NEW YORK — Inflation and lingering economic sluggishness are likely to continue to confound the industry well into next year, according to a panel of seven industry analysts at SN's 16th annual Analysts Roundtable here.

“If the economy doesn't improve, the consumer will be in worse shape next year, and rationality may not prevail the way it has so far this year,” John Heinbockel, managing director for Guggenheim Partners, New York, said. “I'm much more concerned about what happens when the clock turns to 2012.”

Scott Mushkin, managing director for Jefferies & Co., New York, also said conditions could get worse. “I can't believe I'm saying this, but I believe we're looking at packaged food inflation of probably 5% to 8% in the back half of the year, [so] the second half of 2011 may end up being very challenging, [and] there's fear about 2012.

    From left: Andrew Wolf, Scott Mushkin, Mark Wiltamuth, John Heinbockel, Meredith Adler, Gary Giblen and Chuck Cerankosky.

“Every gauge we look at indicates the unemployment rate is probably heading higher, and that does not bode well for the back half of the year. It means there will be more trading down, and this rational environment could easily break down.”

Consumers are continuing to suffer and to experience more uncertainty, Andrew Wolf, managing director for BB&T Capital Markets, Richmond, Va., pointed out. “To be in the middle of a recovery and have the middle class buying less is a new thing for our economy, and that has really hurt the industry,” he said.

Problems created by the weak economy will take a long time to resolve, Chuck Cerankosky, managing director for Northcoast Research, Cleveland, said.

“You're hearing more and more food companies saying they are trying to get gross margin dollars even. They're not even talking about getting back the margin. And the retailers are threatening CPGs with private label.

“There's a lot of worry about passing costs along to a customer who isn't necessarily going to take it. It will require time, especially with employment numbers going in the wrong direction.”

    Meredith Adler  

Even private label is becoming less of a safety valve for most chains, Gary Giblen, managing director for Aegis Capital, New York, said. “The increase in the pace of private-label mix is slowing, and if the chains don't have that safety valve, then [problems resulting from the weakened economy] become more serious concerns for them.”

Things could get worse if the market becomes less rational, the analysts said, though they disagreed on who might upend the status quo.

“It might be Wal-Mart — whose price spreads have been narrowing — that ends the rational environment,” Mushkin said. “Wal-Mart's consumable volumes are now negative, and if it tries to turn volumes higher through price investments, it's potentially a big problem.”

    Chuck Cerankosky  

Meredith Adler, managing director for Barclays Capital, New York, suggested Wal-Mart Stores might not have to do anything to change the dynamic “because if a certain number of people hit a budget constraint and decide to go somewhere else, then Wal-Mart can pass the current inflation through and still be the low-price leader by maintaining the same spread it had before. It can be the one place, by default, that many people can afford.”

Mark Wiltamuth, executive director for Morgan Stanley, New York, offered a similar opinion, noting Wal-Mart is more likely to “drag its feet passing through inflation and let inflation do the dirty work on widening the pricing gap. Wal-Mart is going to let the grocers push up inflation while it holds prices as much as it can. It's not going to be a sexy way to open up the gap, but I think that's what it's going to do.”

    Gary Giblen  

Heinbockel suggested it may not be a national player who takes the lead on more aggressive pricing. “It could be painful locally if someone like Wegmans wants to get more aggressive, or Publix wants to do it — and if you happen to be in those markets, you're in trouble,” he said.

The analysts agreed that Kroger Co. is best positioned among the major conventional chains to withstand the industry's competitive pressures, “[with] one of the best models in consumables retailing right now,” Heinbockel said. “Its 4% or 5% comp and its price position mean it can afford to invest selectively in price and simultaneously expand EBIT margin — the best of all worlds.”

But for companies whose sales are already declining, the next couple of years could be particularly problematic, they pointed out.

    John Heinbockel  

“Both Safeway and Supervalu are losing market share right now, and it's those two, which are trying to play catch-up, that are at greater risk,” Wiltamuth said. “Both were late to the party when it came to cutting prices, and it's hard to really stimulate and bring that customer back. Now, with an inflating environment, it's even harder to reposition your relative price in the marketplace.”

For Minneapolis-based Supervalu, one of its biggest assets, Adler said, is its “phenomenally convenient locations.”

Supervalu also has a lot of low-hanging fruit, she added. “There are so many things that were done poorly that it has the option to fix, and it may not have to make radical changes to its pricing to show some improvement, even if it's only less sales deterioration.”

    Scott Mushkin  

For Pleasanton, Calif.-based Safeway, inflation is particularly galling, Wolf pointed out, because it lowered thousands of prices in 2010 and is unlikely to go even lower. “Nobody is doing well if they aren't focused on value. I think Safeway [is] positioned halfway there, [but] does it have the patience and the forbearance and determination to change?”

Wiltamuth said he doubts Safeway will change its pricing. “Safeway has laid its stake down, betting on differentiation and higher-quality remodels, and it has made the decision that it will not go below the competition on price. It almost feels like the Safeway strategy needs some upward plane to the economy for the lifestyle remodel strategy to work because I don't think [it] is willing to cut the price and chase other strategies at this point.”

    Mark Wiltamuth  

Wal-Mart may be struggling a bit as it copes with two years' worth of negative comp sales, the analysts said. “Wal-Mart exerts enormous pressures on the industry — and there is enormous pressure on Wal-Mart as well,” Mushkin said.

Wal-Mart may be caught “between a rock and a hard place,” he added. “If it invests in price, it will really hurt earnings and the company may not get enough incremental sales to justify the lower prices — and if it doesn't invest, it looks like it will continue to bleed share.”

The company may also be losing some of its strong price reputation, Wiltamuth said, pointing to a survey he did of 1,100 Wal-Mart shoppers that indicated only one in four viewed its prices as significantly lower than those of grocery stores.

    Andrew Wolf  

According to Wolf, “Wal-Mart has not been happy seeing its low-end customers going to dollar stores, [so it] is reloading on consumables inventories and [putting] dollar items all over the place.”

Adler said supermarkets can continue to blunt Wal-Mart's effectiveness with strong promotional prices. “Everyday low price cannot match an advertised price — not unless you want to absolutely destroy earnings,” she said.

“Wal-Mart is stuck in a box — a very small box — and it's made of iron, which makes it hard to get out.”

Wiltamuth said he doesn't see much relief for Wal-Mart. With sales of consumables more dependent on low-income shoppers, “Wal-Mart is going to have a hard time turning that part of the store around, and the consumables are going to have their own problems, given the inflation issue,” he said.