The Kroger-Albertsons deal has a chance

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

Kroger-Albertsons

The stock market sees little chance of Kroger’s acquisition of rival grocery chain Albertsons surviving antitrust scrutiny. But the Federal Trade Commission’s case against the deal — currently before a federal court in Portland, Oregon — is not firm.

Walmart, which has 21% of the market, sells more groceries in the US than anyone else. Kroger, a distant second at 9 percent, wants to close the gap. In October 2022, it agreed to buy Albertsons — in fourth place with 5 percent of the market — for $34 a share. Albertsons shares, which were trading around $25, barely moved on the news and remained at $19 yesterday.

On its face, the FTC’s case is strong. The regulator does not consider discount stores such as Walmart and Costco to be supermarkets. That makes Kroger and Albertsons number one and number two in their market, and thus their combination smacks of oligopoly.

But while Kroger and Albertsons are the largest brick-and-mortar grocers, Americans aren’t just buying food from brick-and-mortar grocers anymore.

If the merged Kroger-Albertsons is indeed meant to compete with the Arkansas giant (which also owns fifth-ranked Sam’s Club), the merged retailer should cut prices, not raise them — a boon for Walmart and Kroger consumers alike. From Bill Kirk of Roth Capital Partners:

If you’re a current shopper at Albertsons or Safeway (which is owned by Albertsons), there’s a good chance your experience is about to get better. Prices will have to come down to compete with Walmart, especially at Safeway – which is not competitively priced. A lot of Albertsons and Safeway stores are old and in need of investment and remodeling, which Kroger will need to do to compete.

The FTC also makes an argument about work. It argues that combining the two chains would limit the bargaining power of the unions that represent their workers, particularly in states like California and Arizona, where the combined stores would have a large market share. But this argument also has some problems. Yes, larger businesses have more bargaining power. But we are talking about grocery stores, where the workforce is not specialized and employees often have the opportunity to move on to 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, perhaps to Kroger’s benefit. In June, the Supreme Court ended “Chevron deference,” which had given agencies like the FTC more power to set traffic rules. Given that there is some uncertainty about who Kroger’s competitors are and how that may affect food prices, this creates more room for a judge to side with Kroger.

There is no guarantee that Kroger will be able to compete effectively with Walmart. If not, the merger would only 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 of the Brookings Institution:

Nothing I’ve seen in the pretrial filings suggests that C&S Wholesale, which will buy the divested stores, actually has the skills and scale to be an effective competitor to a merged Kroger. . . And they didn’t set out to divest all the stores in their overlapping markets — they made a few choices. This looks like a classic example of trying to get a merger while throwing some pennies at consumers and workers who, at the end of the day, will be significantly and adversely affected.

When Albertsons bought Safeway in 2015, divestitures were a disaster. The company that bought the stores went bankrupt eight months later, and Albertsons ended up buying some of them back. Therefore, the judge in this case can be extremely cautious.

However, it is surprising to us that the market is placing such high odds on this transaction. It’s a long way from $19 to $34. Is there something we’re missing?

(Reiter and Armstrong)

Breakdown of the real estate rally

Since mid-May, real estate has been the best-performing sector of the S&P 500, with a total return of 23%. This is 13 points ahead of the market. Can the sector continue to lead?

The main reason real estate has done well over the past three months is because it is rate sensitive. The sector is largely made up of investment trusts that are held for their returns; lower rates make those returns more attractive. Similarly, higher rates lower the valuations of the assets Reits hold and threaten the most leveraged and lowest quality assets with default. So the sector fell well after the Fed began raising rates in 2022 and has recouped many of those losses now that the central bank has signaled its willingness to taper.

The futures market’s best guess is that the Fed’s policy rate will drop from 5.25% now to just under 3% in two years. If correct, and the yield curve resumes its normal shape, long-term rates would be in the 3.5% to 4% range, or 1 to 1.5 percentage points above their level before the inflation shock. This difference is important because not all rate-driven real estate losses will be recovered if rates do not return to their old lows. Indeed, it is likely that much of the future decline in rates is already being priced into housing stocks. Barring a further decline in rate expectations, the fuel for further gains in the sector will have to come from elsewhere.

Which market segments still have room to come back? Two groups of Reits stand out. Office Reits (Boston Properties, Alexandria, Healthpeak) are still down more than 30% from peaks and offer dividend yields of 4% to 5%. If you think rates will fall fast enough for the office industry to recover before it hits a default wave, there’s an opportunity there. Apartment Reits (Camden, UDR, Mid-America Apartment, Equity Residential) are still down 10% to 20% and yielding 3% to 4%. Rent inflation, which soared in 2021, is now lower than before the pandemic. Can it warm up a little?

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

A Good Read

Bad hospitality.

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