This week’s bond review looks to the retail grocery sector where the number two grocer in the U.S. is eyeing the exploding growth in e-commerce grocery. Albertsons has become a major player in the grocery industry, due in large part to its merger with Safeway nearly two years ago. The company is aggressively pursuing its e-commerce strategy, with over 60% of its stores already e-commerce capable and more coming online each month. The company will have an e-commerce presence in 8 of the 10 largest markets in the U.S. by the end of its 2017 fiscal year. It is also aggressively updating / remodeling existing stores to improve customer experience and ultimately drive sales. Online grocery sales are projected to increase to $100 billion by 2025 and Albertsons is ensuring it gets its piece of the pie. Cerberus Capital Management, the private equity backer of Albertsons, is working diligently to increase online sales as it most likely has an investor mandate to return profits. This will most likely come from a bid to take the company public. Although Cerberus withdrew a bid to do just that earlier this year, it is still a viable option for the future. The company’s 2024 bonds are couponed at 6.625% and have a current yield-to-maturity of about 7.4%. While this yield-to-maturity is less than some of our more recent reviews, it is still over 3x the 7-year U.S. Treasury yield. Considering Albertsons competitive position and aggressive pursuit of the e-commerce space, these bonds make an excellent addition to our Fixed-Income2 managed income portfolio. The most recent performance of our managed FX2 portfolio is shown below.
Albertsons recently posted its fiscal Q1 results. Some of the company’s highlights from its first quarter included:
Accelerated expansion of its e-Commerce and digital offerings. Albertsons is aggressively pursuing e-Commerce expansion. Currently, over 1,400 stores have e-commerce capabilities, with 1,000 company owned delivery trucks.
Increased penetration of the Own Brands portfolio. Own Brands is the company’s private label line of products. In 2016, Own Brands generated $10.9 billion in sales.
Opened ten new stores, including five acquired stores and remodeled 42 stores. The company continues to expand as well as upgrade / remodel existing stores to enhance customer experience.
In spite of deflationary pressure in several food categories, Albertsons held net sales essentially steady, with an increase of 0.4% over fiscal Q1 2016. Net sales for Q1 were $18.46 billion compared to $18.39 billion.
About the Issuer
Albertsons Companies is one of the largest food and drug retailers in the United States, with both a strong local presence and national scale. The company has more than 2,300 stores spread across 35 states as well as Washington D.C. The company operates under 20 well-known banners including Albertsons, Safeway, Vons, Jewel-Osco, Shaw’s, Acme, Tom Thumb, Randalls, United Supermarkets, Pavilions, Star Market, Haggen and Carrs. Albertsons Companies employs approximately 273,000 people and serves 34 million customers each week. The company also has the nation’s largest brand of USDA-certified organic products with its O-Organics product line. Albertsons is backed by New York based Cerberus Capital Management, a private equity firm. The company maintains corporate locations in Boise Idaho, Phoenix Arizona and Pleasanton California.
Second-Largest Food Retailer
In January 2015, Albertsons completed its merger with competitor food retailer Safeway. The combined entity included 2,230 stores and a team of 250,000 employees. Today, the company has increased its workforce by nearly 10 percent and now has over 2,300 stores. This transaction catapulted Albertsons to being the nation’s second largest food retailer. Equally impressive, the synergies realized as a result of the merger are estimated to be $800 million annually by the end of fiscal year 2018.
Albertsons continues to look for ways to better serve the customer and grow revenues. Some of these growth initiatives include improving the customer experience through store remodels as well as increasing product access through grocery home delivery and “click and pick”.
In a recent interview, Albertsons CEO Bob Miller spoke about the company’s plans in the near term to not only enhance the customer experience, but ultimately grow revenues using home delivery and “click and pick” programs.
