The Kroger-Albertsons deal has a chance

Unlock Editor’s Digest for free

FT editor Roula Khalaf selects her favourite stories in this weekly newsletter.

Good morning. The last jobs report before the Federal Reserve’s September meeting is due out today. If it’s bad, the Fed will cut rates. If it’s good, the Fed will cut anyway. The only question is whether it’s 25 or 50 basis points. But that won’t stop the market from overreacting. Email us: [email protected] and [email protected].

Kroger-Albertsons

The stock market considers it very unlikely that Kroger’s takeover of rival grocery chain Albertsons will survive antitrust scrutiny. But the Federal Trade Commission’s arguments against the deal – currently before a federal court in Portland, Oregon – are not watertight.

Walmart, which has a 21 percent market share, sells more groceries in the U.S. than any other company. Kroger, a distant second with 9 percent, wants to close the gap. In October 2022, the company agreed to buy Albertsons – fourth place with a 5 percent market share – for $34 per share. Albertsons shares, which had been trading at around $25, barely moved after the news and were languishing at $19 yesterday. Adjusted for the $7 special dividend that Albertson paid to shareholders as part of the deal, this figure is more than 40 percent below the transaction price.

At first glance, the FTC’s argument is convincing. The regulator does not consider large discounters like Walmart and Costco to be supermarkets. That makes Kroger and Albertsons number one and two in their market, and their merger reeks of oligopoly.

But while Kroger and Albertsons are the largest traditional grocers, Americans no longer buy their groceries only from traditional grocers.

If a merged Kroger-Albertsons really wants to compete with the Arkansas giant (which also owns Sam’s Club, which ranks fifth), the combined retailer would have to lower prices, not raise them – a boon for Walmart and Kroger customers alike. From Bill Kirk at Roth Capital Partners:

If you currently shop at Albertsons or Safeway (which Albertsons owns), chances are your experience will be better. Prices need to be lowered to compete with Walmart, especially at Safeway – whose prices are uncompetitive. Many Albertsons and Safeway stores are old and need investment and remodeling, which Kroger needs to do to remain competitive.

The FTC also makes a labor argument. It claims that merging the two chains would limit the bargaining power of unions representing their workers, especially in states like California and Arizona, where the merged stores would have a high market share. But that argument isn’t without its problems either. Yes, larger companies have more bargaining power. But we’re talking about grocery stores here, where the labor force isn’t specialized and workers often have the opportunity to move into other retail jobs. Not to mention that a larger Kroger could compete more effectively with non-union Walmart.

The legal landscape has also changed since the deal was announced, possibly to Kroger’s advantage. In June, the Supreme Court ended the “Chevron deference,” which gave agencies like the FTC more power to set traffic rules. Because there is some ambiguity about who Kroger’s competitors are and how that might affect grocery prices, that gives a judge more leeway to side with Kroger.

There is no guarantee that Kroger will be able to compete effectively with Walmart. Otherwise, the merger would simply hurt smaller retailers and possibly consumers. And there are questions about the divestments the companies have promised to avoid local monopolies. From Bill Baer, ​​formerly of the Justice Department and now at the Brookings Institution:

Nothing I’ve seen in the pre-trial filings suggests that C&S Wholesale, which will buy the divested stores, really has the capabilities and scale to be an effective competitor to a merged Kroger… And they haven’t proposed divesting all of the stores in markets where they overlap — they’ve cherry-picked a few. This looks like a classic example of trying to get a merger through while throwing pennies at consumers and workers who will be significantly and adversely affected at the end of the day.

When Albertsons bought Safeway in 2015, the divestitures were a disaster. The company that bought the stores went bankrupt eight months later and Albertsons bought some of them back, so the judge in that case may be especially cautious.

Nevertheless, we are surprised that the market gives such a high chance of this deal being completed. Are we missing something?

*This note has been amended to reflect the impact of Alberson’s special dividend.

(Reiter and Armstrong)

Analysis of the real estate rally

Since mid-May, real estate has been the best performing sector in the S&P 500 with a total return of 23 percent, 13 points above the market. Can the sector maintain its top position?

The main reason for the real estate sector’s strong performance over the past three months is its interest rate sensitivity. The sector is mainly made up of mutual funds held for their yields; lower interest rates make those yields more attractive. In this context, higher interest rates lower the valuation of assets held by mutual funds and threaten the most leveraged and low-quality assets with default. Therefore, the sector fell sharply after the Fed began raising interest rates in 2022 and recovered much of those losses after the central bank signaled its willingness to cut rates.

The futures market is assuming that the Fed’s benchmark interest rate will fall from the current 5.25 percent to just under 3 percent in two years. If that’s roughly correct and the yield curve returns to its normal shape, longer-term rates would be in the 3.5 to 4 percent range, 1 to 1.5 percentage points above their pre-inflationary shock levels. This difference is important because unless rates return to old lows, not all of the real estate market’s interest rate-related losses will be recouped. In fact, it’s likely that much of the coming rate decline is already priced into real estate stocks. Unless interest rate expectations fall further, the fuel for further sector gains will have to come from elsewhere.

Which market segments still have room to recover? Two groups of REITs stand out. Office REITs (Boston Properties, Alexandria, Healthpeak) are still more than 30 percent below highs and offer dividend yields of 4 to 5 percent. If you believe rates will fall quickly enough for the office industry to recover before a wave of defaults hits, there’s an opportunity here. Apartment REITs (Camden, UDR, Mid-America Apartment, Equity Residential) are still down 10 to 20 percent and offer yields of 3 to 4 percent. Rent inflation, which rose sharply in 2021, is now lower than it was before the pandemic. Could it get a little hotter?

The easy money in the real estate sector has probably already been made. Future profits will be generated by investors who know exactly what they are buying.

A good read

Shabby hospitality.

FT Unhedged Podcast

Can’t get enough of Unhedged? Listen to our new podcast, featuring 15 minutes of the latest market news and financial headlines twice a week. Find previous editions of the newsletter here.