Financial Analysts: No Relief in Sight

INFLATION'S IMPACT

Mushkin: Meredith is right when she says inflation has largely been in perishables. But in the last month or two, it's been spilling across other categories.

Heinbockel: It's in virtually every item in the store, which brings up a bigger question: If inflation continues to squeeze out discretionary spending, do the companies that sell consumables actually look pretty good compared to everybody else, whose business is very weak?

Adler: It would be great if that was true, but the 25% who have money to spend actually spend a lot of money. I did a study where we looked at quintiles of households by income, and for all spending, the top quintile spent as much as the bottom three combined. But when it came to food, the bottom three spent more. So a total pullback in discretionary spending was more true when all consumers were scared and pulled back. Everyone focuses on Wal-Mart being the one that will start the trouble, but there are a lot of other retailers that can cause trouble.

Giblen: Dollar stores already have begun to cause trouble.

Heinbockel: But Kroger already said it's not going to price off the dollar stores. If Kroger wanted to stir things up, it could. But it's behaving, and I think it will probably continue to do so. But once you get beyond Kroger and Wal-Mart, it becomes very local. Costco's not going to do it. Target's not going to do it. So it could be painful locally — for example, if someone like Wegmans wants to get more aggressive, or Publix wants to do it, they could, and if you happen to be in those markets, you're in trouble.

Adler: I agree, except even some of those guys have a fair number of places they go. I agree it's not going to be national.

Mushkin: We just don't know. Granted, we know the employment picture is terrible, we know real earnings are going down, and there's also tremendous stress from commodity price increases.

If you look at pricing in Los Angeles, you have to ask how the average person is going to deal with the situation there, with gas prices at $3.90 a gallon and grocery prices up 5% to 6%. So if you're a person making $40,000 to $70,000 a year, the stress looks to be mounting, and when we hear all these companies saying everything is fine, I am skeptical.

Heinbockel: It's clearly bad for that customer — it's tough going out to the movies, going out to eat, buying apparel — which is why the payroll tax holiday is so critical, because that has paid for higher food and gas. If you extend it through next year, it's not a benefit nor is it a negative — the second derivative is zero. What Congress should probably do if it could is expand it to some degree — to put more money back in people's pockets. But that might be politically impossible.

Cerankosky: The bad news here is that resolving this situation is going to take a long time. 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 — that's a step that's going to come in the future. And the retailers are threatening CPGs with private label, and one retailer is threatening to reduce prices while another is not. There's a lot of worry here 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.

Wolf: Kroger is raising prices. It said it was going to pass through prices from branded manufacturers, and it wants to be very transparent about that.

Adler: Yes, but it has also said it doesn't know what the competitive environment is going to look like, and things are going to remain competitive. The one difference this year vs. last year is that Kroger has a lot more money — or “dry powder” — in its pockets than it did a year ago, and the last time Kroger spoke about the competitive environment, it sounded like everything was OK. But if you really talk to management, they say they don't have any idea what the environment is going to look like, though they are confident they are prepared to deal with whatever happens.

I think I didn't take into account enough how deflation created panic. Seeing negative comps freaked out a lot of retailers.

Wolf: Also seeing negative customer counts.

Adler: The one good thing is that inflation will make the sales numbers look better, so you probably get less panicky behavior than you did. I didn't credit that enough, even last year, because I thought this beating each other to a pulp would never end.

Wolf: Volume degradation is the big evil, and I have based a lot of my research on that, so I think I have some authority when I say there is going to be ongoing volume degradation. And as prices go up, people will buy somewhat less in terms of volume. That's not the issue. The issue is, do people go to Wal-Mart or not?

Wal-Mart doesn't even have to increase its spread because if a certain number of people hit a budget constraint and decide to go somewhere else — to dollar stores or wherever — then Wal-Mart can pass the current inflation through and still be the low-price leader by maintaining the same spread it had before. In periods of heavy inflation, it can be the one place — by default — that many people can afford, so that's another reason it doesn't have to enhance its current price spreads.

Cerankosky: A couple of years ago, we had food deflation, which normally means people buy more because it's cheaper. But they didn't. They kept their budgets flat. Now the economy is waffling again, and this time we have inflation.

Wiltamuth: I'm still amused at how investors get so bulled up when inflation comes up as a topic. Two years in a row now, investors have gotten all excited about how inflation's going to help the grocery stocks, and then when the data actually starts coming out, it ends up being disappointing.

Cerankosky: We've done a lot of work with that, using correlation analysis, and there's no correlation — it just doesn't happen.

Adler: It depends on where you see the inflation, because if it's mostly in perishables, then the retailers try to hang on to penny profit rather than going for margin — and that means they don't get incremental earnings.

Wiltamuth: We laid out a bearish call in January saying this was going to be bad news and everybody needed to buckle down, and everybody got all excited through April and May and then, boom, down it came.

Adler: I made the same call in December, and I felt pretty stupid.

Wolf: Well, that's because things were better. What really cut the knees out from under the industry was gas inflation. [Kroger Chairman and CEO Dave] Dillon said rising gas prices were taking $100 monthly from households. My own research indicated the average household's increase in monthly expenses due to inflation was $70 for gas and $30 for food, and while that could change, the point is what really is killing things is gas going up a buck a gallon and what that's doing to the low- and middle-end shoppers and to their budgets. It just shows you how precarious things are.

Cerankosky: Look at how people respond to gas promotions. If you go to a Giant Eagle GetGo station in Cleveland at the end of the month when points are expiring and there's a 30-gallon limit, you would not believe what people pump gasoline into — anything just short of Tupperware. They've got the 12-gallon tank in their car, their lawn tractor, gas cans, etc. They want to save as much money as possible on gasoline.