The grocery business is ripe for investment, and Kroger is a good way to play it even if it isn’t able to complete its acquisition of Albertsons , according to Bernstein. Analyst Dean Rosenblum said he’s bullish on Kroger without the deal, seeing 25% potential upside for the stock from Tuesday’s close. But if the deal is completed, Rosenblum likes it even more. In a research note initiating coverage of hardlines and broadlines retail stocks Monday, he said the long-term fundamentals are sound for both industry segments as each are well-insulated from e-commerce encroachment, and Covid’s impact has actually improved the long-term outlook. Plus, recent market volatility has created opportunities for investors. With a potential recession on the horizon, grocery can provide some safety, as the companies deliver fairly reliable low-single digit growth, he said. “Since 1Q22, Grocery has been growing [high single digits] from inflation, but as inflation abates, we expect growth to settle back down to LSD; and we expect gross margins, which contracted this year, to rebound, also as inflation rolls over,” Rosenblum wrote. According to Rosenblum, Kroger offers a good way to play the sector as Walmart , the market leader, is large and “it’s hard to move a needle this big.” FTC’s second request On Tuesday, Kroger said it received a second request for information from the Federal Trade Commission, which is reviewing the $24.6 billion grocery deal . Kroger said it had anticipated the request and still expects to complete the merger in early 2024. Many have been anticipating an intense review of the deal by regulators . Although the grocery market is highly fragmented, Kroger and Albertsons are two of its biggest players. Some critics have said the combination could hurt competition and result in higher prices for essential grocery items. In testimony before the Senate last week, the CEOs of the two companies said they would spend $500 million in the four years after the deal closes to make sure grocery prices stay low, and they have pledged not to lay off grocery store workers. Says 90% chance the deal will close Rosenblum said he has “pretty high-conviction” that the deal will close, based on his research. That said, it may require the company to sell off some stores in order to make sure there isn’t too much consolidation in any local markets. He said the merger will create a strong player with a near-national reach and better operating margins. If for some reason, the deal doesn’t close. Rosenblum expects Albertsons shares will be worth $19. On Tuesday, shares closed at $21.07, which means investors are still pricing in a good deal of skepticism. Once the deal closes, Albertsons shares should be worth about $27, based on the deal price, net a special dividend the company plans to pay as part of the transaction. “We, however — having talked to the experts, and done the work — put the probability of the deal closing at 90% (subject to the aforementioned modest number of store divestments),” he said. “So we think the stock is worth $26 right now (90% * $27 + 10% * $19), which represents a 24% upside from the current price [on Monday]. And, in the event the deal doesn’t close, we still like Albertsons on its own, and we’re still buyers at the current price.” The bigger picture Beyond the strategic reasons for the Kroger-Albertsons deal, Rosenblum also sees reasons to be optimistic about both grocery and home improvement sectors. His top overall pick is Floor & Decor , which he calls “a retail growth story with legs.” Rosenblum’s $112 price target implies more than 55% upside from Tuesday’s closing price. Year to date, Floor & Decor shares are down more than 44%. His call hinges, in part, on the company’s offering, which he says is hard for rivals to replicate. Also, the company is pretty well established among professional contractors and has plans to expand its store footprint to some 500 stores. Currently, it operates about 180, he said. Beyond these arguments, Rosenblum’s research — which included customer and traffic analysis and in-store field work — has shown that shopper behavior has changed considerably since Covid. He expects the focus to remain on the home, which will benefit both home improvement retailers and grocery stores. “In Grocery, work-from-home/cooking at home will be durable shifts which will bolster growth, and eGrocery went from ~3% of grocery sales to > 11% (and stable), with B & M (brick[-and-mortar) grocers capturing the vast majority of that growth,” he wrote. “In Home Improvement, despite the recent pullback and uncertainty surrounding the housing market, the elevated role of our Homes vs. Pre-Covid is here to stay. And these shifts are long-term tailwinds for our covered companies.” — CNBC’s Michael Bloom contributed reporting.
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