Growth Gets Better With Size For These Retailers

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Customer satisfaction and an enhanced buying experience are the new focus for retailers. The preference for shopping at convenience stores and eating away from home has increased the demand for "mini-markets and supermarkets." Retailers are capitalizing on this opportunity with new stores, innovative products, huge discounts, and loyalty programs. Let's look at the three retail companies developing and executing appropriate strategies in this transforming industry.

Increase in out of home consumption to boost sales

Companhia Brasileira de Distribuicao's (NYSE: CBD  ) Assai is a Brazilian cash and carry wholesale store that targets restaurants, hotels, and other small and medium enterprises that make cheap and bulk purchases.

Assai's gross revenue increased 18.5% year-over-year in 2012, contributing 16.4% to the company's total food sales. Assai's sales per invoice was $49.01, compared to the average of $30.45 in hypermarkets and $19.04 in supermarkets in Brazil in 2012. Furthermore, Companhia Brasileira intends to open 12 to 15 Assai stores in 2013, and open an additional 60 stores across Brazil from 2014 to 2016.

In Brazil, 31.1% of the total population consumed food away from home every week in 2008-09, and according to Portal, regular eating away from home could reach 50% in 2020. The rising wages, lower unemployment, and urbanization are the main drivers behind this increase. Due to the shift in consumers dining away from home and increasing convenience purchases in the neighborhood, Companhia Brasileira is also giving more attention to its Minimercado extra -- a mini-market store. It is planning to open 100 new stores in Brazil by 2013. It opened 23 new stores in the second quarter of 2013 and plans to open 100-150 stores every year. This is because people are avoiding large purchases and are instead making small purchases in mini-markets. Among the company's retail store brands, Minimercado had the highest growth in gross sales at 32.4% year-over-year to $112.24 million in 2012. Analysts expect to generate $175.20 million in 2013 with 207 stores.

Acquisition to achieve upscale expansion

Last month¬†Kroger (NYSE: KR  ) entered an agreement with Harris Teeter (UNKNOWN: HTSI.DL  ) , under which it will purchase all outstanding shares of Harris Teeter at a price of $49.38 each in cash, for a total value of $2.5 billion. Post-acquisition, Harris Teeter will operate as a subsidiary of Kroger. This will increase Kroger's total store count by 9% to 2,630 stores across 34 states in the U.S.

Kroger hasn't been present in high-growth, upscale markets that have a larger population, but this acquisition will help it increase its presence in these markets, such as Washington D.C. Kroger will have the opportunity to exploit a high growth market using Harris's assets and its existing infrastructure. This acquisition is expected to bring cost synergies of $40-$50 million annually in the next 3-4 years.

Harris Teeter is a chain of grocery stores in the U.S. with 212 stores across eight states. Its stores are located in popular tourist destinations, university towns, and other high growth cities. The competition from Wal-Mart and regional retailer Publix in these regions could be one of the reasons why Harris Teeter decided to go ahead with its sale--with the help of Kroger's higher scale of operation and infrastructure, it plans to compete with the big boys. Harris could enhance its loyalty based marketing and general merchandise assortment with the help of Kroger's strong purchasing power, information systems, and loyalty programs. Kroger doesn't plan to close any of Harris's stores, and could give Harris plenty of autonomy in running its stores.

On the other hand, the acquisition of Harris Teeter will affect Kroger's share repurchase program. The program is expected to be in the range of $200-$400 million this year, down from the $1 billion buybacks announced last year. This is because Kroger will use its cash to pay off its maturing debt to protect its investment-grade rating. This will negatively affect the near-term EPS of Kroger. The total debt, after all the restructuring, is expected to be around $10-$10.5 billion by the end of this year. However, synergy gains from the Harris Teeter acquisition will offset the lower EPS, and it is expected to cause EPS accretion of $0.06-$0.09 in the first 12 months post-acquisition.

Companhia Brasileira is capitalizing on changing consumer preference toward buying food away from home. It is opening up new stores, both in self-service with Assai, and in the food mini-market space with Minimercado.

Kroger has acquired Harris Teeter to enter upscale and high growth markets. Harris Teeter will take advantage of Kroger's strong purchasing power and loyalty programs. While the acquisition will reduce share buybacks in the short term, it will generate free cash flows to use toward share repurchases in the future.

Looking at the growth prospects, I recommend a buy on all three stocks.

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