Key Shifts in Grocery Business Highlight Supermarket Weakness

By Tom Gibbs - July 16, 2012 | Tickers: FDO, SWY, SVU, KR, WMT | 0 Comments

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Quite a bit of buzz was stirring in the grocery industry late in the trading week of July 9^th from the release of several news tidbits.  First, large grocery chain operator Supervalu (NYSE: SVU) lost close to half of its market value following the reporting of its dismal first quarter results, the suspension of its dividend, and the announcement that it would pursue strategic alternatives with its troubled operations.  Analysts subsequently downgraded the stock’s outlook and the corporation’s credit rating.

The second news release shows that although a meaningful portion of the grocer’s downfall can be specifically linked to the hulking debt load that was increased with its $11.3 billion acquisition of Albertson’s in the mid-2000s, more general trends within the grocery industry are making it increasingly difficult for corporation’s like Supervalu to operate. 

It’s Tough Being in the Middle

UBS has reported late in the week that a huge shift in grocery consumers is changing the dynamics of their shopping habits.  Between 2000 and 2011, the traditional grocers’ market share – includes publicly traded players like Supervalu, Kroger (NYSE: KR), and Safeway (NYSE: SWY) – has shrunk to 51% from 66%.  The primary driver behind the shift, as depicted by a study conducted by UBS and Kantar Retail, shows that traditional grocers are stuck in the middle of the market on several key shopping points:

In essence, supermarkets are getting squeezed from both ends.  Customers who traded down during the middle of the recession have formed shopping habits with cheaper, but still adequate, alternatives.  Dollar stores including Family Dollar (NYSE: FDO), Dollar General, and Dollar Tree have evolved into the top choice among consumers who use quick “fill-in” trips between larger volume grocery purchases as well as those who shop based on an immediate use type of need (toiletries, for example). 

This trend has little chance of reversing, as higher levels of employment and urbanization factors will limit the time and space consumers have to shop for and store high volumes of groceries.  Collectively, the three publicly traded dollar stores have grown their top lines at an 11.8% CAGR over the past five years, a rate almost 5.6 times greater than the three supermarkets over the same time period.  The corporation’s have been well rewarded for their growth as well – Family Dollar, the “poorest” performing of the three, is up more than 18% year-to-date. 

On the other end of the spectrum, a growing level of discretionary income has allowed more affluent consumers to upgrade their purchases to more expensive alternatives.  One of the fastest growing segments of the grocery industry is the specialty niche, comprised of corporations including Whole Foods Market, Trader Joe’s, and The Fresh Market, which boast a wider selection of fresh, organic, and locally-grown/produced food items.  The more affluent customer base of such retailers and the exploitation of a higher willingness to spend on “better” grocery items is the key driver behind such firms’ more robust gross margins.  The average gross margins between Kroger, Safeway, and Supervalu over the past three years – 24.2% -- pale in comparison to Whole Foods’ three year average margins of 34.7%, for example. 

Rounding out the competition portfolio is the increased presence of general merchandise retailers in the grocery market.  Nearly 55% of Wal-Mart’s (NYSE: WMT) domestic top line is now comprised of grocery sales, up from 47% five years ago, and the same holds true for close competitor Target – 19% of sales in 2011 versus 13% of sales in 2007.  The two general merchandise retailers, because they have expanded the breadth of their food offerings and present a much more convenient one-stop shopping experience than do pure-play grocers, have grown grocery-based sales at a 6.7% (Wal-Mart) and 12.7% (Target) CAGR over the past five years. 

What Now?

Supermarkets have employed many strategies over the past decade to maintain their top lines.  Kroger, Supervalu, and Safeway (as well as other smaller regional players including Southeastern-based Publix) all have launched and heavily-marketed their own private brands that boast ample quality and higher selling margins.  Loyalty programs and “hyperlocal” strategies have also been employed to build a differentiated approach that more successful players like Whole Foods tend to enjoy. 

Most of the growth for these players, however, has been built inorganically through acquisition or through the entry into other product categories.  Kroger is by far the best performing of the three publicly traded grocery chains – growing revenues at a 6.5% CAGR over the past five years – but has made a meaningful expansion into fuel and other general merchandise items including apparel, home fashion, electronics, automotive products, toys, and jewelry.  The corporation now operates more than 1,000 fuel centers (nearing 50% of its store base), and fuel sales have grown at a rate 5x faster than the sale of traditional grocery items.  Although a growth in fuel sales still represents an enjoyable growth for shareholders, the slower growing core revenues (mid-single digits per year) are not immune to the forces of competition from dollar, specialty, and general merchandise stores. 

There is obviously no quick-fix solution to the problem facing supermarkets today.  What can be gleaned from this week’s happenings, however, is that the weaker grocery chains like Supervalu and Safeway, which have plodded along over the past five years, are likely to get much worse before they start showing any signs of potential improvement.  Keep an eye out for key news releases from Supervalu, which is bound to offer more value to shareholders through the breakup and sale of its assets than through its current trajectory. 

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