The retail food industry may face some potential stumbling blocks later this year that could alter the generally positive tone of the competitive environment, securities analysts told SN.
Those blocks could include an inflation-free sales environment, heightened promotional activity and increasing overcapacity.
Jonathan Ziegler, a San Francisco-based securities analyst with Salomon Bros., New York, said that while he expects business to continue to be good this year, there is some cause for concern.
"Sales growth could be more difficult without a kick-start from inflation," he said, "and that could mean competition will heat up a bit without any tail wind from strong same-store sales as more aggressive promotions put pressure on margins."
Debra Levin, a securities analyst with Morgan Stanley, New York, also warned about a possible acceleration in competitive activity "if the low rate of inflation leads operators who don't get the sales increases they've budgeted for to promote more in an effort to spur the top line."
Levin also said an anticipated rise in interest rates could produce an economic slowdown that reduces disposable income.
"We're in an environment right now where the expectation is that interest rates will rise more than once, which will put brakes on the economy, which could result in an economic slowdown and a reduction in disposable income. And there's always the risk that growth rates might slow a bit if there is a slowdown in consumer spending."
Expressing the most optimism was Gary Giblen, managing director of Smith Barney, New York, who said, "Overall it doesn't get much better than it is right now for supermarket operators. The balance of the year will be strong for the industry because all the trends that have boosted results are still there."
Gary Vineberg, a securities analyst with Merrill Lynch, New York, took a more pessimistic tone. "We're in the midst of an ongoing slowdown that began last October, when Albertson's disclosed weak third-quarter results, and the trends are not good," he said. "Winn-Dixie's results have been disappointing and Safeway was off a bit in the first quarter, and while not all companies are slowing down at the same rate, most have been seeing same-store sales slipping for three or four quarters."
Vineberg said he attributes the slowdown to overcapacity in the industry rather than any lack of consumer demand, and he said he does not see any change in demand for high-margin products.
Chuck Cerankosky, a securities analyst with Tucker Anthony, Cleveland, said he anticipates companies that are doing well to continue to do well, "and those that aren't doing well will probably see their difficulties continue unless they find a way to be more competitive." Analysts said several factors will influence the course of business through the balance of the year, including the following:
Interest rates, which are likely to go up, possibly more than once.
Competition, which is relatively stable right now but could change suddenly in given markets if underperforming retailers try to shift the balance of power.
Consolidation, which is likely to continue as more efficient operators buy up smaller or less efficient competitors.
Profitability, which will rise or fall with the economy.
The analysts said they believe interest rates are bound to go up, though the increase will probably have little impact on most operators.
Cerankosky said interest rates are going up, "not to chase inflation, but more as an attempt by the Federal Reserve to fine-tune the rates because of concern that inflation may pick up."
Giblen said he expects interest rates to rise "a little bit, which could affect capital projects over the long term, but nothing immediate. Most companies are deleveraged, so they aren't burdened with a lot of debt that can eliminate volatility."
According to Vineberg, "A rise in interest rates carries some risks that may impact consumers and cause an ugly environment, though I don't see that happening. There are no significant risks of a recession -- unless the Fed overtightens things."
Vineberg also said he believes the industry's overcapacity could heat up competition. "The question is, do retailers succeed by staying rational and focusing on service and other factors besides price-cutting as competitive tools, or do they become more price-competitive?
"I see the latter happening. But without any significant tightening of the economy, consumers will do their best to avoid involving themselves in price wars."
Cerankosky said he does not see price competition becoming more prevalent. "While competition is very much alive in the industry, operators are spending money on information systems or other technologies to become more efficient so they can compete more aggressively," he said.
He also said shelf prices are unlikely to rise this year because "retailers are very, very conscious of consumers' comfort level with today's fairly stable pricing, and that makes them unwilling to raise shelf prices.
"Instead, it drives retailers back to the vendors for help keeping shelf prices level with a year ago, which leads to some shifts in margins from manufacturers to retailers. As a result, retailers who are buying at a good rate and keeping prices stable while achieving operating efficiencies are able to improve the bottom line or to compete more effectively."
Giblen said he believes the industry is in "an exceedingly rational time" concerning price competition, although he anticipates some disruptions for Hannaford Bros., Scarborough, Maine, in Southeastern markets like Charlotte, N.C., and Richmond, Va., where competition is heating up, and possibly for Ahold USA, Atlanta, in some of the Long Island, N.Y., stores it acquired last year.
According to Ziegler, "Competition is relatively benign, with the major players focusing more on growth through acquisitions, which mitigates the impact of new square footage." He also said he expects operators to benefit more this year from category management, "and increased use of technology and frequent-shopper programs should continue to drive sales and earnings."
Analysts said they see industry consolidation as a positive factor. "It's a way to purchase capacity rather than build it," Cerankosky said. "When you have an efficient operator who can enter a market by buying an inefficient operator with good locations, then consolidation makes sense."
Ziegler said he expects more consolidation this year, "as more managements are opting to meet their need to grow through consolidation. When you shift the emphasis to external growth through acquisition rather than internal growth, it's good for competition because there are fewer pressure points."
Regarding profitability, Levin said, "There are still opportunities for companies to benefit from improved efficiencies through technology. Therefore, the profit outlook is solid. However, if there is any kind of economic slowdown, then less consumer spending could mean a slowdown in the growth rate of earnings." Among other factors the analysts discussed as they viewed prospects for the balance of the year were the following:
Labor activity. Giblen said he does not expect labor unrest to have much impact. "There are likely to be little flurries of activity -- like the Alberta strike against Safeway -- because the industry is successful enough that the union feels it can dig in its heels. But that kind of strike is unlikely to cause significant problems for retailers, beyond temporary work stoppages."
Home-meal replacement. Ziegler said the industry will continue to struggle to find the best way to provide in-store meals, "and this could be a key year for crystallizing what it wants to do -- providing HMR through the stores, through a central commissary or through an outside vendor. "Ultimately there will probably be a single, right way for most multiregional companies to go, and I believe that way is the central commissary, which might mean increased labor costs at store-level. But with product prepared more efficiently off-site, retailers may avoid problems of safety and inconsistency and reduce investment costs."
Combination stores. According to Cerankosky, combination stores offer the strongest format for retailers and consumers "because consumers need to save time, and combination stores have the merchandise mix that allows them to trade up and spend money on higher-margin merchandise. "Combination stores are a type of category killer that focuses on one-stop shopping and serves the time-efficient customer, and they do well in various economic climates against all competition, and they should continue to do well, helped by a growing economy."
