Aci 2023 03 20

Morningstar Equity Analyst Report | Report as of 20 Mar 2023 22:59, UTC | Reporting Currency: USD | Trading Currency: USD
| Exchange: NEW YORK STOCK EXCHANGE, INC. Page 1 of 23
Albertsons Companies Inc Class A ACI QQQQQ 20 Mar 2023 21:18, UTC
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Last Price Fair Value Estimate Price/FVE Market Cap Economic Moat Moat Trend Uncertainty Capital Allocation ESG Risk Rating Assessment1
19.20 USD 29.00 USD 0.66 11.11 USD Bil None Negative Medium Standard ;;;;;
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Price vs. Fair Value
Fair Value: 29.00

10 Jan 2023 00:18, UTC
40
Last Close: 19.20
30 Over Valued
Under Valued
20
10
0
Analysis
2018 2019 2020 2021 2022 YTD
— — — 1.10 0.73 0.66 Price/Fair Value
— — — 74.12 -7.02 -6.85 Total Return %
Morningstar Rating
Total Return % as of 20 Mar 2023. Last Close as of 20 Mar 2023. Fair Value as of 10 Jan 2023 00:18, UTC.
Contents
Business Description Omnichannel Improvements Should Pay Off for Albertsons,
Business Strategy & Outlook (2 Feb 2023)
Bulls Say / Bears Say (2 Feb 2023) Though Kroger Deal Could Be a Distraction
Economic Moat (2 Feb 2023)
Fair Value and Profit Drivers (2 Feb 2023)
Business Strategy & Outlook Zain Akbari, CFA, Equity Analyst, 2 Feb 2023
Risk and Uncertainty (2 Feb 2023)
We remain convinced that the long-term environment for the grocery sector will feature intense price
Capital Allocation (2 Feb 2023)
Analyst Notes Archive competition, high customer expectations, and more costly fulfillment (particularly delivery). With
Financials Walmart battling Amazon for national supremacy, traditional grocery leader Kroger building a highly
Appendix automated delivery fulfillment network with Ocado, and the hard discounters boosting their presence,
Research Methodology for Valuing Companies we believe Albertsons will be hard-pressed to defend its returns on invested capital (14% on average in
Important Disclosure fiscal 2020-21 but only 7% on average in fiscal 2018-19, including goodwill). Additionally, we are
The conduct of Morningstar’s analysts is governed by Code of Ethics/Code of
Conduct Policy, Personal Security Trading Policy (or an equivalent of), and skeptical that Kroger’s proposed acquisition of Albertsons will achieve regulatory approval.
Investment Research Policy. For information regarding conflicts of interest, please
visit: http://global.morningstar.com/equitydisclosures.
Price is a prime competitive weapon for grocers, with traffic paramount to generating profit dollars. The
The primary analyst covering this company does not own its stock.
sector requires efficiency and cost leverage to deliver returns, particularly considering razor-thin margins
The ESG Risk Rating Assessment is a representation of Sustainalytics’ ESG Risk
1
Rating.
and limited switching costs. The environment should endure even as the industry moves to an
omnichannel footing as shoppers continue to embrace delivery and curbside pickup for part of their
grocery needs. In physical retail, we anticipate shoppers will choose sellers based on convenience,
price, and breadth of assortment, demanding high value as well as a compelling store environment.
While Albertsons benefits from proximity to its customers and a strong standing in its core markets,
Walmart’s omnichannel strength and Amazon’s grocery ambitions have diluted the importance of local
strength.
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Morningstar Equity Analyst Report | Report as of 20 Mar 2023 22:59, UTC | Reporting Currency: USD | Trading Currency: USD | Exchange: NEW YORK STOCK EXCHANGE, INC. Page 2 of 23
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Sector Industry Still, the picture is not universally bleak. Albertsons’ work to bolster its owned-brand lineup and
s Consumer Defensive Grocery Stores
omnichannel abilities (both of which have historically lagged Kroger) should offset some of the
Business Description profitability strain. Furthermore, Albertsons is better positioned than smaller rivals, which do not have a
Albertsons is the second-largest conventional grocer in
similar ability to leverage costs or invest in potential efficiency-boosting initiatives like micro-fulfillment
America, operating 2,276 stores under 24 banners in 34
centers, self-checkout, analytically driven store assortments, and automation. Additionally, subscale
states as of the end of fiscal 2021. Around 75% of stores
have pharmacies, while nearly 20% also sell fuel. rivals are less able to capitalize on digital-driven top-line opportunities, particularly boosted search and
Albertsons has a significant private-label operation, targeted promotions.
accounting for around 20% of sales (excluding fuel).
While its owned-brand assortment is mainly Bulls Say Zain Akbari, CFA, Equity Analyst, 2 Feb 2023
manufactured by third parties, Albertsons operates 20 u Albertsons benefits from a top-two standing in most of its major markets, providing benefits from local
food production plants (as of the end of fiscal 2021).
scale as advertising, distribution, and supply chain costs are spread over a large sales base.
Albertsons is a top-two grocer in two thirds of its major
u With the scale needed to justify investments in micro-fulfillment centers and other technologies that
markets (as of early 2022, according to company data),
and virtually all of its sales come from the United States. can reduce the cost of digital fulfillment, Albertsons should be in a better position than small rivals.
Kroger has offered to acquire Albertsons in a $25 billion u Albertsons’ growing loyalty program should improve its customer data set, providing avenues to
deal; if the transaction is approved by regulators, it optimize its assortment and target its marketing.
should close in 2024.
Bears Say Zain Akbari, CFA, Equity Analyst, 2 Feb 2023

u As the pandemic ends, intense competition should re-emerge in grocery, pressuring prices and
necessitating investment in the store experience.
u Despite investments in fulfillment technology, fast-growing pickup and delivery orders are less lucrative
than traditional shopping, which should restrain margins and returns.
u Kroger’s proposed acquisition of Albertsons should run into regulatory headwinds and could prove to be
a distraction.
Economic Moat Zain Akbari, CFA, Equity Analyst, 2 Feb 2023

We do not believe Albertsons has secured an economic moat (on a stand-alone basis, leaving aside its
proposed acquisition by narrow-moat Kroger), considering an intensely competitive industry landscape.
The competitive environment poses headwinds that, in our opinion, are not outweighed by its size (sales
only around half that of the largest American traditional grocer, Kroger) or its still-developing private-
label and omnichannel capabilities. Our estimate of Albertsons' return on invested capital (including
goodwill) averages 11% over the next decade, higher than our 7% estimate of its weighted average cost
of capital. However, our return estimate falls to 9% by the end of our 10-year explicit forecast, and at
the same point in our downside scenario, approaches 6% (indicating the firm does not generate
economic profits by that point). This is not a sufficient margin of safety to give us confidence in the
durability of Albertsons' standing. A narrow moat rating generally implies we are confident that the firm
can outearn its weighted average cost of capital over a 10-year period (and generally, in grocery,
economic moats that do exist are underpinned by intangible assets, a cost advantage, or both).
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Competitors
Albertsons Companies Inc Class A ACI The Kroger Co KR Koninklijke Ahold Delhaize NV AD Sprouts Farmers Market Inc SFM
Fair Value Fair Value Last Close

