Ahold and Delhaize seek US grocery saving

Nearly a decade after their last attempt, the Dutch grocer Ahold and its Belgian rival Delhaize are once again discussing a merger.

On Tuesday morning, the companies confirmed they were in discussions following reports in the Belgian press over the weekend and big jumps in both their share prices on Monday.

Shares in both groups sustained their rally - with Delhaize's closing 16 per cent higher than on Friday, and Ahold gaining 7 per cent. But this positive reaction on the Brussels and Amsterdam exchanges came in spite of some decidedly mixed comments from analysts.

Many have questioned the rationale - and the potential for savings - from a tie-up that has been discussed before and fell through as recently in 2006.

Supporters of the deal argue that there is now a stronger conviction that a combined group could deliver synergies and economies of scale. "They are serious this time," said one deal watcher.

Together, Ahold and Delhaize would become a €25bn food retail group, with branches stretching from the US to Europe and across to Indonesia, employing 377,000 people. Their combined annual sales are currently €50bn, generating earnings before interest, tax, depreciation and amortisation of about €3.4bn. Analysts estimated that their merger could deliver total savings of anywhere between €450m and €1bn a year.

For most investors, though, it is the two companies' prospects in the US that matter most, as this is where both derive two-thirds of their sales. Ahold's Stop & Shop and Giant food chains and online grocer Peapod accounted for €19.6bn of its €32bn in annual sales last year. Similarly, Delhaize's Food Lion and Hannaford brands account for €13bn of the group's €21bn annual sales.

According to analysts at Jefferies, a combined company would be "a pretty formidable grocer", operating from Maine to South Carolina.

However, they gave the deal only a 50-50 chance of going ahead, and suggested that the tie-up could involve Ahold in effect paying €115 a share for Delhaize - a 30 per cent premium to the Belgian retailer's 16-year share-price high of €89.32.

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Bruno Monteyne, senior analyst at Bernstein, warned that the proposed cost savings would be hard to come by.

US operating margins for both companies have suffered a long-term decline, as both Delhaize and Ahold have been squeezed between low-end discounters and high-end rivals, such as Whole Foods.

"Those have all made inroads," said Patrick Roquas, an analyst at Rabobank. "There is too much competition and a lack of differentiation."

Ahold's operating margin has dropped from 5.5 per cent in 2004 to 4 per cent today. Delhaize's operating margin has slipped from 4.5 per cent to 3.5 per cent over the same period.

They still have some competitive advantage, though. Peapod, Ahold's online grocer, is the biggest in the US, for example. With shares in US retailers trading at a higher multiple of earnings than their European peers, combining the US businesses of Delhaize and Ahold and spinning them off may be profitable for shareholders.

But Mr Monteyne of Bernstein remains sceptical about such a US focus. "We think investors are more sophisticated than that and are able to value [the] sum of the parts of two regions."

Some investors will also recall the European grocery industry's recent record of pulling off mergers and acquisitions. In the UK, Wm Morrison and Safeway combined in 2004 in a deal from which the Bradford-based supermarket has struggled to recover. Carrefour's share price is half what it was before its €16bn purchase of French rival Promodes in 1999.

An Ahold-Delhaize deal would come with similar "execution risk". Nevertheless, with both companies struggling for growth and suffering increasingly squeezed margins, a deal may be necessary, according to some analysts.

"In retail, you can survive for a long time with lower sales and lower margins every year," said Mr Roquas of Rabobank. "But in the end you need a drastic change."

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