The Kroger Co. (KR): Is This the Right Time to Add This Giant Grocer to Your Portfolio?

Grocery stores have become an integral part of every consumers life. According to a report issued by the Food Marketing Institute, American consumers purchases food worth $600 billion every year. Even though the growth of this industry is not as rapid as the others, an investment in this industry will provide steady and stable returns in the long-term.

With Wal-Mart Stores, Inc. (NYSE:WMT) becoming the largest grocery seller in the U.S., this industry has become heavily competitive. The Kroger Co. (NYSE:KR) – the largest grocery chain in the U.S. has been facing tremendous pressure from Wal-Mart Stores, Inc. (NYSE:WMT) – which has been opening new standalone grocery stores in the U.S. Kroger has become even bigger now. This Ohio-based company recently acquired Harris Teeter Supermarkets Inc (NYSE:HTSI) for $2.4 billion in cash. Is this the right time to buy The Kroger Co. (NYSE:KR)? Let’s take a close look at the deal and find out.

The deal and its benefits

Kroger signed up for a bigger dose of fruits and vegetables. In a deal valued at $2.5 billion, The Kroger Co. (NYSE:KR) offered $49.38 per share, a premium of around 33.7%, compared to Harris Teeter’s closing price on January 18, 2013. Kroger will also assume Harris Teeter’s $100 million debt. The company also expects the deal to result in cost savings of $40 million-$50 million in the next 3-4 fiscal years.

Harris Teeter Supermarkets Inc (NYSE:HTSI) is an upscale grocer known for its fresh food like good quality meat, salads and fresh vegetables. It is the number one market share competitor in Charlotte, N.C. and the sixth-largest grocery chain in Washington, D.C.

The Kroger Co. (NYSE:KR) has tremendous scope to learn and improve from Teeter’s expertise in fresh food. This will help Kroger in increasing its position in the organic food industry. The deal will also help Kroger expand its footprint in areas with rich, affluent shoppers and tremendous growth potentials like Washington and Carolina – where Harris Teeter has around 212 stores.

The deal was attractive to The Kroger Co. (NYSE:KR) because Harris Teeter’s margins were better than the other national grocers. The table below shows the operating and profit margin of 4 different grocers-

Harris Teeter is a growing business; the company increased its stores count from 199 in 2010 to 212 in 2012. It generated revenue of $4.5 billion for the 2012 fiscal year and for the most recent quarter – it reported a 9% increase in its earnings. As of March, it has no interest bearing debt on its balance sheet and has around $193 billion in cash. Solid financials and the best margins made Harris Teeter the most obvious choice for Kroger.

Valuation and competition

Even though Kroger has been facing tremendous pressure from the rapidly growing Wal-Mart, it has always dominated its rivals like Safeway Inc. (NYSE:SWY).

With more than 1600 retail outlets, Safeway Inc. (NYSE:SWY) reported 63% earnings growth, primarily because of unexpected tax-benefits. It reported a 1.5% increase in its same-store sales.

The company recently sold its Canadian branch to Sobeys for $5.7 billion, of which it plans to use $2 billion to pay off its debt. The rest of the proceeds will be used for share repurchase programs and investment opportunities.