Analysts say real sales
growth may return in
the first half
With inflation receding and prices coming down, supermarkets may see real improvement in sales and earnings during the first half of this year, some industry analysts told SN.
That would represent a reversal of fortunes from the trends they experienced during the second half of 2008, when real growth was tough to come by.
During the six months paralleling the second half of the calendar year, total food sales among the top 10 chains with public equity or debt rose 4.8% above levels in the same period of 2007; however, with inflation running as high as 6% during part of that period, actual sales gains were tough to achieve, industry analysts pointed out.
Comparable-store sales during the second half of the year showed supermarket growth slowing, with average increases of just 2% during the July to September quarter — compared with a 3.4% average increase a year earlier — and a 0.7% average increase during the October-to-December period — compared with a 3.5% average increase in the prior year.
Operating income during the second half rose 4.3% among the 10 chains, aided by the uptick in private-label sales.
“Demand was actually slowing during the second half, and while nominal sales picked up 6% in the third quarter, inflation rates of 6.4% brought real growth down to a negative 0.4%,” said Andrew Wolf, managing director at BB&T Capital Markets, Richmond, Va., “and by the fourth quarter, when nominal growth was up only 3%, real growth worsened to negative 3% while inflation remained high at 6%.
“That’s about the same time the economy was squeezing income, consumer confidence and wealth, with inflation pushing food prices higher; pushing supermarket customers to warehouse clubs, dollar stores and supercenters; and pushing many customers to private label.”
Wolf said he believes the fourth quarter may turn out to be the trough in the sales cycle. “For most retailers, the worst experience was in December and January,” he said.
Since then, inflation has fallen to just 1.2%, “so there’s less pricing pressure, which is good for gross margins. And the shift to private label continues uninterrupted, which is also having a positive earnings impact.”
Chuck Cerankosky, an analyst with FTN Equity Capital Markets, Cleveland, said the second half of 2008 was the period when the economy began weakening. “By the middle of that period, consumers were getting concerned, and by the end, they were frightened.
“They started the half thinking about combining shopping trips because of high gas prices and saving money by starting to trade down, but by the end of the year they were reducing the amounts they purchased and skipping some categories altogether.”
Of the 4.8% increase in total sales for the top 10 public chains, Cerankosky said about 3% could be attributed to inflation — less than Wolf had indicated — “while the decline in comps year-over-year and from one quarter to the next reflected consumer concerns and the move to buying less-expensive items, including the big shift to private label.
“Operating profits rose, reflecting that shift, but those increases also showed the chains were more interested in generating cash by passing through inflationary price increases and not necessarily worrying about customer counts or same-store sales.”
Moving into the first half of 2009, Cerankosky said consumers at all levels are trading down — not only in what they buy but also to a degree in where they shop — “so the Wal-Mart customer may be switching to a dollar store or a limited-assortment banner, a Whole Foods customer is switching to Kroger, and a restaurant customer to spending more time at the supermarket — any supermarket.”
Most consumers have already made adjustments to the economy, he noted. “Individual households have a better idea today about their access to credit than they did late last year, and the general scare that may have affected buying decisions in November and December has abated.
“And it’s nice to have an environment in which food inflation is down and the price of gas has stabilized below $3 a gallon, with many consumers feeling better about their employment prospects and spending money more comfortably — though many are continuing to trade down or buying less.”
Bryan Hunt, an analyst with Wachovia Securities, Charlotte, N.C., said there was more happening to supermarket sales than just inflation during the second half of last year, including a serious decline in restaurant patronage and a parallel increase in dining at home, which combined to help strengthen comparable-store sales for supermarkets in the half — “though trading down among consumers, which accelerated as the year progressed, dropped the average ticket late in the year while helping to boost profitability.”
Looking ahead, Hunt said he expects competitive factors to escalate.
“We’re seeing a shift among consumers to trade down to dollar stores, whose same-store sales are increasing in the high single digits, and that’s a trend that could impact supermarkets during the first half of the year as dollar stores, drug stores and restaurants compete more aggressively for the food dollar,” he said.
Karen Short, an analyst with Friedman, Billings, Ramsey & Co., New York, told SN she expects the first half of this year to be tough for supermarket top lines. “While there’s some expectation the environment may improve in the second half of 2009, it’s not yet clear if those expectations are realistic,” she said.
“There will be a drop in LIFO charges, which will affect chains’ earnings results differently. But the stock values won’t go up till top-line results flow to the bottom line, and that’s unlikely to happen this year, though there may be some leveraged growth from cost-cutting by the chains.”
