At a recent investor day, Kroger (NYSE: KR) announced it was exploring a potential sale of its convenience store business. You might not have known Kroger was in this business, but in its long history of acquisitions, many buyout targets kept their names. That’s not only true for the convenience stores but even Kroger’s core grocery business with brands like Ralph’s, Harris Teeter, and King Soopers, among others.
Kroger shareholders have been under heavy pressure due to price wars in the grocery industry, compounded by the looming threat of a rejuvenated Whole Foods following its acquisition by Amazon . Is the potential sale of convenience stores an act of desperation or just prudent capital allocation?
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Kroger owns 784 convenience store locations under brand names Kwikshop, Tom Thumb, Loaf N’ Jug, and Quickstop, which bring in a total of $4 billion in annual sales, gasoline and snacks included. The company claims the potential sale was not in response to any industry events in particular but rather from a routine assessment of the company’s large asset base. Management also indicates the return on a sale to a strategic buyer is likely to yield a greater return than holding the assets.
While most convenience stores in the U.S. are owned by oil refining companies or integrated oil majors, there are two large, pure-play convenience store stocks, Casey’s General Stores , with about 2,000 locations, and Murphy USA (NYSE: MUSA) , which owns about 1,400 locations. Casey’s stock is valued at about 0.6 times sales, while Murphy’s sells for only 0.25 times sales due to its lower margins. With buyout premiums commonly falling between 20% and 30%, one could see Kroger generating an estimated $2 billion to $3 billion from a sale.
How would Kroger use the cash?
Kroger could use the proceeds for a number of purposes. First, it’s likely to reinvest in its core grocery business to fend off not only Amazon but also foreign chains like Aldi and Lidl. Ongoing competitive pressure has forced Kroger to lower its prices, which the company hopes to make up for with improved technology and optimization.
During the investor day, management outlined a plan to invest $9 billion dollars in capital spending over the next three years, and much of this spending will be focused on these tech, supply chain, and store optimization measures. For instance, the company is expanding its popular Clicklist pickup service to 1,000 of its 2,800 locations this year, and the company hopes to build its customer data analytics into entirely new revenue drivers, even outside of groceries. Tech and efficiency investments are forecast to total about $3.5 billion, but management predicted they would expand operating margin dollars by more than that amount .
Moreover, the company believes it will pay out $1.5 billion in dividends over the next three years and perhaps triple that in stock buybacks . That means shareholders would receive an average $2 billion per year for the next three years, or an approximately 10% return at current price levels. With the stock down nearly 40% year to date, management likely sees the weak trading as a prime opportunity for share repurchases, too.
Overall effect is minor
It should be noted that Kroger is in the early stages of a sales process, which is no sure thing. But even if a deal closes, it should have do little to change an investor’s outlook on the company, as the convenience stores make up less than 4% of its $118 billion in annual revenue.
However, I still believe the company is doing the right thing by pursuing the sale of its non-core assets. Shoring up the main grocery business is the most important task in this challenging environment. And while Kroger stock is volatile, I continue to believe it’s worth a look for value investors.
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Billy Duberstein owns shares of Amazon and Kroger. The Motley Fool owns shares of and recommends Amazon and Casey’s General Stores. The Motley Fool has a disclosure policy .
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.