Albertsons May Be Win-Win Proposition, With Or Without Kroger Deal (NYSE:ACI)

Albertsons Companies, Inc. (NYSE:ACI) has suffered in price during 2024 on the roadblocks to a merger with Kroger (KR), erected by Federal Trade Commission (“FTC”) actions and numerous state-filed lawsuits. Two of America’s largest grocery chains are trying to create a monster-sized company, which may end up raising prices for customers on reduced competition. I get the conflict inside the fair-trade appraisal process.

However, my investment view is that Albertsons is cheap enough as a standalone company (with stable operations and management), it will not only survive, but likely thrive, if the proposed business marriage is completely scuttled.

When I crunch the numbers, I am confident ACI is well equipped to produce strong gains for investors, absent a takeover. So, any resumption and approval of the transaction by regulators would serve as an added catalyst to deliver quick gains, nothing more. In the end, Albertson shareholders may actually be able to enjoy above-average gains either way, the rest of 2024.

Terms of the deal announced in October 2022 are a little confusing, but the remaining value (if it were to succeed in the approval process) amounts to $27.25 in cash per ACI share, after the payment of a one-time dividend of $6.85 in November 2022 is subtracted from the total agreed price of $34.10. You can read up on these calculations in an excellent August article by Seeking Alpha analyst Dane Bowler.

Offered by management, the counterargument to approve the deal is Walmart (WMT) and Amazon (AMZN) already have larger food delivery networks across the nation. So, the combined assets of nearly 5,000 retail stores serving 85 million households in 48 states would remain a smaller competitor vs. several peers. I will say this argument does hold some weight based in common sense, when you take a step back.

To me, the valuation argument to own Albertsons is getting so powerful, I plan on buying a position next week. It’s performance and business model are relatively recession-proof, while the organization is able to pass along and even benefit from rising inflation.

Undervaluation Extreme

For starters, when we compare Albertsons with Kroger, you can understand the core logic behind the larger Kroger’s desire to acquire ACI. On calendar-year 2024 estimates of earnings and sales, ACI’s lower stock price valuation will be nicely accretive to KR shareholders, especially when asset sales and synergies are factored into the equation. Albertsons projected 8x P/E ratio is a 30% discount to Kroger’s 12x, while the 0.146x multiple on sales is a better than 40% discount to KR’s 0.265x.

In fact, the incredibly low P/E ratio of 8x represents a solid 12% earnings yield on investment, which gives ACI owners the best upfront business performance on your invested capital in the major U.S. food retailing category during 2024. My sort group includes national chains Kroger, Walmart, Target (TGT), Amazon, Casey’s General Stores (CASY), Sprouts Farmers Market (SFM), Dollar General (DG), Dollar Tree (DLTR), Costco (COST), and BJ’s Wholesale Club (BJ).

Even when we account for total debt and liquid investment holdings, basic cash generation EBITDA and net revenue can be purchased today at a significant peer discount to enterprise value. As it stands today, EV to EBITDA of 4.7x is far below Kroger’s equivalent of 5.97x. And, the EV to Revenue multiple of 0.243x is a much cheaper alternative to KR’s 0.314x.

Again, Albertsons is the clear bargain on EV to EBITDA in the food retailing group, available for investment on Wall Street. Compare ACI’s 4.7x number to the inflated bubble valuation at Costco of 30.5x!

Why is Albertsons this inexpensive on its fundamentals? The easy answer is the company carries higher-than-normal levels of debt. One measure of excessive debt is comparing annual cash flow generation vs. total financial debt. Today’s 0.32x price to trailing cash flow means it would take a theoretical three years of regular operations to repay all debt, shunning any dividend payout and all capital expenditures. After capital expenditures in 2022-23 are accounted for, it would take about 10 years of average “free” cash flow (at roughly $700 million annually) to repay all financial debt (ignoring store lease obligations).

For sure, extra leverage is a serious risk if sales decline and/or retailing costs rise faster than food inflation. However, with steady consumer demand at its stores and decent rates of inflation as current realities, rising cash generation over time may mean its debt load is quite manageable.

For a more complete company/stock overview, Seeking Alpha’s ranking system gives an “A” Quant Valuation Grade to Albertsons. If the balance sheet had slightly less debt with higher book value readings, on top of a raise in the dividend payout by management, an A+ score would be possible.

Final Thoughts

As the company is in a holding pattern for major business change decisions until the merger deal is figured out, not much sales or earnings growth is expected from Albertsons over the next two fiscal years (ending in February). More food for thought, Wall Street analysts are projecting very low levels of food inflation going forward.

My view is a more rapid pay down of debt as a standalone business, compounded in a positive way by rising food inflation (with the company keeping the same profit spread on climbing sales) could mean far better earnings and cash flow generation are around the corner. In addition, if Kroger walks away from the deal, Albertsons would receive $600 million in a transaction breakup fee, the same as 9-12 months of free cash flow from operations. Yes, the ending of its merger agreement might be a net positive development at this stage, not a negative one.

More good news for shareholders, stock trading momentum for ACI may be signaling a lack of selling interest has developed. Sliding in price from almost $24 in September, the current quote of $20.62 seems to be in a much smarter place for new buying. On Balance Volume trends have been quite positive since the merger announcement, with another low outlined in early March (green arrow). The Accumulation/Distribution Line bottomed in November (blue arrow). Plus, 20-day Chaikin Money Flow has been in positive territory nearly all of 2024. So, even with serious doubts about the successful conclusion of its deal with Kroger, Albertsons shares appear to be under steady accumulation by investors.

For upside price targets, $27.25 is due if the merger is completed this year, good for up to +34% in total returns (with 2.3% in annual dividends included, depending on timing).

However, an even brighter long-term outlook might be possible if the company remains independent. Assuming management uses the breakup fee to pay down debt and decides to sell some less profitable grocery store brands to reduce debt obligations (and interest expense), it could nicely benefit from a Wall Street rerating of its valuation on the lower-leverage business setup. Under this scenario, a share price above $30 is possible by 2025, with a business valuation closer to Kroger’s on marginally improved profitability. Then, if food inflation continues to stay high, as I expect it will, stock gains to $35 or even $40 are possible by 2026-27 (using $3.00 EPS as a forecast). We’re talking about total return investment potential in the +100% range over 2-3 years.

What could go wrong with my bullish take? The overriding downside risk for investors is operating costs, including interest expense (which rose $90 million over the fiscal year just ended), jump faster than retail selling prices for food/beverage items. This is the main operating math every grocery store and retailing outfit must face/conquer on a daily basis.

Retailing is tough, so consumer trust in your brand is critically important. It is imperative stores are kept clean and well-stocked for goods, while enough checkout lines are open for customer convenience. Labor relations and worker pay must be kept on an even keel, which can be difficult in a rising inflation environment.

In summary, outside of the day-to-day operating issues, getting debt and interest expenses down would be my #1 priority suggestion for management. Such would both push earnings higher and help with Wall Street’s risk-based valuation of the stock. If the Kroger deal falls through, all is not lost. Refocus on consolidating stores to your best locations, while reducing Albertsons debt burden.

Otherwise, the stock valuation is not excessively high like many U.S. equities during May 2024, and grocery stores have stable sales trends, even during recessions. One unusual upside argument for Albertsons ownership to think about is high labor costs are making eating out at restaurants too expensive for Americans on the lower end of the income scale. This situation may support stronger-than-expected performance at major retailers, as individuals transition food demand to regular grocery locations.

I rate Albertsons a Buy. My goal is to start acquiring shares next week at prices under $21.

Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.