SN asked the analysts about each chain’s individual performance. Their comments follow:
• Kroger Co., Cincinnati, which saw second half sales increase 4.4%; same-store sales, excluding fuel, increase 5.6% in the third quarter and 3.8% in the fourth; and operating income climb 6.1% in the half.
“Kroger remains the best-positioned retailer in the group,” Short said, “because it’s the farthest ahead on price initiatives by a long shot. Realizing that it took Kroger 18 quarters before it began getting traction on its price investments, it’s hard to say how long it will take for the other chains that are just beginning to make that investment — though with consumers more sensitive to pricing right now, it could move faster than it did for Kroger.”
“Kroger’s sales are strong,” Cerankosky said, “because it’s been consistent in executing a value strategy that drives customers — along with some aggressive promotional pricing — and it’s working.”
He said he’s been very impressed with the ability of Kroger to merchandise its stores to each neighborhood, driven by loyalty-card data that comes from its partnership with Dunnhumby, the British- based technology firm. “They look at the whole store, not just at categories.”
He said the solid increase in operating profits reflects the chain’s ability to utilize its strong sales volume to leverage corporate expenses. “Kroger is willing to give up some gross margin to pick up its SG&A [selling, general and administrative expenses] line,” he explained.
For Wolf, Kroger’s sales during the half paralleled the rest of the industry — solid in the third quarter, softer in the fourth — “but they started from a higher base than everyone else,” he pointed out, “because their go-to-market proposition and their well placed price elements proved to be very relevant to consumers in the economic cycle we were in.”
• SAFEWAY, Pleasanton, Calif., whose total sales, including an extra week, rose 3.7%; comps, excluding fuel, rose a modest 0.5% in the third quarter and 0.4% in the fourth; and operating profits for the half were up 1.1%.
Safeway’s results were hurt by two factors beyond its control, Wolf noted — the deflation in fuel prices and the rate of the dollar exchange for its Canadian business.
“But their same-store sales weakened significantly because their go-to-market position is more upscale, with a higher-price image, so they were more susceptible to customer flight,” he noted. “Although Safeway wanted to do better on the top line, it ran its business during the fourth quarter to gain operating profits closer to what Wall Street was expecting,” Cerankosky said. “It was also a little late reacting to the trading-down by consumers, though its strong private-label program helped it keep earnings on track.”
Safeway’s decision to reinvest in price occurred late in the half, Short said, so it may be awhile before a positive impact is felt.
• SUPERVALU, Minneapolis, whose retail sales were flat for the half; comps were down 1.3% in the second quarter and 0.5% in the third; and operating income for the half declined 18.4%.
“The story at Supervalu is that it’s generating cash and paying down debt,” Cerankosky pointed out. “Management has indicated it’s willing to slow down its remodeling program to focus on the balance sheet — and the corollary to that is, the company isn’t trying to drive sales to the extent Kroger or Safeway might, so the results are what they are, with management willing to see operating profits drop.”
He said the flat sales results reflect Supervalu’s focus on cash flow and the balance sheet rather than on market share.
Short offered a similar opinion. “Supervalu is obviously in a more challenged situation, and it’s up against increasing competition from Wal-Mart in markets like Chicago and New England. And it’s also dealing with duplicate merchandising functions as it transitions to a more centralized program.”
• AHOLD USA, Quincy, Mass., which saw sales rise 4.1% for the half; comps rise an estimated 3.4% in the third quarter and 3.7% in the fourth; and operating income climb 33.3%.
Ahold’s results show the effectiveness of its lower pricing programs at Stop & Shop in the Northeast, Wolf pointed out. “It shows that even in this current economy, if you move significantly on pricing, then you’ll get some traction within a year. With consumers more focused on prices — and if a company stays consistent with its program — then you will see the kind of movement Ahold has seen.”
Operating income benefited from comparisons with the big price cuts that occurred in the prior year, Wolf added.
• DELHAIZE AMERICA, Salisbury, N.C., whose sales rose 3.2% during the half; comps rose 2.5% in the third quarter and 2.9% in the fourth; and operating income rose 10% for the second half.
“The whole chain had a good year, particularly Food Lion, which had suffered through a tough second quarter,” Wolf pointed out. “The chain didn’t react to Wal-Mart during the first half, but it began investing in price in the third quarter and got back some sales momentum — and because it had established a price engine by the fourth quarter, it was able to keep that sales momentum going without any additional investment, which also benefited income.”
