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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Good Morning. The last jobs report before the Federal Reserve’s September meeting comes out today. If it’s bad, the Fed will cut. If it’s good, the Fed will still cut. 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 puts very low odds on Kroger’s purchase of rival grocery chain Albertsons surviving antitrust scrutiny. But the Federal Trade Commission’s argument against the deal — currently before a federal court in Portland, Oregon — is not ironclad.
Walmart, which has 21 per cent of the market, sells more groceries in the US than anyone else. Kroger, a distant second at 9 per cent, wants to close the gap. In October 2022, it agreed to buy Albertsons — in fourth place with 5 per cent of the market — for $34 a share. Shares of Albertsons, which were trading at about $25, barely moved on the news, and were languishing at $19 yesterday. Adjusting for the $7 special dividend that Albertson’s paid to shareholders as part of the deal, that is over 40 per cent below the transaction price.
On its face, the FTC’s case is strong. The regulator does not think of big box discount stores such as Walmart and Costco as supermarkets. That makes Kroger and Albertsons first and second in their market, and so combining them reeks of oligopoly.
But while Kroger and Albertsons are the largest traditional grocers, Americans don’t only buy food from traditional grocers any more.
If a merged Kroger-Albertsons really means to compete with the Arkansas giant (which also owns Sam’s Club, ranked fifth), the merged retailer would have to drive down prices, not up — a boon to Walmart and Kroger’s consumers alike. From Bill Kirk at Roth Capital Partners:
If you are a current shopper at Albertsons or Safeway [which is owned by Albertsons], there is a good chance your experience gets better. Prices will have to come down to compete with Walmart, especially at Safeway — which is not priced competitively. A lot of Albertsons and Safeway stores are old, and they need investment and remodels, which Kroger will need to do to compete.
The FTC also makes an argument about labour. It claims the combination of the two chains would limit the bargaining power of the unions that represent their workers, particularly in states such as California and Arizona where the combined stores would have a high market share. But that argument has some issues, too. Yes, larger businesses have more bargaining power. But we are talking about grocery stores, where labour is not specialised, and employees often have the ability to switch to other retail jobs. Not to mention a larger Kroger could compete more effectively with non-union Walmart.
The legal landscape has also shifted since the deal was announced, perhaps to Kroger’s benefit. In June, the Supreme Court ended “Chevron deference”, which had given agencies such as the FTC more power in determining the rules of the road. Given that there is some haziness about who Kroger’s competitors are and how this may affect grocery prices, that creates more room for a judge to side with Kroger.
There is no guarantee Kroger will be able to compete effectively with Walmart. If not, all the merger would do is harm smaller retailers and, potentially, consumers. And there are questions about the divestitures the companies have promised in order to avoid local monopolies. From Bill Baer, formerly at the Department of Justice and now at the Brookings Institution:
Nothing I have seen in the pretrial filings suggests that C&S Wholesale, which will buy the divested stores, really has the skill and the scale to be an effective competitor with a merged Kroger . . . And they have not proposed to divest all stores in markets where they overlap — they did some picking and choosing. This looks like a classic example of trying to get a merger through while throwing out some pennies to consumers and workers that, at the end of the day, will be significantly and adversely affected.
When Albertsons bought Safeway in 2015 the divestitures were a disaster. The company that bought the stores went bankrupt eight months later, and Albertsons wound up buying back some of them. The judge in this case may therefore be extra cautious.
Still, it is surprising to us that the market is putting such extremely long odds on this deal going through. Is there something we’re missing?
*This note has been amended to reflect the impact of Alberson’s special dividend
(Reiter and Armstrong)
Breaking down the real estate rally
Since mid-May, real estate has been the best-performing sector of the S&P 500, with a total return of 23 per cent. That is 13 points ahead of the market. Can the sector continue to lead?
The main reason real estate has done well over the past three months is that it is rate sensitive. The sector is mostly made up of investment trusts that are owned for their yields; lower rates make those yields more attractive. Relatedly, higher rates bring down the valuations of the assets Reits own, and threaten the most leveraged and lowest quality assets with default. So the sector fell a lot after the Fed started to raise rates in 2022, and has taken a lot of those losses back now that the central bank has signalled its readiness to cut.
The futures market’s best guess is that the Fed’s policy rate will fall from 5.25 per cent now to a bit under 3 per cent two years from now. If that’s about right, and the yield curve regains its normal shape, longer term rates would be in the range of 3.5 per cent to 4 per cent, or 1 to 1.5 percentage points above their level before the inflation shock. That difference is important, because not all of real estate’s rate-driven losses will be regained if rates don’t return to the old lows. Indeed, it is likely that much of the coming decline in rates is priced into real estate stocks already. Barring a further decline in rate expectations, fuel for further sector gains will have to come from elsewhere.
Which segments of the market still have room to recover? Two groups of Reits stand out. Office Reits (Boston Properties, Alexandria, Healthpeak) are still down more than 30 per cent from the peaks and offer dividend yields of 4 per cent to 5 per cent. If you think rates are going to fall fast enough for the office industry to recover before a default wave hits, there is an opportunity there. Apartment Reits (Camden, UDR, Mid-America Apartment, Equity Residential) are still down 10 per cent to 20 per cent and have yields of 3 per cent to 4 per cent. Rent inflation, which spiked wildly in 2021, is now lower than before the pandemic. Might it heat up a bit?
The easy money in the real estate sector has probably been made. Future gains will be earned by investors who know exactly what they are buying.
One Good Read
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