Supermarket Chain Albertsons Rated Hold Until Kroger Merger Completes

Summary

• Albertson's Companies is rated Hold, in line with consensus from Wall Street and the SA quant system.
• Positives include dividend growth and cheap share price, along with low P/E valuation.
• Some headwinds include revenue and earnings weakness, underperformance vs S&P500 index, and overvalued P/B ratio.
• Risks to consider are merger regulatory hurdles, as well as current debt levels and rising interest costs.

Stock Overview

In today's research note, I take a trip to the local supermarket again and cover a major brand behind many stores you may have come across throughout America.

Albertson's Companies (NYSE:ACI) is an Idaho-based company trading on the NYSE and according to its corporate fact sheet is the company behind supermarket brands like Safeway, Albertsons, Vons, Randall's, and others.

Some other fun facts are: over 2,000 stores, 35MM+ weekly customers, 22 distribution centers, operates in 34+ states.

A key point to mention is that the company entered into a merger agreement with its peer Kroger (KR) as of October 13th, 2022. Relevant to that topic, an October 17th article in Forbes highlighted that many stores and facilities are in the process of being sold to a third-party:

On September 8, 2023, Albertsons and Kroger confirmed that they had entered into a definitive agreement with rival C&S Wholesale Grocers for the sale of a collection of stores, banners, distribution centers, offices and private label brands.

Rating Methodology

The stock's rating is based on its WholeScore, which is my approach to holistically rate a stock by considering 13 metrics of equal weight I think are relevant to investors and analysts. Key financial data presented is sourced from Seeking Alpha as well as the company's recent fiscal 2023 Q2 earnings release that came out on October 17th. Their next earnings report is not due until January.

Revenue Growth vs Peers

Using data from the food retail stocks data on Seeking Alpha, I created the table below to compare the YoY revenue growth of Albertson's vs 4 other peers. In this case, my focus stock of Albertson's saw a 4.5% YoY revenue growth, just below this peer group average. As my target was to beat the peer group by 5% or better, it missed my target and so lost a potential rating point from me here.

Here are some relevant data points from their fiscal Q2 release highlighting their positive growth, and adding to my confidence in the top-line potential of this company:

• Identical sales increased 2.9%
• Digital sales increased 19%
• Loyalty members increased 17% to 37.4 million

To understand this industry, I will keep it simple, because one of my first seasonal jobs was in a supermarket: it is a very capital-intensive, high-overhead business dependent on a high volume of sales and getting product off the shelves.

During the pandemic of 2020/2021, one thing I noticed is the adaptability of a supermarket and how busy their curbside pickup department had gotten, as more people were ordering groceries from an app rather than walking in.

With that said, as an analyst of this stock rather than a customer, I see it as a potential investment in a critical / essential industry.

Revenue Growth (YoY)

From data in their income statement, I put together the table below which shows they achieved a 2% YoY revenue growth when comparing the two quarters shown. My target was for 5% or better growth so they missed my target this time too, losing a potential rating point.

Earlier, I already mentioned some positives about their growth. It is positive, however, it could be better I think.

In his Q2 comments, here are some headwinds CEO Sankaran mentioned that I think are relevant to my readers interested in this stock, considering that this is a consumer-driven business model dependent on a high volume of sales and getting product off the shelves:

a more challenging economic backdrop, including declining federal and state government assistance and higher interest rates, and their effects on consumer spending and our business.

Earnings Growth (YoY)

Also from its income statement, the earnings tell a story. We can see this company had a 22% YoY earnings decline. My target for net income was a 5% or better growth, so it missed this goal as well, still not earning a rating point yet.

One key driver I found that is affecting expenses is interest expense, and you can imaging how much debt such a capital-intensive business may need to borrow. This is one risk concern of mine in the current high rate environment, and here is more detail the company revealed in their Q2 release:

Interest expense, net was $111.9 million during the second quarter of fiscal 2023 compared to $89.8 million during the second quarter of fiscal 2022. The increase in interest expense, net was primarily attributable to higher average outstanding borrowings and higher average interest rates, as well as lower interest income.

So, it remains to be seen as to what the debt picture will look like for the new combined company expected to complete its merger in early 2024, especially since they seem to be divesting from a lot of stores at this time.

Cashflow Growth (YoY)

From its cashflow statement, I pulled data to make the table below, showing that free cash flow per share saw a 79% YoY decline, providing more disappointment. My target of 5% growth was missed, so again no rating point in this category.

I know that capital expenses can impact cash flow, so after some investigating it is likely the cause of the cash flow drop, and here is supporting data from their Q2 release which shows a lot of capital spending:

During the first 28 weeks of fiscal 2023, capital expenditures were $1,084.3 million, which primarily included the completion of 80 remodels, the opening of three new stores and continued investment in our digital and technology platforms.

Looking towards 2024, I expect them to continue with innovation/tech spending to stay ahead of their competition, particularly with the reality of ordering groceries from an app like I mentioned earlier, a technology that is not one-and-done but constantly open to process improvement and upgrades just like most technologies.

Equity Growth (YoY)

Using data from its balance sheet, it appears I have more bad news for my readers. The equity saw a 56% YoY decline, missing my target of 5% YoY growth.

We can see a key driver in the balance sheet of this is a rise in total liabilities along with a drop in total assets, and one key liability that grew about 11% was long-term debt, now topping $7.3B.