30.09 Last Close
29.00 52.00
Uncertainty : Medium Uncertainty : Medium 32.72
Last Close Fair Value Fair Value
Last Close 47.35 24.50 30.50
Uncertainty : Medium Uncertainty : Medium
19.20
Economic
Analysis Moat None
Security 1 Narrow
Security 2 None
Security 3 None
Security 4
Moat Trend Negative Negative Stable Negative
Currency USD USD EUR USD
Fair Value 29.00 10 Jan 2023 00:18, UTC 52.00 2 Feb 2023 10:57, UTC 24.50 1 Nov 2021 10:18, UTC 30.50 23 Jan 2023 06:56, UTC
1-Star Price 39.15 70.20 33.08 41.18
5-Star Price 20.30 36.40 17.15 21.35
Assessment Under Valued 19 Mar 2023 Under Valued 20 Mar 2023 Over Valued 20 Mar 2023 Fairly Valued 19 Mar 2023
Morningstar Rating QQQQQ20 Mar 2023 21:18, UTC QQQQ20 Mar 2023 21:18, UTC QQ18 Mar 2023 01:12, UTC QQQ20 Mar 2023 21:18, UTC
Ioannis Pontikis, Senior Equity
Analyst Zain Akbari, Equity Analyst Zain Akbari, Equity Analyst Zain Akbari, Equity Analyst
Analyst
Capital Allocation Standard Exemplary Standard Standard
Price/Fair Value 0.66 0.91 1.23 1.07
Price/Sales 0.13 0.23 0.35 0.55
Price/Book 13.56 3.34 1.90 3.24
Price/Earning 7.89 15.29 11.85 13.52
Dividend Yield 2.46% 2.12% 3.26% —
Market Cap 11.11 Bil 33.49 Bil 29.23 Bil 3.39 Bil
52-Week Range 19.29—37.16 41.82—62.78 24.03—31.23 22.56—35.59
Investment Style Mid Value Mid Value Large Value Small Core
Albertsons does not meet that standard.
The U.S. grocery industry was highly competitive long before the rise of Amazon or its acquisition of
Whole Foods in 2017, with Walmart's relentless price aggression pressuring margins for decades (the
retail juggernaut derives nearly 60% of its domestic namesake stores' sales from its grocery operations).
The strain from Walmart contributed to the failure of Albertsons' merger and acquisition-driven growth
ambitions in the early 2000s, leading to the company's breakup in 2006, with grocery stores split
between Cerberus and SuperValu; CVS bought many of the company's pharmacies. The picture did not
improve significantly despite closures of underperforming stores and fuel stations, the reunion of the
SuperValu and Cerberus-controlled parts of legacy Albertsons in 2013 (under Cerberus' ownership), the
acquisition of Safeway (a $9 billion deal done in 2015) and a number of other smaller grocers, and a
series of abortive attempts at an initial public offering during 2015-20, which culminated in the
somewhat disappointing sale of $800 million of stock in mid-2020, an offering that was downsized and
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priced below its target range. From fiscal 2015 to 2019, Albertsons' operating margin averaged a bleak
1.3%, before the pandemic's sales surge and internal efficiency efforts led to a 4.0% 2020-21 average.
The competitive landscape features more than just Amazon and Walmart (both of which benefit from
prodigious cost leverage that we believe exceeds that of any of their rivals), although the battle
between the two giants for omnichannel supremacy should be the primary motivating force behind
incessant price competition over the years ahead. Like Walmart, club stores (wide-moat Costco
generates more than half of its sales from fresh and packaged food and sundries) and other general
merchandise retailers like no-moat Target use grocery to drive traffic that often leads to sales of more
lucrative items. This incentivizes such chains to price groceries aggressively as they have numerous
avenues to monetize the resultant traffic. Convenience stores and pharmacies have also expanded their
grocery assortments, and hard discounters continue to expand in the United States, using the margin
benefits of a lineup featuring private-label items to hold prices down.
We believe the tough pricing environment demands considerable efficiency and cost leverage in
addition to strong execution. With margins tight, volume dictates profits, as grocers that can spread
fixed investments (in omnichannel fulfillment, self-checkout, data analytics, owned brands, advertising,
and distribution) over a large sales base are at an advantage.
While we do not suggest economic moats are impossible to build in traditional U.S. grocery, we contend
that Albertsons does not benefit from durable competitive advantages. We believe economic moats in
the grocery sector generally stem from cost advantages and intangible assets (particularly, the strength
of their banners, their relationships with vendors, and the insights that can be gleaned and potentially
monetized from customer transaction data). In these areas, Albertsons is, in our view, a step behind its
larger peers.
From a cost standpoint, Albertsons' nearly $72 billion in fiscal 2021 sales is far from negligible and is
considerably higher than that of its smaller rivals in what is a fragmented U.S. grocery industry (the top
four grocers only combine for about 40% market share, and Kroger's management, citing data from
Planet Retail and Edge Retail Insight, indicates that around one third of the market is held by smaller
scale operators). However, it pales in comparison with Walmart ($219 billion in fiscal 2022 grocery sales
at the namesake banner in the United States) and Kroger ($138 billion in fiscal 2021 sales). In our view,
this translates to meaningfully less procurement leverage, particularly over a branded assortment that
varies little from grocer to grocer. Although the dynamic should change if Kroger's proposed acquisition
of Albertsons is consummated, we are skeptical that the deal will be approved by regulators.
We believe an omnichannel approach is the most likely to emerge from the grocery sector's current
upheaval, particularly in light of dramatically increased e-commerce penetration during the pandemic.
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Customers are likely to vary their fulfillment mechanism of choice depending on a variety of
factors—shopping in store, utilizing store pickup (often curbside), and ordering delivery based on the
items purchased, time of week, and other factors. Here, too, cost leverage is particularly important to
improving economics. Pickup and delivery channels are generally less cost-efficient than traditional
customer visits, as picking orders imposes labor costs (unless an automated, parallel infrastructure is
used) and fees are under pressure.
In this spirit, we support Albertsons' work with Takeoff Technologies to develop a network of micro-
fulfillment centers that will feature considerable automation in picking and packing customers' digital
orders. Such investments (together with other labor-saving devices like self-checkout) can meaningfully
improve grocers' economics on digital orders while reducing their exposure to wage inflation, a
particularly meaningful benefit considering high levels of unionization in the sector. Still, we believe
Albertsons' solution has considerably less potential to be a game-changer than the avenue Kroger is
pursuing, in an exclusive (in the U.S.) partnership with Ocado, which will feature the firms building and
operating a network of customer fulfillment centers, or CFCs, nationally. Ocado has already proved the
value of its CFCs through its established network of highly automated and efficient locations in the U.K.
Micro-fulfillment centers are smaller than CFCs, offering less breadth of available items. Furthermore,
while Albertsons is considering broadening its approach from its current store-linked network to stand-
alone micro-fulfillment centers, it still uses stores to service orders of many fresh and specialty items,
limiting picking efficiencies from time and labor cost standpoints. Lastly, while Takeoff Technologies is
developing its micro-fulfillment capabilities alongside strong partners like Ahold Delhaize and Carrefour,
it does not match Ocado's experience in the sector, important considering the benefits of iteration in the
development of artificial intelligence and machine learning solutions that underpin aspects of
automated fulfillment. Takeoff opened its first micro-fulfillment centers in 2018, while Ocado has been a
leading online grocer since 2000.
Despite the pandemic's digital sales surge, Albertsons lags its peers in e-commerce penetration
(management suggested penetration was in the low to mid-single digits as a percentage of sales as of
mid-2021, versus a high-single-digit share for Kroger). Albertsons' 2021 partnership with Google should
help accelerate the company's digital transformation and omnichannel development. The two firms plan
to work together to use Google's search and mapping tools to help customers find items in store and
build artificial intelligence-based capabilities that should help Albertsons streamline the online and
offline shopping experience. However, the partnership is in its early days, and the company is at a
disadvantage as online grocery sales continue their rapid growth.
Aside from e-commerce, Albertsons has work to do to realize its potential in other aspects of the
business. With traffic critical to maintaining dollar profits, grocers employ a range of strategies to
ensure customers remain engaged. While Albertsons has made progress (in private-label and loyalty),
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we believe it trails moat-endowed firms in the sector, particularly Kroger.
In particular, grocery stores are often paired with fuel stations and a pharmacy, both of which we
believe add recurring customer traffic and further embed the company's stores into shoppers' daily and
weekly routines. While Albertsons has pharmacies in around 75% of its stores (somewhat behind
Kroger, which is above 80%), it has fuel stations in less than 20% of its stores (Kroger has fuel at around
half of its locations). Although we acknowledge the importance of fuel stations should decline over time
as the vehicle fleet electrifies, we believe the difference will be relevant for more than a decade,
especially considering that the average age of a car or truck in the United States is over 12 years.
Grocers are also able to build the value of their banners through robust private-label portfolios, which
are becoming increasingly important as hard discounters expand. Albertsons has a solid portfolio of
labels that spans the store and has driven penetration to around 25% (or around $15 billion in fiscal
2021 sales) from the low 20s over the last five years. Still, penetration lags Kroger's roughly 30% mark.
Furthermore, Albertsons only manufactures about 10% of its owned-brand portfolio. While this is
beneficial from a capital investment standpoint, we believe a firm like Kroger (which manufactures
about 40% of its owned-brand grocery lineup) has more control over quality and can more responsively
introduce differentiated items aligned with ever-changing customer tastes while containing costs. The
stakes in private label are particularly high, with Albertsons indicating that gross margins are around
1,000 basis points higher for its owned-brand lineup.
Grocers have also been able to use their store and website traffic to generate significant customer
transaction data using programs that give shoppers the best pricing and access to (increasingly tailored)
promotions in exchange for their contact information. While Albertsons' loyalty program is expanding
rapidly (spurred by high pandemic-era sales and an improved set of membership rewards), the
implementation is a work in progress. The company only started to roll out this program nationally in
2016 (after acquiring it in the Safeway deal), reversing an earlier aversion to loyalty programs and digital
coupons. While the signup gap appears to have narrowed (Kroger's loyalty program claims around 60
million member households, versus 30 million for Albertsons; the former's top line is around double that
of the latter), Albertsons' data history is far shallower. Kroger indicates around 96% of its transactions
are tied to a loyalty card, as has basically been the case for decades (we believe part of the case for
Kroger's narrow economic moat rests on its loyalty strength).
Even if Albertsons were to match Kroger's loyalty penetration, the lack of data history in Albertsons'
program is meaningful. Grocers can use historical purchase data and trends to inform their assortments
and inventory on a store-by-store basis, target advertising and promotions based on customer buying
history, and leverage insights gleaned from data to inform their owned-brand assortments. As a result of
its smaller size and more nascent loyalty focus, we believe Albertsons will not be able to achieve the
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same level of value from its transaction data as Kroger. The latter firm has begun selling data insights
and analytics to consumer packaged goods firms, with a unique value proposition that allows such
companies a way to see the impact of flavor, packaging, and promotional decisions on direct purchasing
outcomes. We believe Kroger is better positioned than Albertsons to offer such insights, considering its
significantly greater size and resulting coverage of the U.S. market. In addition to strengthening the
retailer-vendor relationship, such analytics offerings have the added benefit of being asset-light and
high margin, providing added ammunition to deal with the competitive environment.
Still, we do have a favorable view of Albertsons' mid-2021 introduction of FreshPass, a membership

