Did Kroger Miss a Golden Opportunity With Safeway?

Kroger was rumored to have been the mysterious Company A that was positioning itself to make a run for regional grocer Safeway, which instead sold itself to a private-equity consortium led by Cerberus. Did Kroger miss out on a chance to increase shareholder value?

May 20, 2014 at 3:15PM

                            

Kr

Source: Kroger.

Neighborhood grocery kingpin Kroger (NYSE:KR) has done a good job of building the preeminent middle-market grocery chain, sandwiched between Whole Foods and Wal-Mart Stores (NYSE:WMT), the kings of the high-end and low-end segments, respectively. However, the company had a chance to massively increase its scale with a purchase of regional grocer Safeway (NYSE:SWY), which would have upped its overall store base to roughly 4,000 locations and put it more on par with Wal-Mart's domestic store base. Kroger is rumored to have been the mysterious "Company A" that was interested in acquiring Safeway, as detailed in Safeway's annual meeting and merger proxy.

Instead, a private equity consortium led by Cerberus acquired Safeway. The consortium intends to combine the company with its existing grocery banners, thereby creating a major player with approximately 2,400 stores across 34 states. So did Kroger pass on an opportunity to increase shareholder value?

What was the value?
Despite a reduction of its overall store network over the past few years, Safeway is still a major force in the grocery business. It operates more than 1,300 stores around the country, with a major presence on the West Coast of the U.S.  The company has dramatically improved its financial profile lately, mostly through the sale of its Canadian operations in 2013 for $5.8 billion Canadian dollars. The cash inflow has allowed Safeway to reduce its debt load and has provided funds for the company to invest in growth initiatives, like its Just For U digital-marketing initiative.

Unfortunately, Safeway's business changes haven't yet had the desired effect, namely making the company a more profitable enterprise. Indeed, Safeway's adjusted operating income actually fell 1.9% in its latest fiscal year, mainly hurt by the higher costs of its various marketing initiatives. That said, the company is still a consistently profitable franchise that generates a sizable amount of operating cash flow, which more than funds its capital expenditures.

Kroger undoubtedly could have improved the operating profitability of Safeway's franchise, partially by leveraging its own larger network of manufacturing plants and distribution centers as well as its own initiatives in the digital marketing arena. Digital marketing is clearly a focus area for Kroger, as highlighted by its recent acquisition of You Technology Brand Services, a major digital marketing services provider. In addition, Kroger could likely have increased the top-line growth at Safeway's store network, given the momentum that it has exhibited in its own store network; it posted a 3.3% comparable-store sales gain in its latest fiscal year, nearly double that of Safeway.

A battle brewing in groceries
More important, an acquisition of Safeway would have given Kroger a much larger footprint, especially in highly populated West Coast markets, as the company continues to engage in a battle for customer market share against Wal-Mart and Whole Foods. Wal-Mart, in particular, is becoming a larger threat for Kroger because of its major push to expand its smaller-format Neighborhood Markets brand, a shot across the bow for Kroger.

While Wal-Mart's results in its latest fiscal year were below average, as evidenced by its first negative comparable-store sales performance since fiscal 2011, it continues to generate a prodigious amount of cash flow as a result of its position as the low-cost seller in most of its markets. Consequently, Wal-Mart has a healthy cash war chest with which to invest in its growth initiatives, like its Made in America sourcing campaign, to further differentiate itself from its competitors.

The bottom line
Kroger has built a winning franchise of neighborhood grocery stores, with more than 2,600 at last count, as it succeeds in a space that has proven difficult to maneuver, as evidenced by shrinking store footprints at competitors like Safeway and SUPERVALU. However, the company likely missed out on a game-changing acquisition with Safeway, which would have given Kroger one of the largest store bases in the grocery business and undoubtedly improved its operating efficiency. Instead, Cerberus and company captured the prize and will have an overall network that rivals Kroger in absolute size, estimated at 2,400 stores. While Kroger's management saw more risks than rewards with Safeway, only time will tell if it was the right move.

Don't miss this golden opportunity
Give me five minutes and I'll show you how you could own the best stock for 2014. Every year, The Motley Fool's chief investment officer hand-picks one stock with outstanding potential. But it's not just any run-of-the-mill company. It's a stock perfectly positioned to cash in on one of the upcoming year's most lucrative trends. Last year his pick skyrocketed 134%. And previous top picks have gained upwards of 908%, 1,252% and 1,303% over the subsequent years! Believe me, you don't want to miss what could be his biggest winner yet! Just click here to download your free copy of "The Motley Fool's Top Stock for 2014" today.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool’s board of directors. Robert Hanley owns shares of Safeway and Whole Foods Market. The Motley Fool recommends and owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers