Albertsons Companies, Inc. (NYSE:ACI) operates grocery stores and drug stores in the United States with brands such as Albertsons, Safeway, Vons, Pavilions, and multiple others.
Since an IPO in 2020, Albertsons’ stock has returned around 75%. The company’s story has seen changes in the past years due to an acquisition offer by Kroger (KR). The acquisition offer has since gone under FTC scrutiny and is expected to likely fail when comparing the stock price and the agreed acquisition sum. Albertsons continues to post stable financials as an independent company, and despite a good share appreciation, the company trades at an incredible discount to comparable publicly listed companies.
A Performance in Line with Peers
Albertsons’ financial performance has been on par with peers such as Kroger and Walmart (WMT). Although Walmart also sells other items than just groceries, altering the financial performance from grocery chains slightly, the company is still comparable in my opinion.
The companies have achieved very similar growth in past years, as can be seen from FY2017 forward. Albertsons’ revenues have grown by a total of 32.8% from FY2016, with Kroger and Walmart showing an incredibly similar performance at comparable figures of 30.1% and 33.4% respectively. Kroger’s and Walmart’s fiscal years are off by a month compared to Albertsons, but are still very comparable.
Albertsons does have the weakest of the three companies’ operating margins at 3.0% in FY2023 compared to Kroger’s 3.3% and Walmart’s 4.2%. All of the companies have thin margins, very typical to companies in the consumer staples sector. Notably, Albertsons has achieved quite good margin expansion compared to Kroger’s more moderate margin expansion and Walmart’s stable margin.
The recent FY2023 performance shows a worse profitability trajectory for Albertsons compared to peers. In the Q4 press release, the lower margin is related to wage and benefit inflation, turbulent food inflation, and a growing mix of lower-margin pharmacy and digital business sales among other influences. While the other factors should affect Kroger and Walmart just as greatly, the pharmacy and digital business mix growth is a company-specific factor that could affect the margin trajectory slightly in the future as well. I believe that the companies should post quite stable margins going forward, and Walmart’s long-term history of margin declines looks worse than Albertsons’ FY2023 softness.
Albertsons’ return on capital is in line with the consumer staples sector with a current 8.8% compared to the sector’s median of 6.8% despite lower margins than the sector as a whole. Kroger and Walmart post similar returns on capital at 10.1% and 7.5% respectively.
Scrutinized Merger with Kroger Seems to Weigh on the Stock
Kroger confirmed the plans of a merger with Albertsons in October 2022, planning to acquire Albertsons for a consideration of $34.1 per share. With a $6.85 special dividend already paid, the cash consideration would now imply $27.25. The merger was already initially viewed skeptically by analysts such as Wells Fargo, relating both to the merger’s rationale and the FTC’s potential block of the merger.
Afterwards, many parties expressed concern over the merger, including Senator Elizabeth Warren, attorney generals of several states, and seven states that requested the FTC to block the merger. Finally, in February 2024, FTC sued to block the merger relating to concerns of too high pricing power for the combined entity.
The markets seem to price the merger as unlikely to happen with the stock trading 35% below the acquisition price. Kroger and Albertsons have agreed to sell a total of 579 stores to C&S to improve the likelihood of the merger going through, with 166 stores added into the planned sale in April. Roth MKM has raised the probability of the merger going through into 50% from 20%, but markets still price the merger skeptically.
A Relatively and Absolutely Low Valuation
Relative Valuation has a Wide Gap
Considering the similar financial performance, Albertsons’ stock trades at an inexcusable gap to the comparative peers – Albertsons currently trades at a forward normalized P/E of only 8.1 compared to Kroger’s 11.7 and Walmart’s significantly higher 27.7 – the gap shows an upside of 45% and 242% to the companies’ respective earnings multiple, unexplained by the companies' financial performance.
Compared to the consumer staples sector, the gap is similar as Seeking Alpha’s sector valuation metrics show – the forward P/E shows an upside of 119% to the sector median, and other metrics mostly show a significant discrepancy.
Consumer staples stocks often trade at quite high multiples due to the sector's incredibly stable nature. The companies often share a significantly low beta, and provide stable earnings throughout economic turbulence as Albertsons has also proven to be able to do. The P/E of 8.1 doesn't reflect the defensive nature of the business.
DCF Model Shows the Same Story of Undervaluation
To estimate a fair value for the stock, I constructed a discounted cash flow model (DCF model). In the model, I estimate a growth of only 1.2% for FY2024 in line with Wall Street analysts as food inflation slows down. Afterwards, I estimate stable growth of 2% in line with very long-term inflation, and representative of Albertsons’ longer-term organic performance.
For the EBIT margin, I estimate some deleverage from 3.0% into 2.6%. Albertsons’ capital requirements are quite low with the estimated growth, and I estimate a fairly good cash flow conversion.
The estimates put Albertsons’ fair value estimate at $38.44, 90% above the stock price at the time of writing. The wide valuation gap remains with an absolute valuation, making Albertsons a stable and incredibly undervalued pick.
A weighted average cost of capital of 5.90% is used in the DCF model. The used WACC is derived from a capital asset pricing model:
In Q4, Albertsons had around $124 million in interest expenses making the company’s interest rate 6.51% with the current amount of interest-bearing debt. Due to stable operations, Albertsons is able to leverage high amounts of debt. I estimate a long-term debt-to-equity of 50%.
To estimate the cost of equity, I use the United States’ 10-year bond yield of 4.30% as the risk-free rate. The equity risk premium of 4.60% is Professor Aswath Damodaran’s latest estimate for the United States, updated on the 5th of January. I use Seeking Alpha’s beta estimates, with the used 0.41 beta coming from the average of Albertsons’ 0.30, Walmart’s 0.50, and Kroger’s 0.44. Finally, I add a liquidity premium of 0.2%, creating a cost of equity of 6.40% and a WACC of 5.90%.
Takeaway
A dragged battle with FTC for the merger with Kroger seems to have turned investors away from Albertsons. The company performs stably, on par with other grocery chains and the consumer staples sector. Despite a similar performance to Kroger and Walmart, the valuation has been left into a widely cheaper level. The stock has great upside with either the merger going through or failing as Albertsons continues to perform incredibly stably, and as such, I initiate Albertsons Companies at Strong Buy.
Caffital Research
I write mostly about small cap companies in the United States, focusing on a thorough explanation on valuation. My investment philosophy revolves around the DCF model, and analysis that leads into my assumptions used in the model. The approach doesn't limit my investment philosophy into either growth or traditional value investing - rather, I factor in both into my thesis, revolving my theses on a large-scale picture instead of single catalysts.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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