In its last fiscal year, Albertsons remodeled over 200 stores and it has plans to remodel over 200 more in the current fiscal year, according to Miller. Indeed, the company has earmarked $575 million of its $1.5 billion capital expenditure budget for FY 2017 for store remodels and new stores. If you can keep the consumer in the store longer, they are more likely to purchase additional items. Another focus for Albertsons this year is grocery home delivery. According to Miller, Albertsons is aggressively rolling out home delivery, with the company’s goal of having a grocery home delivery presence in 8 of the 10 biggest U.S. markets by the end of this fiscal year. The company already has over 1,400 stores with e-commerce capabilities and over 1,000 company-owner, temperature-controlled delivery trucks. Along with home delivery, the company also has a “click and pick” program where customers order groceries online and can pick them up curbside at their local store.
Online Grocery Sales Trends
Many people already use online shopping and home delivery for many of the products they use. From books to clothes / shoes to home goods, online shopping and home delivery has exploded over the past 10 or 15 years. Now, that model is permeating the grocery space as well. As indicated by this graphic, online grocery sales are increasing at a rapid pace. A recent Food Marketing Institute / Nielsen report estimates that online grocery shopping could grow to $100 billion annually over the next decade. The report found that nearly a quarter of American households currently purchase some groceries online, up from 19 percent in 2014. Also from the report, millennial shoppers were more willing to purchase groceries online, perhaps due to the fact that this group tends to have a more pervasive use of technology.
One of the key findings in the FMI / Nielsen report is that online grocery spending could grow between 2016 and 2025 from 4.3 percent of total U.S. food sales to as much as 20 percent, or approximately $100 billion. By comparison, in 2016, online grocery sales were about $20.5 billion. The report’s conservative scenario predicts a compound annual growth rate between now and 2025 of 9 percent. The challenge for food retailers will be wooing the online consumer for a piece of this growing market.
Interest coverage is of paramount importance to bondholders as it indicates the company’s ability to pay the interest on its current debt levels. For its fiscal Q1, Albertsons had $90.6 million in operating income. When adding the non-cash depreciation and amortization charge for Q1 of $578.4 million, this gives operating income of $669 million. With the Q1 interest expense of $270.5 million, this gives an interest coverage of 2.5x.
Another measure investors look at is liquidity levels. During the company’s latest earnings call, management indicated that Albertsons current cash level is $750 million. The company also has approximately $3.0 billion available on its asset based revolver. This is a healthy level of liquidity even considering the high operating costs of grocery retailers.
The default risk for bond investors is tied to whether Albertsons can continue to capitalize on its merger with Safeway as well as its success in integrating e-commerce purchasing into its business model. From all accounts, Albertsons is successfully integrating the two large grocery chains into one seamless grocery retailer, producing an estimated $800 million in synergies between the two companies by the end of FY 2018. Its aggressive pursuit of its online business has resulted in over 1,400 of its stores already equipped with e-commerce capabilities with the company projecting its presence in 8 of the 10 biggest U.S. markets by the end of this fiscal year. With these positive developments, the excellent 7.4% yield-to-maturity on the company’s 2024 bonds appears to outweigh the risks identified.
Earlier this year, online retailer Amazon acquired Whole Foods, sending shock waves throughout the grocery sector. While an Amazon-backed Whole Foods may certainly be cause for concern, traditional grocery retailers have been making inroads into e-commerce models and will continue to do so. The recent news that Amazon slashed prices on key grocery items at Whole Foods is certainly a positive step for the consumer, but this move only scrapes the surface of the underlying problems with Whole Foods. Meanwhile, traditional grocers can continue to build additional avenues to connect their product with the customer.
Summary and Conclusion
Albertsons, already a major player in the grocery retail space, catapulted itself into the prominent number two position through its merger with Safeway stores almost two years ago. Now, it is driving to become a major force in the rapidly expanding e-commerce grocery space. While Amazon is taking steps to “fix” Whole Foods, Albertsons is forging ahead with its e-commerce initiative, with over 60% of its stores already e-commerce capable. The company’s 2024 bonds, couponed at 6.625%, with a current yield-to-maturity of about 7.4% offer investors diversification into the retail grocery sector and make an ideal addition to our FX2 managed income portfolio.
Issuer: Albertsons Companies LLC
Ratings: B3 / B+
Yield to Maturity: ~7.39%
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Disclosure: Durig Capital and certain clients may have positions in Albertsons 2024 bonds.
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