• WHOLE FOODS MARKET, Austin, Texas, whose sales for the half, which had one less week than the prior year, rose 1.3%; comps were up 0.4% in the company’s fourth quarter and fell 4% in its first quarter; and operating income declined 32.6%.
If Safeway’s sales were hurt because of its upscale image, “then Whole Foods was Safeway on steroids,” Wolf said. “Even Whole Foods’ cross-over customers, who have been at risk as other chains have gotten more involved with natural and organic merchandise, stopped coming, and customers who stayed traded down.”
“Whole Foods is an upscale operator, and this is a tough environment for it to operate in, especially when it’s adding so much new space,” Cerankosky said. “Attracting customers to some of those new stores is a challenge, particularly when many consumers are looking for ways to save money on their food bills by trading down or buying less.”
Short said Whole Foods did reinvest in price during the half to demonstrate more value. “But it was up against very tough comparisons from the prior year, when comps were soaring. And even with Wild Oats in the comp base, which was positive, the trading down by some and the trading away by others hurt sales, while legal expenses [concerning its acquisition of Wild Oats] hurt profitability.”
• A&P, Montvale, N.J., which saw sales climb 70.4% because of the inclusion of Pathmark; comps, including Pathmark, rise an estimated 2.8% in the chain’s second quarter and an estimated 1.1% in its third; and EBITDA grow 49.3% on a pro forma basis.
Integration expenses hurt A&P in its second quarter, Short pointed out — with approximately $20 million in EBITDA — though it showed signs of improving profitability in its third quarter “as it got past the integration issues for some fairly decent results.”
While the Philadelphia Super Fresh stores still had some problems, the rest of the chain did well, Short noted, “though the Pathmarks have not yet reached their potential.”
A&P insisted on lowering Pathmark prices across the board, she added, “though I don’t understand why there’s such a sense of urgency about doing so since consumers still perceive Pathmark as being a low-price operator.”
• WINN-DIXIE STORES, Jacksonville, Fla., whose overall sales rose 1.5% during the second half of calendar 2008; comps rose 3% in the company’s first quarter and 0.2% in its second; and EBITDA was up 54.6%.
Winn-Dixie benefited in the July-September period from hurricane-affected results in the second half of 2007, Short pointed out, while it took its lumps in the October-December quarter from a scaling back of promotional activity. “The company made the decision that there was no benefit to going after cherry-pickers so it stopped offering free turkeys and other big promotions, which hurt sales but preserved gross margin dollars.”
Cerankosky said the numbers indicate Winn- Dixie is doing “pretty well, though it has some big challenges ahead, but for now it’s concentrating on the stores that have better-than-average comps, and those are the ones that are getting capital investments.
“At the same time, the management team has put together a better private-label program, and it’s giving more thought to its promotional positioning.”
• STATER BROS. MARKETS, San Bernardino, Calif., which saw total sales drop 1.9% during the half, which had an extra week; comps rise 1.1% in the company’s fourth quarter and 1.4% in its first; and operating income fall 14.6%.
Hunt said Stater Bros. management declined to pass through all inflationary increases as it focused on growing sales and customer count.
Most Stater Bros. stores are in the San Bernardino- Riverside area of Southern California, which has a very weak economy and one of the highest home foreclosure rates in the U.S., Hunt said. “Yet the chain’s increasing customer counts are a positive sign, indicating that somewhat lower profitability due to an aggressive promotional program and increases in labor pension contributions are unlikely to be serious problems.”
• HARRIS TEETER, Matthews, N.C. — a division of Ruddick Co., Charlotte, N.C. — whose second half sales climbed 6.8%; comps increased 2.2% in the company’s fourth quarter and fell to minus-2.1% in the first; and operating income rose 2.6%.
Second-half results were negatively impacted by the shift of New Year’s into the chain’s January quarter, Short pointed out, “though that impact was only about 0.8%, so comps in the year-end quarter would still not have been positive.”
The gains it had in the half were driven largely by square footage from new stores that are not yet reflected in the comp-store basis, Cerankosky noted, “but Harris Teeter customers are trading down to other stores, and though it still has a good market share and great operations, it’s in a tough market.”
Wolf said Harris Teeter, like Safeway and Whole Foods, suffers from a high-price perception, “so it’s very susceptible in this economy to consumers buying less or switching to a lower-priced store.”
Cerankosky said the rise in operating profits reflects the fact that management pays a lot of attention to generating profit margins “and has become more careful with the aggressiveness of its promotions.”