program that provides delivery on orders of at least $30 for no charge beyond a $99 annual fee. The
offering should help it build a stronger relationship with its recurring digital customers, but we believe it
will take time for this initiative to contribute meaningfully to Albertsons' competitive standing.
Fair Value and Profit Drivers Zain Akbari, CFA, Equity Analyst, 2 Feb 2023
Our valuation of Albertsons is on a stand-alone basis, as we are skeptical that Kroger’s proposed
acquisition of the firm (for total consideration valued at $34.10 per share at the time of announcement)
will survive regulatory scrutiny.
Our fair value estimate remains at $29 per share after the firm announced solid third-quarter results
(including 8% identical sales growth, excluding fuel). Our valuation corresponds to forward fiscal 2023
enterprise value/adjusted EBITDA of 6 times and adjusted price/earnings of 10.
With inflation and rising economic uncertainty leading consumers to eat at home at an elevated rate
(relative to before the pandemic), we expect grocers to face near-term top-line tailwinds alongside cost
pressure. From Albertsons’ perspective, we expect 6% growth in its identical sales (excluding fuel) in
fiscal 2022, spurred mostly by inflation. The long-term picture should look much like Albertsons’
performance before the pandemic; we anticipate identical sales excluding fuel to grow at a little over
2% annually, near our expectations for food inflation despite intense price competition. Albertsons will
likely open a few stores to increase density in its existing markets, while also spending to build out its
network of micro-fulfillment centers (alongside and independent from stores). In all, revenue should rise
at a roughly 3% compound annual rate over the next decade.
Limited cost leverage (considering tepid top-line growth), intense price competition, and omnichannel
fulfillment costs should leave Albertsons’ operating margin near 3% on average over the next decade,
still somewhat better than its 1% five-year average before the crisis as its owned brand lineup grows
and as micro-fulfillment centers make digital orders more economical. The performance and capital
expenditures equal to about 3% of yearly sales should combine to leave Albertsons’ adjusted returns on
invested capital in the low double digits (against a roughly 7% weighted average cost of capital).
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Albertsons is likely to pursue partnerships and acquisitions (aside from the Kroger deal), but we do not
incorporate such deals into our valuation. Instead, we assume Albertsons returns excess capital to
shareholders, with dividends and stock buybacks accounting for around 35% of operating cash flow by
the end of our explicit forecast.
We have analyzed the sensitivity of our valuation to a variety of factors. As the pandemic recedes, it
leaves behind an unsettled consumer landscape. The degree to which shoppers’ embrace of digital
fulfilment options has been accelerated remains to be seen; such orders are generally less lucrative
than traditional shopping trips. More positively for traditional grocers, customers’ increased
consumption of food at home and greater tendency to cook during the crisis could endure to some
extent, particularly amid economic uncertainty.
Over the longer term, customers are likely to demand an array of fulfillment options, switching between
conventional shopping, curbside pickup, and home delivery. This will demand agility from grocers to
ensure order picking, advertising, delivery routes, and inventory replenishment are flexible and efficient.
Walmart, Amazon, and hard discounters are likely to drive pricing and delivery surcharges downward,
adding to the pressure. Still, Albertsons is far better suited to the emerging grocery landscape than
subscale independent and regional rivals.
In a downside case, the landscape could prove even more intensely price-competitive over the long term
than we expect. Consumers could prefer the more costly home delivery channel, with intense
competition eroding fees. Albertsons is also exposed to hard discounters’ rise (as its private-label
portfolio is suboptimal), and better-than-expected expansion for Aldi and Lidl could pressure its market
standing. Amazon’s push to open physical stores could erode Albertsons’ nascent omnichannel
advantages.
In this downside scenario, Albertsons would see 2.5% 10-year compound average annual revenue
growth (as opposed to 2.8% in the base case), with a 2.4% average operating margin over the next
decade (relative to 3.0% in the base case), resulting in a fair value estimate of $16.80 per share.
On the other hand, shoppers could be slower to shift away from home dining than we expect.
Albertsons’ digital capabilities could combine with its store footprint to offer the convenience customers
demand, with micro-fulfilment centers unlocking new markets. More disciplined industry pricing
(perhaps born of a shift toward targeted digital advertising) could provide profitability relief. Meanwhile,
Albertsons’ expanding owned brand lineup could prove more of a draw than we expect.
In this case, we see Albertsons achieving 10-year compound average annual revenue growth of 3.1%
with a 3.2% average adjusted operating margin over the same period. This scenario would result in a
fair value estimate of $34 per share.
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Risk and Uncertainty Zain Akbari, CFA, Equity Analyst, 2 Feb 2023
We assign Albertsons a Medium Uncertainty Rating. Inflation, economic turbulence, and changing
shopping patterns after the pandemic have broadened the range of outcomes for Albertsons. Longer
term, the pandemic has accelerated the digital transformation of the sector.
Before the pandemic, grocery was rife with competition, with Amazon’s growth in an increasingly digital
sector and hard discounters’ expansion casting a shadow over traditional chains. While the pandemic
saw Amazon bolster its grocery offerings and Walmart rapidly accelerate its e-commerce development,
Albertsons’ capabilities have also made strides. Still, buying habits are unsettled as food purchases are
increasingly nationalized, upending the traditional distance- and routine-based relationship between
customers and grocers. We do not believe Albertsons’ omnichannel, private-label, and data analytics
capabilities meet the standard set by larger rival Kroger, leaving it with less ammunition to meet the
competitive onslaught. If Albertsons cannot retain customers, it could find itself with too many stores
and diminishing economics. We believe price competition in grocery is endemic, and thin margins raise
the stakes further.
From an environmental, social, and governance standpoint, Albertsons relies on transaction data to
influence its assortment and marketing efforts. This depends on customers continuing to join and use its
loyalty program; a data breach could change their willingness to do so. Food safety missteps in its
owned-brand lineup could impact performance, and Albertsons also faces risk in managing a workforce
of around 290,000 employees (at the end of fiscal 2021), of which around 70% are covered by one of
several collective bargaining agreements. While we believe these risks are noteworthy, we do not
expect them to be material.
Albertsons’ proposed acquisition by Kroger could prove to be a costly distraction, particularly as the deal
faces intense antitrust and political scrutiny.
Capital Allocation Zain Akbari, CFA, Equity Analyst, 2 Feb 2023

We assign management’s capital allocation practices a Standard rating.
Under CEO Vivek Sankaran, who took the helm in 2019, joining the grocer from PepsiCo, Albertsons
continued to reduce debt despite investing in its omnichannel transformation, while completing its
(tepidly received) IPO in 2020. Net debt was less than 1.2 times adjusted EBITDA at the end of fiscal
2021, aided by the pandemic-related sales windfall but continuing a downward trend in place since
fiscal 2017 (when net debt was nearly 5 times adjusted EBITDA). Although the company used debt to
fund its $4 billion special dividend (announced in conjunction with its proposed acquisition by Kroger),
leverage remains manageable. Albertsons does not have significant near-term maturities, and we
believe liquidity is ample.
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Albertsons is the product of several acquisitions, which were largely pursued and completed by prior
leadership teams (as a result, we do not factor the prolific earlier M&A activity into our capital allocation
rating). The current management team has done well to focus on bolstering Albertsons omnichannel
fulfillment capabilities (including the ongoing development of a network of micro-fulfillment centers in
partnership with Takeoff Technologies), which had lagged those of some of its peers prior to the
pandemic. Leadership has also identified the company’s fresh assortment, data analytics, and private-
label capabilities as focus areas for investment, which we view favorably as the former offers some
opportunities to differentiate and drive traffic, while the latter creates margin improvement possibilities.
Sankaran and his team have operated the business well despite the pandemic’s upheaval and have
shown remarkable agility in accelerating Albertsons’ omnichannel improvement initiatives. Furthermore,
we maintain that the company’s 2021 partnership with Google will help accelerate Albertsons’ digital
efforts by providing artificial intelligence-based capabilities that should improve its omnichannel
offering, targeted marketing efforts, and store experience. However, we are concerned that the
company’s planned acquisition by Kroger will prove to be a distraction, considering the likelihood of
intense antitrust scrutiny.
Management’s record of shareholder distributions is appropriate, in our view, although the limited time
that has passed since the 2020 IPO leaves relatively few data points to analyze. The company instituted
a dividend not long after its share sale and repurchased $1.9 billion of stock in fiscal 2020. If the Kroger
deal is not completed, we expect continued capital returns to shareholders and anticipate Cerberus and
the company’s other long-standing sponsors (which, together with newcomer preferred stock investor
Apollo, still controlled the vast majority of the voting power of the shares in early calendar 2021) will
gradually reduce their interest. We would support share repurchases if they came at prices more
attractive than our fair value estimate. We do not believe capital return has inhibited investment in the
business.
Analyst Notes Archive
Strong Third-Quarter Results Suggest Albertsons’ Turnaround Is Progressing; Shares Attractive Zain
Akbari, CFA, Equity Analyst, 10 Jan 2023
We do not plan to significantly alter our $29 per share valuation of no-moat Albertsons after it
announced solid third-quarter (ended Dec. 3) results, including 8% identical sales growth (excluding
fuel). Although the firm’s proposed acquisition by narrow-moat Kroger could prove to be a distraction as
antitrust scrutiny is likely to be intense, we see a buying opportunity. We believe prevailing sentiment
does not adequately credit Albertsons’ ability to improve its private label and omnichannel capabilities
independent of Kroger (our valuation is on a standalone basis).
While the company remains a step behind Kroger in its omnichannel and own-brand capabilities, we
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believe prevailing sentiment also underestimates Albertsons’ ability to outperform subscale rivals.
Although its advantage over such companies is not sufficient to confer an economic moat in our view
(especially considering the pricing pressure applied by wide-moat-rated Walmart and Amazon, as well
as hard discounters), we still expect Albertsons to post roughly 5% long-term adjusted EBITDA margins,
on average, as cost leverage offsets some of the competitive strain. We similarly do not believe the
company’s plans to pay a $4 billion special dividend will materially affect its abilities to invest behind its
ongoing transformation (although the payment has met resistance from various state attorneys general,
we expect it will eventually be made).
Year to date, Albertsons’ net sales are up 9% against a 6.1% adjusted EBITDA margin (in line with its
profitability performance to this point last year). Our full-year targets (7% sales growth, 5.8% adjusted
EBITDA margin) should rise modestly, tempered by Albertsons lapping more of the late-2021 and early-
2022 inflationary surge as its fourth quarter unfolds. Digital sales rose 33% and loyalty members
increased 16%, both of which suggest to us that Albertsons’ recent investments in its omnichannel
capabilities and assortment differentiation are paying off.
Solid Second Quarter for Albertsons as It Embarks on Merger Process; Shares Trade Fairly Zain
Akbari, CFA, Equity Analyst, 18 Oct 2022
Our $28.50 per share valuation of no-moat Albertsons should rise by a low- to mid-single-digit
percentage, reflecting the time value of money and solid second-quarter earnings (including 7%
identical sales growth) that has it tracking ahead of our full-year estimates (3.5% expansion). Our long-
term forecast (low-single-digit percentage revenue growth, mid-single-digit percentage adjusted
EBITDA margin) and valuation reflect Albertsons’ prospects on a standalone basis, as we believe the
firm’s combination with narrow-moat Kroger will garner regulatory resistance, with divestitures
potentially insufficient to garner approval. We still suggest prospective investors await a greater margin
of safety.
First-half (ended Sept. 10) revenue rose 9%, with Albertsons’ adjusted EBITDA margin holding at 6.0%
despite rising costs. Both metrics exceed our full-year targets (6% sales growth, 5.6% adjusted EBITDA
margin). We anticipate second-half results will cool as Albertsons laps late 2021’s inflationary surge but
plan to modestly boost our near-term targets.
Albertsons’ digital sales rose 36% in the second quarter, with the firm continuing to make progress in its
omnichannel transition. Still, we believe the prospective combination with Kroger (if regulators permit it
to proceed) should allow the purchased stores to tap a superior digital infrastructure, particularly as
Kroger continues to work with no-moat Ocado to build a network of highly automated fulfillment centers
to efficiently process home deliver orders. Albertsons’ growing use of micro-fulfillment centers should
help its overall efficiency, but the strategy’s dependence on conventional stores for less commonly
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ordered items should impede its long-term prospects. Similarly, the merger with Kroger should upgrade
Albertsons stores’ private label assortment, with the former company ahead of the latter in developing
distinctive items that drive traffic and attachment.
Kroger-Albertsons Merger Will Draw Regulatory Scrutiny but Could Deliver Value Zain Akbari, CFA,
Equity Analyst, 14 Oct 2022
While we see the merits of Kroger’s cash offer to acquire Albertsons for an estimated total of $34.10 per
share, we are skeptical that regulators will approve the deal. So, we are leaving our fair value estimates
in place: $28.50 for Albertsons and $49.50 for Kroger.
Aside from regulatory factors, the deal—which values Albertsons at similar multiples as Kroger’s before
the rumors—should strengthen Kroger while giving Albertsons investors a roughly 30% premium to the
shares’ prerumor trading price and 20% more than our valuation. Scale is critical to achieving the cost
leverage, purchasing power, customer data, and own brand lineup that allow grocers to navigate
intense price competition amid an omnichannel shift in an industry with minimal switching costs for
shoppers. The $1 billion annual cost synergy target (around 1.5% of Albertsons’ total costs in fiscal
2021, to be realized over four years) seems reasonable, and we foresee revenue synergies
(acknowledged but unquantified by management) as private-label, omnichannel, loyalty, and data
analytics offerings are optimized. If completed, the deal should boost narrow-moat Kroger’s competitive
standing despite Albertsons’ no-moat rating, largely because of scale. Consistent with our Exemplary
capital allocation rating, Kroger has integrated past acquisitions well (though this transaction is far
bigger), and deal terms seem fair. Indeed, the acquisition could be worthwhile for Kroger even if
divestitures exceed the 100-375 stores anticipated by the firms.
However, the regulatory response is unlikely to be warm, considering recent blocked deals (including
Sysco’s attempt to acquire US Foods in 2015 and failed attempts to merge Staples and Office Depot)
and an unfriendly political environment, with food inflation in the headlines. Divestitures may be
insufficient to mollify regulators, and we are concerned about the distraction the deal, which is not
expected to close until 2024, could pose amid industry turmoil.
Potential Kroger-Albertsons Combination Would Add Scale, but Draw Regulatory Scrutiny Zain
Akbari, CFA, Equity Analyst, 13 Oct 2022
Neither our $49.50 per share valuation of narrow-moat Kroger nor our $28.50 per share valuation of no-
moat Albertsons will change in light of rumors that they are considering a merger, as we await more
concrete information before incorporating a deal into our analyses (shares of the former are roughly flat
and the latter up around 10% in the wake of the report). While we believe a combination between the
two largest pure-play grocers in the United States would create scale benefits (and associated cost and
purchasing leverage) that would help fend off burgeoning omnichannel titans Walmart and Amazon, we
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20 Mar 2023 10 Jan 2023 00:18, UTC
suspect overlap between the two chains’ footprints in many markets may lead regulators to scrutinize a
transaction closely.
We have long held that local market scale, cost leverage (particularly in omnichannel fulfillment,
analytics, procurement, distribution, and advertising), own brand portfolios, and data generated from
loyalty programs can help grocers fend off rivals in an intensely competitive industry. We believe Kroger
stands well above other American pure-play grocers, with leading analytics, private-label, and
omnichannel presences, while Albertsons is a step behind on all fronts. Whether Kroger could extend its
advantages to Albertsons depends to a large degree on the extent to which regulators force divestitures
in certain markets, as both companies are rivals in many regions.
Before the speculation, Kroger traded at roughly 11 times consensus fiscal 2022 earnings (or an
enterprise value of 6 times adjusted consensus EBITDA; consensus as calculated by FactSet), while
Albertsons traded at around 9 times earnings (enterprise value/adjusted consensus EBITDA of 5). If
Albertsons were valued at a similar multiple as Kroger in an acquisition, its shareholders would receive
a roughly 30% premium. However, we believe the price would depend on an assessment of the
potential divestitures required, which could drive the premium meaningfully lower.
Albertsons’ Momentum Continues in Digital, Own Brands, Productivity; Shares Trade Fairly Zain
Akbari, CFA, Equity Analyst, 26 Jul 2022
We do not plan to alter our $28.50 per share valuation of no-moat Albertsons significantly after it
reported first-quarter earnings that are consistent with our long-term thesis. The firm appears to be
navigating the inflationary environment well, with its adjusted EBITDA margin down only about 10 basis
points (to 6.1%) as it benefits from an improving private label assortment and productivity investments.
With its omnichannel efforts also showing continued momentum (including strong customer acquisition
and retention), we believe the firm is on track to meet our long-term targets (low-single-digit average
annual percentage sales growth and operating margins). We still suggest prospective investors await a
greater margin of safety.
First-quarter (ended June 18) identical sales increased 6.8% (excluding fuel) as double-digit inflation
was offset by customers buying fewer units in response to higher prices. Management indicated the
firm gained market share in units and dollars, which we believe suggests Albertsons is leveraging its
growing digital capabilities and own brand portfolio to bolster its value proposition. Leadership boosted
full-year guidance in response to the quarter and subsequent momentum, now targeting 3% to 4%
identical sales growth (previously 2% to 3%) and $2.80 to $2.95 in adjusted EPS (up $0.10 at both ends).
Our 4% identical sales growth forecast should not change significantly, and our $2.79 earnings target
should rise modestly.
Own brand penetration rose 30 basis points, to 25.8%, which we believe reflects trade down and
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Albertsons’ improved private label offerings. While we believe the company’s portfolio still lags that of
narrow-moat Kroger (which tends to boast a roughly 30% penetration rate), the increase is meaningful
as customers are focused on value and as costs continue to rise (Albertsons’ own label portfolio garners
margins that are roughly 1,000 basis points higher than its profitability on the national brand items it
sells).
Solid End to Fiscal 2021 for Albertsons, but Underwhelming Guidance Leaves Our Thesis Intact Zain
Akbari, CFA, Equity Analyst, 12 Apr 2022
Our $28.50 fair value estimate for no-moat Albertsons should not change much after the firm
announced full-year earnings that exceeded our expectations but offered somewhat underwhelming
fiscal 2022 guidance. With the fiscal 2022 discrepancy likely a result of transitory phenomena
(pandemic, inflation), our 10-year forecast for low-single-digit average annual sales growth and
operating margins is intact. Although our reaction is more tempered than the shares’ high-single-digit
percentage swoon after the news (likely on account of our somewhat more muted expectations for
fiscal 2021 and 2022), we suggest investors await a more attractive entry point.
Albertsons posted $71.9 billion in sales and $3.07 in adjusted diluted earnings per share for fiscal 2021
(ended Feb. 26), both ahead of our $71.1 billion and $2.94 respective estimates as high-single-digit
inflation in the fourth quarter outpaced our expectations. Management expects $2.70-$2.85 in fiscal
2022 adjusted EPS. While the high end of the range is only $0.01 below our $2.86 mark, recent food-at-
home inflation (around 10% in March) is higher than we expected, so guidance suggests elevated cost
pressure, as our 1.5% revenue growth assumption seems conservative.
Albertsons indicated that customer behavior has not changed in response to rising prices, with little
evidence of trade-down or changed spending patterns, even among lower-income consumers. As fuel
prices continue to exert strain, we expect the dynamic to shift as the year goes on. Grocers have tools to
combat the potential headwinds, such as their private-label assortment (Albertsons’ penetration
reached 25.6% in the fourth quarter, similar to prepandemic levels) and more sophisticated pricing and
promotional tools borne of increasing data analytics capabilities. Still, we believe Albertsons is behind
narrow-moat Kroger on both fronts, though we applaud its recent efforts to invest in its own brand,
omnichannel, and data capabilities. K
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Competitors Price vs. Fair Value
The Kroger Co KR
Fair Value: 52.00

