Harris Teeter Lands in Kroger's Cart

While I was in Blacksburg, Va., my coworkers would speak in reverential tones of a supermarket that used to be in Roanoke. Harris Teeter (UNKNOWN: HTSI.DL  ) was spoken of as a magical place, where subs were freshly made, and the produce department overflowed with vibrant greens. When I moved closer to one in North Carolina, I discovered that actually, it was just another nice-ish store. Kroger (NYSE: KR  ) apparently thought more highly of the business, and today it agreed to buy the whole thing.

A Harris Teeter primer
If you've never lived in a mid-Atlantic state, you've probably never come across the brand: Harris Teeter operates in eight states and the District of Columbia. In its last fiscal year, the company reported $1.1 billion in sales, with an operating margin of 3.5%. Kroger, on the other hand, pulled in $96.7 billion in sales, with a slim 2.9% operating margin.

Harris Teeter was founded in 1960 in North Carolina, and has grown to 212 stores. The business has grown slowly, and half of its current store count was acquired in two acquisitions in the 1980s. Both Food World and Big Star operated 52 locations at the time they were purchased. Over the last two years, the company has grown its square footage by less than 5% a year. The company also increased its central Carolina stronghold by trading some locations with Lowes Food.

Harris Teeter's management announced earlier this year that the company was exploring a sale, though that move was prompted by interest from private equity. The news revived the flagging stock, which had fallen 16% in the 12 months before the exploratory announcement. Since that time, the stock has risen sharply, up 33% and resulting in a mere 2% premium on the sale.

What's next
While the increased margin is nice, it's not the reason Kroger is buying the brand. Harris Teeter has a strong regional brand and a reputation as the "nicer" place to go shopping. Kroger is planning to keep that brand, and I wouldn't be surprised to see it transition Harris Teeter locations into something that can compete with Whole Foods (NASDAQ: WFM  ) .

While Whole Foods has made a solid dent in the mid-Atlantic, Kroger has been thin on the ground. Whole Foods has marched, seemingly uninterrupted, to a predicted 6.7% operating margin, blowing Kroger and Harris Teeter out of the water.

If I were Kroger, I would bump up the balance of organic and local food in my new Harris Teeter locations, while not abandoning standby offerings. If the company can manage to take some more share from Whole Foods, it could set itself up for expansion over the next five years, bringing a new offering to consumers looking for a middle ground between Kroger and Whole Foods. I think the Harris Teeter brand has a long way to run, and Kroger just picked it up for a song.

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