Safeway Is Latest Buyout Target as Grocer Consolidation Continues

Safeway (NYSE: SWY  ) may be about to join forces with one of its competitors, Albertsons, as the grocery-store sector continues to see more consolidation. The combined company is expected to save cash, lower its prices, and be better equipped to compete with other food retailers. The merger should also bring a quicker response in serving the communities where both chains operate and deliver not just lower prices but better products.

Safeway's deal is valued at about $9.4 billion and is Cerberus Capital's latest U.S. grocery-chain acquisition. Cerberus is paying about $40 a share for the company, a price in line with the company's current market value. The deal will also create a separate transaction for Safeway shareholders in mid-April that will distribute shares of gift-card company Blackhawk Network Holdings valued at $3.95 each.

By joining forces, the merged company should be able to save cash by combining distribution and purchasing channels. The reduced costs can translate into lower prices at stores and can be used to improve retail locations. The combined company can also be more effective at competing against lower-priced food retailers like Wal-Mart Stores as well as those at the higher-end such as Whole Foods Market. News of a deal has caused Safeway shares to rise about 27% since February.

Safeway reported fiscal fourth quarter diluted earnings per share from continuing operations, excluding special charges, of $0.53 versus $0.59 reported in the same quarter in 2012. Sales and other revenue were virtually unchanged -- $11.3 billion in the latest fourth quarter and $11.2 billion in 2012. Lower fuel sales offset a 1.6% increase in identical-store sales. Gross profits rose in part due to lower advertising expenses and higher income due to the last-in first-out inventory method.

Kroger may also bid for Safeway
The deal includes a go-shop provision, calling for Safeway and its bankers to seek other offers for the company. It's possible that Cerberus may face competition to acquire Safeway from Kroger  (NYSE: KR  ) , which is said to be considering its own offer. Kroger, Safeway's larger rival, may have to contend with possible antitrust issues if it ends up extending a bid.

Cerberus' cash part of the deal involves paying $32.50 per share, and Safeway shareholders would have the right to receive proceeds from asset sales that could potentially be worth $3.65 a share. Talks have been ongoing for several months with Cerberus about a buyout of Safeway's 1,300 stores. With Cerberus already owning Albertsons, a purchase of Safeway appears to be a likely scenario.

The private equity firm attempted to buy high-end grocer Harris Teeter in 2013 but lost out to Kroger, which acquired Teeter's 227 stores. Kroger had also expressed some desire to acquire an interest in some of Safeway's stores, but no specific details have been disclosed. While Safeway is accepting other bids, the plan is to consider offers for the entire grocery chain.

Kroger grew its market share in 2013, and with the latest fourth-quarter results achieved its 41st consecutive quarter of same-store sales growth. Fiscal 2013 also marked the ninth consecutive year of an operating expense reduction as a percentage of sales, an important achievement that helps to keep prices at a competitive level. Kroger also invested $928 million in share buybacks and dividends. The company's fiscal 2014 net earnings guidance is for between $3.14 and $3.25 per diluted share; the Harris Teeter transaction is expected to add $0.06 to $0.09 to net earnings. This translates into a growth rate for the year of 10% to 14%. After 2014, growth is expected to decline to a range of 8% to 11%.

Grocers still facing a challenging environment
Grocery competitor SUPERVALU is facing a challenging environment much like its competitors; the economic recovery continues at a slow pace, and low levels of consumer confidence create a highly competitive and price-sensitive marketplace.

The grocery chain, which earned revenue in excess of $17 billion in fiscal 2013, is focused on driving top-line sales while managing its cost structure. The company's long-term plans were highlighted in its quarterly report containing November -- increasing sales and operating cash flow, improving the balance sheet, and generating value for shareholders.

SUPERVALU's gross profit for fiscal 2014 year-to-date increased 9.2% to $1.9 billion versus approximately $1.8 billion in fiscal 2013. The gross profit improved in two out of three business segments -- independent business and retail food. Selling and administrative expenses improved in the year-to-date period by 4.9%.

Foolish conclusion
The merger between Albertsons and Safeway is expected to close during the fourth quarter of 2014, creating a network of 2,400 stores, 27 distribution facilities, and 20 manufacturing plants. No store closures are expected due to the transaction. The combined company's broad assets will facilitate an inventory with greater variety that includes a better selection of fresh foods and private-label food products along with more efficient distribution and supply channels.

Investors considering Safeway shares should note that while shares have risen to roughly match Cerberus' offer price, a competing bid from Kroger could send shares higher.

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