In early December, a judge granted the White House’s request to block a proposed merger between Kroger , based in Cincinnati, Ohio, and Albertsons , based in Boise, Idaho. However, this disappointment may have opened up a trading opportunity for astute investors. The FTC claimed the merger would result in a monopoly that would raise consumer prices. White House National Economic Council Deputy Director Jon Donenberg said, “The Kroger-Albertsons merger would have been the biggest supermarket merger in history—raising grocery prices for consumers and lowering wages for workers.” The companies subsequently terminated their merger agreement. Several politicians and the current administration have favored a narrative that the steep inflation in grocery prices consumers have faced over the past few years resulted from “price-gouging.” Unsurprisingly, the administration targeted the deal and patted itself on the back. However, revenue and income margin trends at the largest grocery chains, including Kroger and Albertsons, present a very different picture. Over the past eight years, Albertsons Companies’ revenues have grown by about 35%, which may seem okay until one realizes the U.S. economy has grown by more than 55% over the same period. The grocery business is an exceptionally low-margin business generally and for Albertsons particularly. As the chart above reveals, while margins did expand through the middle of 2020, that’s mainly because the company had been barely breaking even or even losing money in the years before. Even so, the company’s profit margin peaked at 2.6% in the pandemic period, less than the 2.8% the company achieved for the quarter ending February 24th, 2018. The average profit margin since YE2019 has been unimpressive, at 1.6%. Buyers of Albertsons stock before the Kroger deal was terminated may have hoped that the merged company’s margins would be at least as good as the 2% to 2.2% that Kroger has achieved over the past couple years, an improvement that would have lifted Albertsons’ net income to about $1.8 billion a year. At its current 11.5 billion market capitalization, Albertsons would be trading at 6.4x price-to-projected earnings versus ~8.7x at the current projected 1.6% net income margin. The trade The question investors must ask themselves now is whether Albertsons is a “value trap.” A value trap is a stock that appears undervalued based on traditional valuation metrics, such as a low price-to-earnings (P/E) ratio, low price-to-book (P/B) ratio, or a high dividend yield. Value traps fail to deliver long-term gains because their poor fundamentals or structural issues prevent meaningful recovery or growth. Value traps often lure investors looking for bargains, but these stocks may remain undervalued or decline further due to inherent problems in the company or industry. The company does bear some of the hallmarks. Revenue, earnings, and cash flow have been stagnant for some time. The industry is mature, and the “appetite” for its goods will not—or at the very least should not—grow faster than the population. The flip side is that Albertsons does not sell products falling out of favor. Other than selling products people need to buy to survive, Albertson’s dividend yield of 2.43% as of Friday’s closing price is roughly double that of the S & P 500. The free cash flow of ~7.35% is also far greater than that of the S & P. Slower growth rate, but a stable business with a relatively low cost of capital does become attractive at some point. It would be reasonable to assume that the S & P 500 will grow at least twice as fast as Albertson’s. Still, it is more than three times as expensive (trailing 12-month P/E), primarily a function of the 14% decline Albertsons has experienced over the past 12 months, even as the S & P appreciated by 26.5% over the same period. ACI 1Y mountain Albertsons, 1 year Consequently, this may be an interesting entry point. Albertson’s is scheduled to report earnings on Wednesday, January 8. The options market implies a move of ~ 4% higher or lower after the report, more significant than the 3% move the company has averaged over the past 10 years. This may partially be due to uncertainty regarding management comments and strategy after the Kroger acquisition fell through. I like owning the stock here or, if one is inclined to be more creative going into earnings, using a diagonal call/spread risk reversal such as the January/July example . The short strikes (the $19 put and $20.5 call) target the 4% implied move higher or lower. Sell ACI Jan. 17 $19 put Buy ACI Jul 18 $20 call Sell ACI Jan. 17 $20.50 call DISCLOSURES: (None) All opinions expressed by the CNBC Pro contributors are solely their opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent company or affiliates, and may have been previously disseminated by them on television, radio, internet or another medium. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
A broken merger opens up an opportunity for investors to scoop up a value stock