3 Year Dividend Growth

When it comes to dividends, some good news is finally appearing. When comparing the quarterly dividend from October 2023 with that of October 2020, it shows a 20% growth in this period. My target, as usual, was a 5% or better growth, so it easily beat it and finally won a rating point here.

Also relevant to dividend-oriented investors who may not be aware of the "special" dividend of $6.85 per share in October 2022, that had to do with the merger.

Keep in mind that the final merger still needs full regulatory approval and so on. In fact, SA analyst Investor Overview highlighted back in 2022 that many investors were not fully confident the merger would even succeed:

They are skeptical because they expect the company will not receive approval of the merger because of the formation of a strong monopoly.

So, I guess we will have to wait until sometime in 2024 to see if the green light finally does happen.

Dividend Yield vs Sector

When it comes to the forward dividend yield, however, the stock at 2.24% yield is about 18% below its sector average. It is not a terrible yield but not terrific either, however it missed my goal of being above the average. Again, no rating point here.

In my opinion and experience as a dividend investor, it is really best as a longer-term holding. However, it is November and there is an acquisition by Kroger expected to complete in a few months perhaps, so that can add ambiguity to this topic.

Share Price vs Moving Average

Also reported by SA analyst Investor Overview back in 2022 is that Kroger is to pay Albertsons shareholders $34.10 per share when the acquisition finally completes.

From looking at the chart of the share price vs the 200-day moving average, the share price (as of market close on Nov. 24th) seems like a no-brainer at $21.47, if the potential upside is a $13/share profit.

Although my strategy calls for buying price dips below the average, preferably of 5% or more below average, the share price is practically in line with the moving average and considering the upside potential I will call this a decent buy price, and give it another rating point here towards its whole score.

Price Return vs S&P500

When it comes to market momentum, we can see from my table that the stock saw a nearly 4% return in the last year, whereas the S&P500 index was closer to 13%. This stock therefore underperformed the index by about 71%, missing my target of outperformance and losing a rating point.

By comparison, though, its potential acquirer Kroger performed worse in this period with a 1 year price return of negative -9.9%.

I wrote in a few recent articles that I am noticing bearish market momentum on a lot of consumer product-driven stocks, perhaps over concerns from high inflation and recession risk impacting spending.

By contrast, the extremely hyped up "big tech" stocks brought out the bulls this year. Case in point: Facebook parent Meta Platforms (META) saw a 1 year price return of nearly 204%, while Google's parent Alphabet (GOOG) (GOOGL) saw a nearly 42% return in this period.

Perhaps something to keep in mind if I was investing in this stock, is whether the bears will continue to pull down stock prices in this food retail sector.

P/E Ratio

Now, let's briefly touch upon valuation metrics. The forward P/E ratio shows some really nice undervaluation, which is what I am looking for so I gave it a rating point here. While it is priced at 10x earnings, that is a much lower premium than the sector average closer to 19x earnings. Tying this back to my earlier talk on financials, it appears what could be driving this undervaluation is the steady fall in share price since September.

P/B Ratio

When it comes to the forward P/B ratio, it is highly overvalued, and so I won't be giving it a rating point as it is over 64% above average for this sector. More importantly, in trying to understand the driver of this overvaluation, tying back to the earlier financials I would say it is the 54% decline in equity / book value that is likely driving this ratio, even though share price has also been on the decline.

Return on Equity

From the profitability data section on Seeking Alpha, you can see that a key metric tracked is the trailing twelve month return on common equity, which I simply refer to as ROE here. In this case, it impressed with nearly 35% ROE, while the sector barely got 12% ROE, so it outperformed the sector by over 196% and earned another rating point from me here.

Again, I think tying back to the talk on equity is relevant because the 54% drop in positive equity would likely cause a spike in ROE.

Risk Score

One risk to consider is that the final merger/acquisition by Kroger may not get regulatory approval, particularly concerns over anti-trust and monopoly issues. In fact, an October article by Reuters highlighted that the California Attorney General was even considering a lawsuit to try and stop the merger.

This could set the stage for a costly and time-consuming court battle perhaps, if that even were to occur.

The current risk that concerns me is the rising debt and interest costs. From the income statement, we see the interest went up 24% on a YoY basis, while long term debt went up 11%.

At the same time, however, the company is divesting from a few hundred stores it will sell off to competitor chains, which will raise several billion dollars.

So, I think the risk impact of debt is medium, with probability being medium/high, and a total risk score which is tolerable.

WholeScore Rating

In today's note this stock got a WholeScore of just 5, barely making the "hold" rating from me.

In comparing my rating to the consensus, I am agreeing with the sentiment from Wall Street and the SA quant system:

Summary and Forward Outlook

The neutral /hold rating I gave this stock is driven by positives like low P/E valuation, high return on equity, dividend growth, modest risk score, and a share price not much above its 200-day average. All the other metrics are headwinds to this stock.

If I was trading this one in my portfolio, I would hold on to it if I got in at a much earlier price point, and if the merger passes then at $34/share from Kroger I can realize a nice profit.

If for some reason the acquisition fails, then holding this stock could be a steady dividend-income play.

Either way, I would consider it an investment in the critical infrastructure of America which depends on supermarkets for everyday food needs.