Albertsons IPO Looks Good

Albertsons Companies Inc. (NYSE: ACI), one of the largest grocer, is going public this week, offering 66 million secondary shares at an expected price of $18-$20, valuing the company around $9 billion and an enterprise value of $19.0 billion. We believe this is a good price for what is shaping up to be a great company.

You have the right to be cautious

Now taking a look at a grocery store business when things that are working in the stock market are – bankrupt car rentals, airlines near bankruptcy, SPAC’s and cruise liners that are fight hard to stay afloat, is a hard choice, but we believe Albertsons is worth it.

“Investors even remotely tempted to buy new issues must ask themselves how could they possibly fare well when a savvy issuer and a greedy underwriter are on the opposite side of every underwriting. Indeed, how attractive could any security underwriting ever be when the issuer and underwriter have superior information as well as control over the timing, pricing, and stock or bond allocation? The deck is almost always stacked against the buyers.” – Seth Klarman, Margin of Safety

We are usually not a fan of IPO deals brought up by private equity firms, since faring well against a savvy investor with superior information is a damn hard thing in investing, more so against a private equity firm like Cerberus Capital.

Risks, there are some

After the Cerberus-led group acquired the company in 2005 via leverage buyout, there have been failed attempts to take it public, like the proposed public offering in 2015 that was withdrawn in 2018 and planned merger with Rite-Aid (NYSE: RAD) that never materialized.

Even now, the business carries more than $8 billion of debt that may prove to be high if the economy doesn’t turn back quickly and the elevated sales seen during the Covid-19 pandemic eventually tapers off.

Grocery sales have been strong through the lockdown, partly driven by the closure of restaurants and people staying at home, and investors have the right to be skeptical about sales trends once the lockdown ends.

Potential of more shares in the market down the road, given 65 million barely makes up 11% of the shares outstanding, is another threat that may put a cap on the stock.

Focus on the phenomenal job done restructuring the business

Even with the risks, the risk-reward trade-off seems favorable, considering the great job done by the management restructuring the business, and the momentum may just continue, especially looking at the execution under Vivek Sankaran, the new CEO.  

As a private company, they have already done the heavy lifting in terms of building the franchise with big enough store network, of more than 2250 stores, and upgraded backend infrastructure.

What started as a purchase of a few hundred Albertsons stores in 2006 by the private equity consortium, the current business consists of all Supervalu bought in 2013 and Safeway stores bought in 2015. Integration of stores, supply chain and technology platforms are completed, a tall task for any retail store chain, especially a grocery with an extensive list of SKU’s.

The current CEO, Vivek Sankaran, has come over from Pepsico (NYSE: PEP) and within a year, his mark is visible in the numbers, eight straight quarters of identical sales increases, and improved profitability through the profit & loss statement.

So what have they restructured?

Much of the large investments upgrading stores and technology are behind. The company spent $6.8 billion on capital expenditure over the last 4 years and $1.5 billion in 2019 alone. The spending includes 950 store remodels and 57 new stores. $375 million was spent on digital and technology projects in 2019.

The results are evident in the numbers,

Albertsons Inc.   
    
 201720182019
Sales Growth 1.0%3.2%
Identical Sales Growth-1.3%1.0%2.1%
As % of Revenue   
Gross Margin27.3%27.9%28.2%
Selling, General and Admin27.0%26.8%26.6%
Source: SEC Filings. Adjusted for stock based compensation

Even though the sales growth has been impressive, improvement runs much deeper. An all-important metric for a retailer – Identical sales growth, has complexly turned around, highlighting that the turnaround story has been in place much before Covid-19 related push.

There’s a considerable improvement on the profitability front too. Gross margins have shown a consistent 20-basis improvement, which may accelerate as productivity and cost reduction efforts taken over the last year start to kick in. Indeed, shrinkage levels have declined by 45-basis points over the last two years.

Some of the current efforts that may deliver for the company over the next 2-3 years are, 

  • Extension of Drive Up & Go pickup service to 1,600 locations.
  • Up-gradation of the company’s website for full-digital customer experience
  • Up grading mobile App to enable rewards, basket-building tools and meal & recipe recommendations.
  • Increasing penetration of private label – ‘Own Brands’ from 25.4% in 2019 to 30%. 
  • Adding 800 products annually to the ‘Own Brands’ portfolio over the next few years.

Deal price not cheap, but the potential for improvement is much larger

Qualitatively, Apollo Global Management’s, another large private equity fund, the recent purchase of 17% stake in the company offers a positive vote of confidence, more so given the private equity firm’s history of success in the retail space, e.g. Sprouts Farmers Market (NYSE: SFM).

We believe, at $18-20 per share, expected IPO price, the stock would be priced close to 13-15 times next year’s Street’s earnings estimates, which isn’t too cheap if one compares it to Kroger (NYSE: KR), but at a significant discount if one compares to Costco Wholesale Corp. (Nasdaq: COST).

Yes, Albertsons is no Costco, but the business does offer significant upside potential from restructuring.

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