Is The Kroger Co. (KR) a Buy After The Recent Acquisition?

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The Kroger Co. (NYSE:KR)The food industry has gotten hot with M&A activities as The Kroger Co. (NYSE:KR), the nation’s largest grocery chain, offered $49.38 per share to acquire Harris Teeter Supermarkets Inc (NYSE:HTSI), for a total transaction value of $2.5 billion. The offering price represented a 34% premium to Harris Teeter Supermarkets Inc (NYSE:HTSI)’s trading price in the middle of January, when the company first announced it was seeking strategic alternatives. Is a $2.5 billion fair for Harris Teeter? Is The Kroger Co. (NYSE:KR) a buy after the deal? Let’s take a closer look and find out.

Harris Teeter’s business snapshot

Harris Teeter Supermarkets Inc (NYSE:HTSI) is a regional supermarket operator with around 208 stores in eight states, mainly in the southeastern and mid-Atlantic U.S., as well as the District of Columbia. In the past three years, Harris Teeter has managed to increase the number of its stores from 199 in 2010 to 208 in 2012, while the average weekly net sales per store also has risen consistently as well, form $395,510 in 2010 to $425,235.

In the past ten years, Harris Teeter has managed to grow its revenue at a decent rate, from $2.73 billion in 2003 to $4.54 billion in 2012, while its net income rose from $60 million to $83 million during the same period. Since 2003, Harris Teeter’s operating cash flow has been consistently positive, but the free cash flow has fluctuated widely, in the range of $(59) million to $118 million. In the past twelve months, the company produced $238 million in operating cash flow and $29 million in free cash flow.

Investors would feel safe with Harris Teeter because of its conservative capital structure. As of March 2013, it had more than $1 billion in equity, $193 million in cash and no interest-bearing debt. The contractual obligations came in at only $227.17 million in less than a year (since September 2012) and $281.74 million in the period of 1-3 years. At $49.38 per share, Harris Teeter is valued at around 8 times its trailing EBITDA.

The Kroger Co. (NYSE:KR) could expand the business in higher growth areas

The Kroger Co. (NYSE:KR) is considered the world’s largest grocery chain, operating 2,419 supermarkets and multi-department stores in 31 states. Around $48.67 billion, or 50.3% of the total sales, were generated from non perishable goods, while the perishable goods ranked second with nearly $19.9 billion in 2012 sales. Fuel stayed in third place, accounting for 19.5% of the total revenue in 2012. The acquisition of Harris Teeter will allow The Kroger Co. (NYSE:KR) to expand its national footprint into higher growth areas, especially in fresh foods and private-label goods. David B. Dillon, The Kroger Co. (NYSE:KR)’s Chairman and CEO, felt bullish about the acquisition, saying

They have a stronger fresh reputation, and by fresh I’m really referring to all the perishable departments, than some of the Kroger operations. Our intent is to learn from them. ‘How do they get that reputation? What are some of the things they do that create that?’ It won’t be as much, I think, in the actual products as in the methods by which we get the products to the market.

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