The announcement by Grupo Chedraui concerning a new 1.4 million square foot distribution facility lease is a key clue in the next phase of organic growth for Chedraui USA, one perhaps overlooked by many.
In May, Chedraui confirmed the beginning of a more full rollout of the El Super and Smart & Final supermarket/club store formats in the western United States. Details for 2 El Super locations were released on 2023 openings in California and Nevada. Additionally, 3 new Smart & Final locations, up from 2 potential new store openings previously indicated, were confirmed for 2023 grand openings.
While 5 new US locations in 2023 may seem modest to bystanders, Chedraui was quite busy digesting the Smart & Final acquisition for the past year. An almost tripling of the total US store count without incident requires considerable management expertise to successfully pull off; the existing executive team proved their capacity to fold a much larger chain into the overall corporate structure. The initial 2023 management capital budget had stressed a much faster growth rate in the Mexican store count, with a view towards increasing sales in Mexico to about 45% of corporate consolidated revenues.
Of equal importance in the May update was an announcement that 40 Smart & Final locations are to undergo remodeling during 2023. These expenditures all represent a sensible use of the significant free cash flow being produced by the highly profitable grocery chain.
The planned 32 acre Rancho Cucamonga distribution center will increase distribution capacity for the US division by 50%.
Located in the Central Valley of California, roughly 38 miles west of Los Angeles, this facility represents a very significant overbuild, completely in excess of the needs for the present existing store count or even based upon a longer term growth plan at the assumed rate of American GDP over a decade.
The only logical explanation for leasing a property of this size and location is based upon an internal management expectation of a far more significant store rollout than is presently envisioned by analysts. Realistically, this facility can service as many as 120 additional store locations in a tri-state locale mid-term, focusing upon a southern and central California footprint and extending as far west as Nevada, Arizona and potentially a push into the state of New Mexico.
Chedraui, being a household name in Mexico among grocery shoppers and tourists, possesses a natural recognition among the many Hispanic residents/citizens in the south-western USA. An opportunity to grow the store count in those states seems the path of least resistance in the competitive grocery marketplace. The size of the new distribution warehouse puts the first pin on the map, it affirms the mid-term ambitions to grow out the Smart & Final/El Super retail banners in the US west.
Quite unexpectedly, Chedraui has started touting their success within the grocery world.
Recent reports put forth by Chedraui now refer to the footprint in the terms of a “top 4 grocery retailer in California“. That indication will surprise most investors, because the top companies in terms of store count or sales in California were previously considered to be Albertsons, Walmart, Trader Joe and Ralphs.
Ralphs and Trader Joes currently report more total locations than Chedraui USA, which would infer that Chedraui generates more sales per store than at least one of the two peers. Chedraui typically stays well clear of competitive chest-thumping and a shot of this nature across the bow of other grocers represents something other than a boast; it serves to inform the region that Mexico’s largest independently held grocery store chain will not remain content to sit in the back of the bus, but that they have opted to become more assertive. The preferred growth banner in the US western states looks to be the Smart & Final format.
US management is actively seeking out new potential locations with a roughly 40,000 square toot sales floor in population basins of at least 60,000 persons.
Retail markets of that size are largely ignored by existing the warehouse clubs in the US western states (Sams Club and Costco). They prefer population centers of at least 200,000 persons before considering adding a new warehouse location.
The current store format permits Chedraui to open up Smart & Final locations in areas completely unserved by Sams Club or Costco, and, potentially open up locations in regions underserved by either of the larger club store formats.
Smart & Final represents an interesting banner niche; the format is more than a grocery store but eliminates the requirement for a membership.
The chain is closer in merchandising offers to the top 3 club store operators presently serving the US markets vs traditional grocers. In the most recent quarterly conference call, executive indicated that they feel this market may be extremely large, not just in the United States, but also in Mexico. One issue in Mexico with Smart & Final lies in a franchise/partnership license covering 17 northern Mexico locations Smart & Final locations operated by a third party. I would expect this licensee may eventually need be purchased outright in Mexico, so as to roll out the format nationally and turn Smart & Final into a multi-country retailer.
A potential divestiture of Albertsons locations in California in order for Kroger to gain approval to acquire Albertsons should also be monitored.
Chedraui, with a virtually debt free balance sheet, has the financial strength to readily purchase a number stores from Kroger, with a view towards changing the signage. Kroger has proposed a potential spinoff or divestiture of as many as several hundred locations in the US western states to comply with regulators pondering approval of the Kroger/Albertsons combination.
A massive new supermarket distribution center could be put to very good use in short order, provided another 50 or so locations were to be converted from a competing chain to a Chedraui USA banner in southern and central California. I don’t personally believe that a Chedraui purchase of non-core Albertson locations is likely; however, it is possible, and prudent investment modeling attempts to take everything into account.
For the right price, Chedraui will, without doubt, be interested in a piece of the potential disposals, as will other chains. Differing from many competitors, Chedraui has the balance sheet strength to acquire a reasonable number of stores, or even an entire smaller chain, without requiring expensive and dilutive debt financing. This is the benefit of being relatively unburdened with interest charges in a high interest environment. Potentially generating $1.2 billion US or more in 2023 forecast EBITDA offers options, some completely unmodeled by analysts.