The Kroger-Albertsons deal has a chance

Good morning. Today is the last jobs report before the September Federal Reserve meeting. If it’s bad, the Fed will cut. If it’s good, the Fed will cut anyway. The only question here is 25 basis points or 50. But that won’t stop the market from overreacting. Email us: robert.armstrong@ft.com and aiden.reiter@ft.com.

Kroger-Albertsons

The stock market is pricing in virtually no chance that Kroger’s purchase of rival supermarket chain Albertsons will survive antitrust scrutiny, but the Federal Trade Commission’s argument against the deal (which is currently in federal court in Portland, Oregon) is not airtight.

Walmart, which has 21 percent of the market, sells more food in the U.S. than any other company. Kroger, which is a distant second with 9 percent, wants to close the gap. In October 2022, it agreed to buy Albertsons, which is ranked fourth with 5 percent of the market, for $34 a share. Albertsons shares, which were trading at about $25, barely budged on the news and were languishing at $19 yesterday.

On its face, the FTC’s argument is sound. The regulator doesn’t consider big discounters like Walmart and Costco to be supermarkets. That puts Kroger and Albertsons in first and second place in their market, so combining them smacks of oligopoly.

But even though Kroger and Albertsons are the largest traditional grocery stores, Americans no longer shop only at them for groceries.

If a merged Kroger-Albertsons really wants to compete with the Arkansas giant (which also owns fifth-ranked Sam’s Club), the merged retailer would have to cut prices, not raise them, which would benefit both Walmart and Kroger shoppers. From Bill Kirk of Roth Capital Partners:

If you are a current shopper at Albertsons or Safeway [which is owned by Albertsons]There’s a good chance your experience will improve. Prices will have to come down to compete with Walmart, especially at Safeway, which is not price competitive. Many Albertsons and Safeway stores are older and need investments and remodeling, which Kroger will have to do to compete.

The FTC also makes a labor-related argument. It claims that combining the two chains would limit the bargaining power of unions representing their workers, particularly in states like California and Arizona, where the combined stores would have a high market share. But that argument has some problems, too. Yes, larger companies have more bargaining power, but we’re talking about grocery stores, where labor is unskilled and employees often have the ability to change jobs in retail. Not to mention that a larger Kroger could compete more effectively with a nonunion 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 determine the rules of the game. Since there is some confusion about who Kroger’s competitors are and how this may affect food prices, that creates more room for a judge to side with Kroger.

There are no guarantees that Kroger can compete effectively with Walmart. If not, the merger would only hurt smaller retailers and, potentially, consumers. And there are questions about the divestments the companies have promised to prevent local monopolies. From Bill Baer, ​​a former Justice Department official and now a fellow at the Brookings Institution:

Nothing I’ve seen in the pretrial filings suggests that C&S Wholesale, which will be buying the divested stores, actually has the skill and scale to be an effective competitor to a merged Kroger… And they haven’t proposed divesting all the stores in the markets where they overlap; they’ve made some choices. This seems like a classic example of trying to push through a merger while giving some money to consumers and workers who, at the end of the day, will be significantly and negatively affected.

When Albertsons bought Safeway in 2015, the divestitures were a disaster. The company that bought the stores filed for bankruptcy eight months later, and Albertsons ended up buying back some of them. So the judge in this case may be extremely cautious.

Still, we’re surprised that the market is betting so heavily on the possibility of this deal going through. There’s a big difference between $19 and $34. Is there something we don’t know?

(Reiter and Armstrong)

Analysis of the real estate rally

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

The main reason the real estate sector has performed well over the past three months is that it is rate-sensitive. The sector is comprised primarily of investment trusts that are held for their yields; lower rates make those yields more attractive. Relatedly, higher rates drive down the valuations of assets held by REITs and threaten default on more leveraged, lower-quality assets. The sector therefore fell sharply 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 cut rates.

The best estimate from the futures market is that the Fed’s policy rate will fall from the current 5.25% to just under 3% within two years. If that is correct and the yield curve returns to its normal shape, long-term rates would be in the 3.5% to 4% range, or 1 to 1.5 percentage points above their pre-inflation shock level. That difference matters, because not all of the rate-driven losses in the housing sector will be recovered if rates do not return to previous lows. In fact, much of the coming rate decline is likely already baked into real estate stock prices. Unless rate expectations fall further, the fuel for further gains in the sector will have to come from elsewhere.

Which market segments still have room to recover? Two groups of REITs stand out. Office REITs (Boston Properties, Alexandria, Healthpeak) are still 30% below their highs and offer dividend yields of 4% to 5%. If you think rates are going to fall fast enough for the office industry to recover before a wave of defaults hits, there is an opportunity. Apartment REITs (Camden, UDR, Mid-America Apartment, Equity Residential) are still 10% to 20% below and have yields of 3% to 4%. Rent inflation, which spiked wildly in 2021, is now lower than before the pandemic. Could it pick up a bit?

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

A good read

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