2 Feb 2023 10:57, UTC
200
Last Close: 47.35
150 Over Valued
Under Valued
100
50
0
Analytics
2018 2019 2020 2021 2022 YTD
0.93 1.07 0.96 1.05 0.90 0.91 Price/Fair Value
1.60 7.60 11.90 44.96 0.57 6.80 Total Return %
Morningstar Rating
Total Return % as of 20 Mar 2023. Last Close as of 20 Mar 2023. Fair Value as of 2 Feb 2023 10:57, UTC.
Koninklijke Ahold Delhaize NV AD
Last Close: 30.09

40 Fair Value: 24.50
1 Nov 2021 10:18, UTC
30 Over Valued
Under Valued
20
10
0
Analytics
2018 2019 2020 2021 2022 YTD
1.13 1.06 1.05 1.23 1.10 1.23 Price/Fair Value
23.83 5.53 7.96 33.45 -8.17 12.11 Total Return %
Morningstar Rating
Total Return % as of 17 Mar 2023. Last Close as of 17 Mar 2023. Fair Value as of 1 Nov 2021 10:18, UTC.
ß
Sprouts Farmers Market Inc SFM
Last Close: 32.72

40 Fair Value: 30.50
23 Jan 2023 06:56, UTC
30 Over Valued
Under Valued
20
10
0
2018 2019 2020 2021 2022 YTD Analytics
0.89 0.90 0.82 1.10 1.10 1.07 Price/Fair Value

-3.45 -17.69 3.88 47.66 9.06 1.07 Total Return %
Morningstar Rating
Total Return % as of 20 Mar 2023. Last Close as of 20 Mar 2023. Fair Value as of 23 Jan 2023 06:56, UTC.
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Morningstar Historical Summary

Financials as of 30 Nov 2022
Fiscal Year, ends 28 Feb 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 YTD TTM
Revenue (USD Bil) 3.71 20.05 27.20 58.73 59.68 59.92 60.53 62.46 69.69 71.89 59.38 76.77
Revenue Growth % — 440 35.6 115 1.6 0.4 1.0 3.2 11.6 3.2 9.0 9.2
EBITDA (USD Mil) 56 201 -27 2,022 2,261 1,799 2,591 3,540 3,781 4,866 3,779 5,024
EBITDA Margin % 1.5 1.0 -0.1 3.4 3.8 3.0 4.3 5.7 5.4 6.8 6.4 6.5
Operating Income (USD Mil) 39 -475 -649 402 608 152 622 952 1,579 2,422 1,787 2,450
Operating Margin % 1.0 -2.4 -2.4 0.7 1.0 0.3 1.0 1.5 2.3 3.4 3.0 3.2
Net Income (USD Mil) 79 1,733 -1,225 -502 -373 46 131 466 850 1,620 1,202 1,658
Net Margin % 2.1 8.6 -4.5 -0.9 -0.6 0.1 0.2 0.8 1.2 2.3 1.5 2.1
Diluted Shares Outstanding (Mil) 584 584 584 584 584 584 581 580 578 475 530 519
Diluted Earnings Per Share (USD) 0.14 2.97 -2.16 -0.88 -0.66 0.08 0.23 0.80 1.47 2.70 1.72 2.47
Dividends Per Share (USD) — — — — — — — — 0.20 0.44 0.36 0.48
Valuation as of 28 Feb 2023

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Recent Qtr TTM
Price/Sales — — — — — — — 0.1 0.2 0.1 0.1 0.1
Price/Earnings — — — — — — — 11.1 24.6 7.2 7.2 8.1
Price/Cash Flow — — — — — — — 2.4 4.7 3.4 3.4 3.7
Dividend Yield % — — — — — — — 0.57 1.39 2.31 2.31 2.41
Price/Book — — — — — — — 5.5 7.2 2.5 2.5 13.8
EV/EBITDA 0.0 0.0 0.0 0.0 0.0 0.0 0.0 5.8 6.8 4.5 0.0 0.0
Operating Performance / Profitability as of 30 Nov 2022
Fiscal Year, ends 28 Feb 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 YTD TTM
ROA % — 18.5 -7.0 -2.0 -1.6 0.2 0.6 2.1 3.3 5.9 — 5.6
ROE % — 98.5 -62.4 -26.6 -25.0 3.3 9.2 25.0 47.2 74.5 — 103.1
ROIC % — 31.8 -6.6 2.7 2.7 4.8 5.6 6.8 7.6 12.0 — 11.8
Asset Turnover — 2.1 1.6 2.4 2.5 2.6 2.8 2.7 2.7 2.6 — 2.6
Financial Leverage
Fiscal Year, ends 28 Feb 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Recent Qtr TTM
Debt/Capital % — 67.4 84.6 88.1 89.8 89.3 87.8 85.9 91.2 80.6 93.9 —
Equity/Assets % — 18.8 8.4 6.8 5.8 6.4 7.0 9.2 5.0 10.8 2.7 —
Total Debt/EBITDA — 18.4 -460.4 6.0 5.5 6.6 4.1 4.1 3.8 2.9 4.0 —
EBITDA/Interest Expense 7.8 — 0.0 2.1 2.5 2.3 3.2 5.2 7.1 10.6 12.1 12.5
Morningstar Analyst Historical/Forecast Summary as of 29 Jan 2023

