This report does not constitute a rating action.
Kroger Co. (BBB/Negative/A-2) announced its $24.6 billion acquisition of Albertsons Cos. Inc. (BB/Watch Pos/--) on Oct. 14, 2022. The transaction would combine the two largest pure-play grocers in the U.S., with a combined $226 billion in revenues, before planned divestitures. More than seven months after the announcement, we believe we are still at least seven more months away from a potential deal closure. With the regulatory process well underway, the deal’s merits, hurdles, and detractors are rising to the surface.
As a result of the proposed merger announcement, we revised our outlook on Kroger to negative and placed our rating on Albertsons on CreditWatch with positive implications on Oct. 14, 2022. Here, S&P Global Ratings presents frequently asked questions from investors about the proposed Kroger-Albertsons transaction.
Frequently Asked Questions
What is S&P Global Ratings’ expectation regarding the merger’s approval?
There has been no shortage of vocal opponents to Kroger's acquisition of Albertsons. The United Food and Commercial Workers International Union--which represents nearly half of the combined companies’ workers--is the latest to oppose the deal. However, it will be the Federal Trade Commission (FTC) who will initially assess the merits of the combination. Prospects for the merger’s approval seem dimmer than when it was initially announced, but our base-case assumption that the deal will eventually close remains unchanged. We note that our assumption for number of store divestitures has increased since the deal’s announcement seven months ago, when the companies’ estimate of store divestitures stood at 100-375. It is S&P Global Ratings' belief that the deal will require more than 375 store divestitures, potentially closer to the 650-store divestment cap.
How much overlap is there between the two grocers and what are the implications?
According to consulting firm Creditntell, 48% of Albertsons-owned stores are located within three miles of a Kroger-owned store. This figure increases to almost 57% when the radius is expanded to five miles. The FTC could use a radius of more than five miles in defining a geographic market, moving the overlap percentage figure even higher. Notwithstanding this, there is some geographic distinction between the two: Albertsons has more density in the Northeast and the West coast, while Kroger has more concentration from the Midwest to the southeast Atlantic, in addition to parts of Texas and southern California. In a recent Op-Ed published in the Cincinnati Enquirer, the CEOs of Kroger and Albertsons addressed concerns that stores would close as a result of the merger, with Kroger committing to “zero store closures as a result of the merger, and the company will invest in stores post-merger.” Net of divestitures, Kroger expects to realize approximately $1 billion of annual run-rate synergies within the first four years, sourced mainly through improved sourcing, optimization of manufacturing and distribution networks, and opportunities to amplify technology investments.
How do private-label sales fit into the pro forma company's strategy?
Albertsons generated $16.5 billion of private-label sales in 2022, representing approximately 25% of overall sales ex-pharmacy and fuel, manufacturing 10% of such products in company-owned facilities across 19 production plants. Kroger generated more than $30 billion in private-label sales in 2022, representing approximately 27% of overall sales ex-pharmacy and fuel, with approximately 30% of its private-label units produced in one of its own 33 production plants. The deal would further improve private-label production efficiency across Kroger’s 15 and Albertsons’ 11 private-label brands. Kroger has previously stated that gross margins for its private-label products are about 600 basis points better than the national brand equivalents. This is a win-win when, according to the grocer, consumers save up to 10% by buying private label versus national brands. Both companies have seen an increase in private-label penetration as high inflation steers consumers toward lower-priced options, and the combined portfolio would provide a competitive advantage for the new company. The merger would also boost new brand development, as the combined company would have a massive set of first-party data to help it steer development (Kroger stated last year that 92% of households purchase at least one private-label product). With more than 27,000 unique items within the combined private-label portfolio, expanding this margin-accretive piece of the business will play a role in the pro forma company’s strategic evolution. ex-fuel/pharma; 26% pre-merger
How does Albertson's recent dividend affect the rating?
As part of the companies’ October 2022 merger announcement, Albertsons announced its intent to pay a $3.9 billion special cash dividend on Nov. 7, 2022, reducing the purchase price commensurately. Following months of legal challenges, the dividend was ultimately paid on Jan. 20, 2023, after the Supreme Court of the State of Washington lifted a temporary restraining order. Along with over $2.5 billion of cash, Albertsons utilized $1.4 billion in asset-based lending (ABL) borrowings to fund the special dividend (the company repaid $400 million of ABL borrowings thereafter). Incorporating cash we would normally net against debt, the dividend increased S&P Global Ratings'-adjusted leverage by about 0.75x to 3.8x at the end of the fiscal-year-ended Feb. 2023. Despite this, the company’s S&P Global Ratings'-adjusted leverage now sits near our previous upgrade threshold.
What are the credit implications for Kroger if the deal does not go through?
Kroger ended fiscal 2023 with S&P Global Ratings'-adjusted leverage of 2.4x, well below our downgrade threshold of 4x. We attribute some of the leverage improvement since pre-pandemic fiscal-year-ended February 2020 (1.3x deleveraging) to Kroger's S&P Global Ratings'-adjusted EBITDA margin expanding 50 basis points and 21.2% revenue growth since fiscal 2020. As a stand-alone company, Kroger would remain the largest U.S. pure grocer with 2,719 stores as of Jan. 28, 2023. However, Kroger will have to contend with big-box and other nontraditional retailers whether or not the merger closes. As such, the rating may be more contingent on its financial policy as a stand-alone company.
What about for Albertsons?
Over the course of just over three years (April 2018 to June 2021), we raised our rating on Albertsons three times, to 'BB' from 'B'. The consistent factor across these upgrades has been debt reduction. The same would likely apply to any potential upgrade in the future. Albertsons' recent conversion of its remaining convertible preferred stock, which we add to adjusted debt, in the first quarter of fiscal 2023 will help reduce S&P Global Ratings adjusted leverage from the 3.8x level it ended fiscal year 2023 ended February 2023 with. While the special dividend more than offsets this debt reduction, a path toward a higher rating absent the merger could be a possibility further down the road should a stand-alone Albertsons maintain a more conservative financial policy.
Who might buy divested stores?
Albertsons recently named an executive vice president to lead planning for SpinCo, a newly created standalone public company that would hold spun-off stores in conjunction with the regulatory clearance process. We consider this a failsafe should the companies be unable to find a buyer(s) in advance of the early 2024 anticipated close. Koninklijke Ahold Delhaize N.V. (BBB+/Stable/A-2) would likely be near the top of the list. The company has expressed interest in building on geographic adjacencies, and with its eastern-U.S. presence, it would be a logical purchaser. Whole Foods could be another potential buyer. The CEO of Whole Foods' parent company, Amazon.com Inc. (AA/Stable/A-1+), recently penned a letter to shareholders that discussed, among other things, the need for a broader physical store footprint and finding a mass grocery format that is worth expanding broadly. The ultimate buyer of the potential spun-off stores will not have to look far to spot their previous owners, as more than half of Albertsons’ stores are within five miles of a Kroger.
Related Research
- Kroger Co. Outlook Revised To Negative, 'BBB' Rating Affirmed On Announced Acquisition Of Albertsons Cos. Inc., Oct. 14, 2022
- Albertsons Cos. Inc. 'BB' Ratings Place On CreditWatch Positive On Kroger Co. Acquisition, Oct. 14, 2022
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