Kroger and Albertsons combination viewed skeptically by Wells Fargo

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Both Kroger (NYSE:KR) and Albertsons Companies (NYSE:ACI) fell sharply on Friday as the planned merger did not find much optimism. Wells Fargo analyst Edward Kelly added to skeptical voices in a note to clients assessing the deal.

“[Kroger] (KR) announced its intention to acquire [Albertsons Companies] (ACI), a transaction that is about as complex as it gets,” he told clients. “Divestiture risk looks high, even if it clears the FTC hurdle, making the merged company difficult to model. KR is buying an asset that we believe needs a sustained period of investment to reach the company's standards.”

On the divestiture front, Kelly sees potential problems in Kroger’s (KR) plan to spin off up to 375 stores via an Albertsons subsidiary (SpinCo).

“The merger agreement allows KR to walk away and pay a $600M break-up fee if forced FTC divestitures exceed 650 stores,” he advised. “It's difficult to know if an FTC ruling would breach this threshold, but we still expect a high number of divestitures given it may be difficult to find a buyer without providing adequate local scale.”

Kelly also commented that he believes the timing of the deal is not ideal given US grocery chains are set “to lap the best operating environment in their history.” As such, he reiterated a Sell-equivalent rating, which he initiated in January and reiterated in March 2022 previously.

“We see a scenario where the deal could be good for KR and ACI if it closes with an acceptable divestiture outcome and KR slowly invests in the acquired assets over time,” Kelly concluded. “That being said, there is significant uncertainty on many fronts against growing concerns around grocers' ability to keep the historic EBITDA gains of the last few years. It's hard to see meaningful upside at the moment.”

Read more on the implications for the broader grocery sector.