Financials Estimates Forward Valuation Estimates
2021 2022 2023 2024 2025
Fiscal Year, ends 02-26-2022 2021 2022 2023 2024 2025
Price/Sales 0.2 0.1 0.1 0.1 0.1
Revenue (USD Mil) 71,887 77,563 78,976 79,922 82,706 Price/Earnings 9.5 6.0 6.6 6.4 6.0
Revenue Growth % 3.2 7.9 1.8 1.2 3.5 Price/Cash Flow 7.5 10.5 6.5 6.5 6.1
EBITDA (USD Mil) 4,398 4,629 4,468 4,445 4,479 Dividend Yield % 1.5 39.0 3.4 3.5 4.2
EBITDA Margin % 6.1 6.0 5.7 5.6 5.4 Price/Book 3.2 8.1 7.7 5.4 4.0
EV/EBITDA 5.8 4.7 4.9 4.9 4.9
Operating Income (USD Mil) 2,677 2,831 2,646 2,637 2,647
Operating Margin % 3.7 3.7 3.4 3.3 3.2
Net Income (USD Mil) 1,458 1,921 1,739 1,740 1,766
Net Margin % 2.0 2.5 2.2 2.2 2.1
Diluted Shares Outstanding (Mil) 475 599 599 584 554
Diluted Earnings Per Share(USD) 3.07 3.21 2.90 2.98 3.19
Dividends Per Share(USD) 0.44 7.49 0.66 0.68 0.80
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Appendix
Historical Morningstar Rating
Albertsons Companies Inc Class A ACI 20 Mar 2023 21:18, UTC
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Koninklijke Ahold Delhaize NV AD 18 Mar 2023 01:12, UTC
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Sprouts Farmers Market Inc SFM 20 Mar 2023 21:18, UTC
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Research Methodology for Valuing Companies
Overview timate of a firm’s cost of capital, or weighted average In this stage, which can last five to 10 years, analysts
At the heart of our valuation system is a detailed projec- cost of capital (or WACC). Without a moat, profits are make full financial statement forecasts, including items
tion of a company ’s future cash flows, resulting from our more susceptible to competition. We have identified five such as revenue, profit margins, tax rates, changes in
analysts’ research. Analysts create custom industry and sources of economic moats: intangible assets, switching workingcapital accounts, and capital spending. Based on
company assumptions to feed income statement, balance costs, network effect, cost advantage, and efficient scale. these projections, we calculate earnings before interest,
sheet, and capital investment assumptions into our glob- after taxes (EBI) and the net new investment (NNI) to de-
ally standardized, proprietary discounted cash flow, or Companies with a narrow moat are those we believe are rive our annual free cash flow forecast.
DCF, modeling templates. We use scenario analysis, inde- more likely than not to achieve normalized excess returns
for at least the next 10 years. Wide-moat companies are Stage II: Fade
pth competitive advantage analysis, and a variety of other
those in which we have very high confidence that excess The second stage of our model is the period it will take
analytical tools to augment this process. Moreover, we
returns will remain for 10 years, with excess returns more the company ’s return on new invested capital—the re-
think analyzing valuation through discounted cash flows
likely than not to remain for at least 20 years. The longer turn on capital of the next dollar invested (“RONIC”)—to
presents a better lens for viewing cyclical companies,
a firm generates economic profits, the higher its intrinsic decline (or rise) to its cost of capital. During the Stage II
high-growth firms, businesses with finite lives (e.g.,
value. We believe low-quality, no-moat companies will period, we use a formula to approximate cash flows in
mines), or companies expected to generate negative
see their normalized returns gravitate toward the firm’s lieu of explicitly modeling the income statement, balance
earnings over the next few years. That said, we don’t dis-
cost of capital more quickly than companies with moats. sheet, and cash flow statement as we do in Stage I. The
miss multiples altogether but rather use them as support-
length of the second stage depends on the strength of
ing cross-checks for our DCF-based fair value estimates.
When considering a company's moat, we also assess the company’s economic moat. We forecast this period to
We also acknowledge that DCF models offer their own
whether there is a substantial threat of value destruction, last anywhere from one year (for companies with no eco-
challenges (including a potential proliferation of estim-
stemming from risks related to ESG, industry disruption, nomic moat) to 10–15 years or more (for wide-moat com-
ated inputs and the possibility that the method may miss
financial health, or other idiosyncratic issues. In this con- panies). During this period, cash flows are forecast using
shortterm market-price movements), but we believe these
text, a risk is considered potentially value destructive if its four assumptions: an average growth rate for EBI over the
negatives are mitigated by deep analysis and our
occurrence would eliminate a firm’s economic profit on a period, a normalized investment rate, average return on
longterm approach.
cumulative or midcycle basis. If we deem the probability new invested capital (RONIC), and the number of years
of occurrence sufficiently high, we would not characterize until perpetuity, when excess returns cease. The invest-
Morningstar’s equity research group (” we,” “our”) be-
the company as possessing an economic moat. ment rate and return on new invested capital decline un-
lieves that a company’s intrinsic worth results from the
til a perpetuity value is calculated. In the case of firms
future cash flows it can generate. The Morningstar Rating
To assess the sustainability of excess profits, analysts per- that do not earn their cost of capital, we assume marginal
for stocks identifies stocks trading at a discount or premi-
form ongoing assessments of the moat trend. A firm’s ROICs rise to the firm’s cost of capital (usually attribut-
um to their intrinsic worth—or fair value estimate, in
moat trend is positive in cases where we think its sources able to less reinvestment), and we may truncate the
Morningstar terminology. Five-star stocks sell for the
of competitive advantage are growing stronger; stable second stage.
biggest risk adjusted discount to their fair values, where-
as 1-star stocks trade at premiums to their intrinsic worth. where we don’t anticipate changes to competitive ad-
vantages over the next several years; or negative when Stage III: Perpetuity
Four key components drive the Morningstar rating: (1) our we see signs of deterioration. Once a company’s marginal ROIC hits its cost of capital,
assessment of the firm’s economic moat, (2) our estimate we calculate a continuing value, using a standard per-
of the stock’s fair value, (3) our uncertainty around that 2. Estimated Fair Value petuity formula. At perpetuity, we assume that any
fair value estimate and (4) the current market price. This Combining our analysts’ financial forecasts with the growth or decline or investment in the business neither
process ultimately culminates in our singlepoint star rat- firm’s economic moat helps us assess how long returns creates nor destroys value and that any new investment
ing. on invested capital are likely to exceed the firm’s cost of provides a return in line with estimated WACC.
capital. Returns of firms with a wide economic moat rat-
ing are assumed to fade to the perpetuity period over a Because a dollar earned today is worth more than a dollar
1. Economic Moat
longer period of time than the returns of narrow-moat earned tomorrow, we discount our projections of cash
The concept of an economic moat plays a vital role not
firms, and both will fade slower than no-moat firms, in- flows in stages I, II, and III to arrive at a total present
only in our qualitative assessment of a firm’s long-term
creasing our estimate of their intrinsic value. value of expected future cash flows. Because we are
investment potential, but also in the actual calculation of
modeling free cash flow to the firm—representing cash
our fair value estimates. An economic moat is a structural
Our model is divided into three distinct stages: available to provide a return to all capital providers—we
feature that allows a firm to sustain excess profits over a
discount future cash flows using the WACC, which is a
long period of time. We define economic profits as re-
weighted average of the costs of equity, debt, and pre-
turns on invested capital (or ROIC) over and above our es- Stage I: Explicit Forecast
ferred stock (and any other funding sources), using ex-
Morningstar Equity Research Star Rating Methodology pected future proportionate long-term, market-value
weights.
3. Uncertainty Around That Fair Value Estimate

