobuchar and other lawmakers urged the FTC to exercise more scrutiny in its market-by-market analysis of a potential Kroger-Albertsons combination than the commission did in reviewing the 2015 Albertsons-Safeway merger.

“The Federal Trade Commission under the current administration has publicly articulated a more pro-consumer, stronger oversight posture,” Christine Bartholomew, a State University of New York at Buffalo law professor and antitrust scholar, said in commentary on the Kroger-Albertsons agreement. “Its position on this merger will be the first real test of whether the FTC plans to align its words and regulatory actions.”

CFRA, based on research by its Washington Analysis policy team, gives a 75% chance that the FTC will block the Kroger-Albertsons merger, Sundaram reported.

“Probably the next big question is, if they do go and block the merger, will [Kroger-Albertsons] try to keep fighting and appealing it or will they just walk away?” he said. “But the big reason why we think there’s a 75% chance the FTC will block the merger is the current FTC Chair Lina Khan. She’s recently expressed concerns about the impact of grocery store mergers.”

However, R5 Capital sees a path for the deal to get done, citing concentrated overlap in key markets, the likelihood of potential buyers for stores or divisions, and the opportunity for organized labor (both Kroger and Albertsons are union shops) to play “a very constructive role in helping come to a suitable agreement with a buyer, Kroger and the government.”

“We look at it a bit differently. In our minds, there’s a path to getting this done probably much more quickly than is realized,” Mushkin said. “If Kroger is realistic and said, ‘OK, let’s go to the union, let’s get a buyer or two lined up, and let’s go to the FTC together, hand in hand, and say here’s the plan and this is why it’s good for consumers,’” he explained, “then I think you can get it through pretty quickly.”