US retail giant Kroger this week struck a deal to buy regional supermarket chain Harris Teeter in a deal worth US$2.44bn. Analysts believe the deal makes perfect sense, offering synergies and opportunities for Kroger to strengthen its position in the US retail scene. One analyst, however, believes Kroger may face competing bids before a deal is secured. Michelle Russell takes a look.

After five months looking its options, the Harris Teeter board has accepted a bid for the regional US supermarket chain. But it has come from a company few had linked to the upmarket grocer – national retailer Kroger.

Since Harris Teeter revealed it was exploring sale options in February, fellw US retailer Publix, Dutch retail giant Ahold and private-equity owner Cerberus Capital Management (and owner of five former Supervalu Inc chains) had all been linked with the business.

In February, Harris Teeter said approaches from two unnamed private-equity firms had led it to appoint JP Morgan to assist with exploring its options. In the end, it is Kroger, a nationwide retailer with over 2,000 stores, that has struck a deal to buy the business, which is focused on the south-east of the US.

There may have been some surprise among industry watchers about Kroger buying the regional and upmarket Harris Teeter but Barclays Capital analysts, however, believe the deal make perfect sense.

“We think this is a very good acquisition for Kroger, given the quality of the asset and its operations in high-growth markets. The transaction should be accretive by $0.06-$0.09 in the first full year after closing, before synergies and excluding transition and closing costs.”

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On the face of it, the deal may not appear to be a large one. Not when you consider Kroger’s sizeable acquisition of Fred Meyer in 1998 for around $12bn. Harris Teeter also only has 212 stores, compared with Kroger’s network of 2,419.

However, the deal will be the fourth-largest acquisition of a North American food retailer in the past ten years, according to Bloomberg.

Kroger appears to have been wise with its choice of acquisition. Harris Teeter is a well-run chain of stores, primarily located in North Carolina, Virginia, and South Carolina, with some stores in mid-Atlantic states such as Delaware and Maryland.

Harris Teeter is only in three states that Kroger is not but their presence in areas they are both in is different. It has 138 stores in North Carolina; Kroger has just 14. The only real overlaps are in Nashville, Tennessee; Raleigh-Durham; the Hampton Roads area of Virginia; and Charlottesville, Virginia.

Janney analyst Jonathan Feeney believes Kroger has acquired a “great banner and strong brand with minimal overlap, as the company continues to grow its footprint in a measured way, all while leveraging its considerable scale in the process”.

He adds: “Kroger’s move to acquire a banner in markets largely adjacent to its core base will allow it to leverage its considerable scale, and on the surface figures to drive synergies in excess of management’s initial $30-$40m forecast.”

The Harris Teeter deal will leave Kroger with gaps only in the north-east and north central states of North America. But its strong capital and operational efficiency would likely set it up to fill those in with acquisitions at a later date, Barclays suggests.

Kroger CFO Michael Schlotman insisted on a conference call following the announcement it has no plans to close stores following completion of the deal, and that it expects to continue to growth both franchises.

And why wouldn’t it? Harris Teeter is well known in the markets it operates in, so there would be no sense in dropping the name. The grocer has also reported six straight quarters of sales increases, and revenue is expected to increase 5.2% to $4.77bn in the year ending in September, according to Bloomberg.

According to Barclays, Harris Teeter is a “conventional supermarket chain but with a slightly upscale image and offering, with a reputation for product quality and customer service”. Its stores, the analysts say, are located “appropriately” to attract a relatively affluent customer base.

UBS analyst Jason DeRise concurs. He believes an asset like Harris Teeter is “unique” in the grocery world.

“Harris Teeter is a grocer with strong brand equity, has a loyal high income shopper base, highly invested stores, no union, no debt, no pension issues.”

DeRise, however, also Harris Teeter could yet attract other bids. “Publix and Ahold will likely need to consider a bid for strategic purposes because Kroger is known to compete on price.”

Both have been mooted as potential buyers in the last five months. But if Kroger manages to secure the deal, the acquisition could ultimately push it past Publix in the US retail space, its chief rival in the south-east, in the Carolinas and Virginia.

Kroger could also learn some things from Harris Teeter. On its conference call this week, management mentioned Harris Teeter’s click and collect business. Kroger has no presence in online yet but said it is something it has considered. This deal will give it access to Teeter’s expertise in online sales, a market that is seen as a tough nut to crack for US grocers.

In turn, Barclays says Kroger may be able to give Harris Teeter some new technology that the company may not have been able to afford as a 200-store chain.

While the deal is not yet done and dusted, analysts suggest the acquisition makes sense for both. For Kroger, Feeney says its growth strategy appears to be working, despite the competitive threats.

“Kroger is making progress on all four of its keys: positive ID sales, increased FIFO operating margin, ROIC, and market share. The company is putting its strong balance sheet and dry powder to work with the Harris Teeter merger, and while strong capital investments and share repurchase will likely remain front of mind for management, deleveraging in the wake of the announcement will likely be the near term priority for cash flow.”