Morningstar’s Uncertainty Rating is designed to capture
the range of potential outcomes for a company ’s intrinsic
value. This rating is used to assign the margin of safety
required before investing, which in turn explicitly drives
our stock star rating system. The Uncertainty Rating is
ß
aimed at identifying the confidence we should have in as- Morningstar Equity Research Star Rating Methodology
signing a fair value estimate for a given stock.
Our Uncertainty Rating is meant to take into account any-

thing that can increase the potential dispersion of future
outcomes for the intrinsic value of a company, and any-
thing that can affect our ability to accurately predict
these outcomes. The rating begins with a suggested rat-
ing produced by a quantitative process based on the trail-
ing 12-month standard deviation of daily stock returns.
An analyst overlay is then applied, with analysts using
the suggested rating, historical rating data, and their own
knowledge of the company to inform them as they make
the final Uncertainty Rating decision. Ultimately, the rat-
ing decision rests with the analyst. Analysts take into ac-
count many characteristics when making their final de-
cision, including cyclical factors, operational and financial
factors such as leverage, company-specific events, ESG
risks, and anything else that might increase the potential
dispersion of future outcomes and our ability to estimate
those outcomes.
Our recommended margin of safety—the discount to fair

value demanded before we ’ d recommend buying or
selling the stock—widens as our uncertainty of the es-
timated value of the equity increases. The more uncertain factors.
we are about the potential dispersion of outcomes, the For more details about our methodology, please go to
greater the discount we require relative to our estimate of https://shareholders.morningstar.com The Morningstar Star Ratings for stocks are defined be-
the value of the firm before we would recommend the low:
purchase of the shares. In addition, the Uncertainty Rat- Morningstar Star Rating for Stocks QQQQQ We believe appreciation beyond a fair risk ad-
ing provides guidance in portfolio construction based on justed return is highly likely over a multiyear time frame.
Once we determine the fair value estimate of a stock, we
risk tolerance. Scenario analysis developed by our analysts indicates
compare it with the stock’s current market price on a
daily basis, and the star rating is automatically re-calcu- that the current market price represents an excessively
Our Uncertainty Ratings are: Low, Medium, High, Very
lated at the market close on every day the market on pessimistic outlook, limiting downside risk and maximiz-
High, and Extreme.
which the stock is listed is open. Our analysts keep close ing upside potential.
tabs on the companies they follow, and, based on thor-
Margin of Safety
ough and ongoing analysis, raise or lower their fair value QQQQ We believe appreciation beyond a fair risk-ad-
Qualitative Analysis
QRating estimates as warranted. justed return is likely.
Uncertainty Ratings QQQQQRating
Low 20% Discount 25% Premium QQQ Indicates our belief that investors are likely to re-
Please note, there is no predefined distribution of stars.
Medium 30% Discount 35% Premium ceive a fair risk-adjusted return (approximately cost of
That is, the percentage of stocks that earn 5 stars can
High 40% Discount 55% Premium equity).
fluctuate daily, so the star ratings, in the aggregate, can
Very High 50% Discount 75% Premium
serve as a gauge of the broader market’s valuation. When
Extreme 75% Discount 300% Premium QQ We believe investors are likely to receive a less than
there are many 5-star stocks, the stock market as a whole
is more undervalued, in our opinion, than when very few fair risk-adjusted return.
Our uncertainty rating is based on the interquartile range,
companies garner our highest rating.
or the middle 50% of potential outcomes, covering the Q Indicates a high probability of undesirable risk-adjus-
25th percentile–75th percentile. This means that when a ted returns from the current market price over a multiyear
We expect that if our base-case assumptions are true the
stock hits 5 stars, we expect there is a 75% chance that time frame, based on our analysis. Scenario analysis by
market price will converge on our fair value estimate over
the intrinsic value of that stock lies above the current our analysts indicates that the market is pricing in an ex-
time generally within three years (although it is im-
market price. Similarly, when a stock hits 1 star, we excessively optimistic outlook, limiting upside potential and
possible to predict the exact time frame in which market
pect there is a 75% chance that the intrinsic value of that leaving the investor exposed to Capital loss.
prices may adjust).
stock lies below the current market price.
Our star ratings are guideposts to a broad audience and Other Definitions
4. Market Price individuals must consider their own specific investment Last Price: Price of the stock as of the close of the mar-
The market prices used in this analysis and noted in the goals, risk tolerance, tax situation, time horizon, income ket of the last trading day before date of the report.
report come from exchange on which the stock is listed needs, and complete investment portfolio, among other
which we believe is a reliable source.
ß
Capital Allocation Rating: Our Capital Allocation (or Sustainalytics analyzes over 1,300 data points to assess a situation or particular needs of any specific recipient. This
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and shareholder distributions. Analysts consider compan- Unmanaged Risk is measured on an open-ended scale investor. Therefore, investments discussed and recom-
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cess. Beyond investment strategy, financial leverage, and than English and in the case of inconsistencies between
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tions, and accounting practices in the rating. associated with any part or section of a report that has
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Morningstar Equity Analyst Report | Report as of 20 Mar 2023 22:59, UTC | Reporting Currency: USD | Trading Currency: USD

| Exchange: NEW YORK STOCK EXCHANGE, INC. Page 1 of 23

Price vs. Fair Value

Fair Value: 29.00

Bears Say Zain Akbari, CFA, Equity Analyst, 2 Feb 2023

Economic Moat Zain Akbari, CFA, Equity Analyst, 2 Feb 2023

Fair Value Fair Value Last Close

Albertsons does not meet that standard.

we believe it trails moat-endowed firms in the sector, particularly Kroger.

Still, we do have a favorable view of Albertsons' mid-2021 introduction of FreshPass, a membership

Capital Allocation Zain Akbari, CFA, Equity Analyst, 2 Feb 2023

Analyst Notes Archive

Competitors Price vs. Fair Value

Fair Value: 52.00

Koninklijke Ahold Delhaize NV AD

Last Close: 30.09

Sprouts Farmers Market Inc SFM

Last Close: 32.72

0.89 0.90 0.82 1.10 1.10 1.07 Price/Fair Value

Morningstar Historical Summary

Valuation as of 28 Feb 2023

Morningstar Analyst Historical/Forecast Summary as of 29 Jan 2023

The Kroger Co KR 20 Mar 2023 21:18, UTC

Koninklijke Ahold Delhaize NV AD 18 Mar 2023 01:12, UTC

Sprouts Farmers Market Inc SFM 20 Mar 2023 21:18, UTC

Research Methodology for Valuing Companies

3. Uncertainty Around That Fair Value Estimate

Research Methodology for Valuing Companies

Our Uncertainty Rating is meant to take into account any-

Our recommended margin of safety—the discount to fair

Research Methodology for Valuing Companies

Research Methodology for Valuing Companies

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