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Supermarkets Eke Out Gains Amid Inflation

Supermarkets Eke Out Gains Amid Inflation

With a boost from rising inflation and an improving economy, supermarket operators are positioned to continue enjoying slow but steady improvements in financial results that began in the second half of 2010, industry analysts told SN.

With a boost from rising inflation and an improving economy, supermarket operators are positioned to continue enjoying slow but steady improvements in financial results that began in the second half of 2010, industry analysts told SN.

An analysis of the financial results for the 10 largest supermarket chains with public equity or debt indicated that the industry saw some sales gains during the second half of 2010 compared with the second half of 2009, with overall sales up 1.85%, on a weighted basis, from the prior year. Comparable store sales were down an average of 0.36% in the third quarter of the calendar year, but were up 0.94% in the fourth quarter.

Operating income fell an average of 5.4% on a weighted basis for the 10 largest traditional supermarket operators, driven down by double-digit declines at Supervalu, Ahold, A&P and Winn-Dixie.

“The expectation going into the third quarter was that inflation would return and the economy would get better, but we saw none of that,” said Scott Mushkin, an analyst with Jeffries & Co., New York. “Instead, the third quarter was marked by a big deterioration in the competitive environment; and then, as new job growth failed to materialize, supermarkets became more aggressive in their pricing.

“But as the job market got a little bit better in the fall and conditions improved slightly, the competitive environment began to stabilize, particularly as a lot of companies realized that cutting prices was not generating the returns they were hoping for.”

Mushkin said he expects more of the same through the first half of this year, which should lead to improvements in financial results. “Pricing surveys show things have gotten more rational, and consumers are starting to return to more traditional buying patterns,” he explained.

Karen Short, an analyst with BMO Capital Markets, New York, noted that several chains late year indicated that some higher-margin items were moving a bit better, “but that turned out to be mostly a function of higher-end stores, whereas most customer segments were feeling more challenged, especially as gas prices rose.”

She said she sees those trends continuing, with higher-income customers feeling better but most customers seeing little change. “And there’s the potential for a more challenging environment as gas prices continue to rise,” she added.

Bryan Hunt, a high-yield analyst with the Charlotte office of Wells Fargo, said he expects competitive pressures to continue through the first half of 2011, “but with most retailers likely to pass through any price increases, same-store sales should improve on a sequential basis — though those sales will not necessarily fall to the bottom line right away.”

The competitive pressures of last year, which involved triple coupons and buy-one-get-one-free offers, “were dialed back as the year progressed,” he noted. “At the same time the economy started to improve and consumers began to be a little more receptive to higher prices.”

Inflation helped improve sales for most companies during the fourth quarter, Andrew Wolf, managing director for BB&T Capital Markets, Richmond, Va., pointed out, “and it should be even more of a positive factor in the first half of this year.”

He said inflation is likely to continue to have a positive impact on supermarket operators as long as consumers don’t change their shopping patterns. “If consumers maintain their normal ways, then higher prices will mean increasing sales and, over time, increasing profits,” Wolf pointed out.

“However, too much inflation would be a bad thing, and if higher prices force more consumers to switch to alternative formats — which will be raising their prices as well — that could have a very negative impact on supermarkets.”

Gary Giblen, a New York-based analyst, said he’s not sure all companies will actually pass through their increased costs, despite comments from most managements that they intend to do so.

“It’s possible food retailers might have to eat the increases, despite all the rosy prognostications by chain executives about passing through inflationary cost increases,” Giblen said.

“The economic recovery is still fragile enough that consumers could push back on price more than many people expect them to do. It’s also possible some operators will try to gain share for the longer term by absorbing the price increases and intensifying price competition.”

Chuck Cerankosky, an analyst with Cleveland-based Northcoast Research, expressed more optimism about first-half prospects, saying he expects financial results to improve “because we’ll see a measurably better jobs market, with people working more hours, which will mean more income, and that should result in consumers shopping fewer venues, which bodes well for well-placed, well-merchandised and well-priced supermarket operators.”

SN polled analysts on the causes for the financial results each of the 10 chains reported during the second half. Their comments follow:

KROGER CO., Cincinnati, which saw sales for the third and fourth quarters increase 6.6%; identical-store sales rose 2.4% in the third quarter and 3.8% in the fourth; and operating income for the period climbed 9%.

According to Giblen, Kroger has achieved “the holy grail that balances price and margins.”

Wolf said Kroger’s results were trending up during the second half “because it made its price investments earlier than the competition.

“As a result, Kroger is the only one of the major chains that’s been able to take all its price investments and get positive results and grow market share, whereas Safeway and Supervalu had to make investments simply to win back lost share.”

SAFEWAY, Pleasanton, Calif., whose sales in the second half rose 0.2%, while ID sales improved from negative 2.0% in the third quarter to negative 0.8% in the fourth and operating income fell 6.6%.

Short said Safeway’s food sales in the U.S. actually fell approximately 2.5% late in the year, with the company’s overall sales gains resulting from a 23% increase in fuel sales, largely resulting from rising gas prices, and additional benefits from a favorable Canadian exchange rate, while operating income got a boost from property gains.

Wolf said Safeway’s operating income took a hit because of the chain’s heavy investments in lower pricing during the half, “though it did stem the tide and begin to gain back lost market share, and in the second half it was trending back to flat, with the expectation its efforts would have legs and boost sales and profits this year.”

SUPERVALU (retail only), Minneapolis, which saw total sales for the two quarters drop 8.7%; comp sales fall 6.4% in the second quarter and 4.9% in the third; and operating income decline 29.5%.

According to Mushkin, “Pricing is the core issue for Supervalu, and the company is clearly struggling with high price points.”

Progress to correct that situation has been slow, he added, “and the effort to lower prices in the third quarter didn’t work out very well. So Supervalu is continuing to struggle to get prices in line without obliterating operating income.”

Cerankosky also said the second half of the calendar year was a rough period for Supervalu’s retail operation. “Supervalu had weak sales trends, and comp sales were negative again after also being negative in the second half of 2009, which made for a very challenging environment,” he pointed out.

AHOLD USA, Quincy, Mass., which saw sales rise 1.2% in the half; comps increase 1% in the third quarter and 1.9% in the fourth; and operating income decline 28.5%. The company said results for the half were negatively impacted by an extra week in the prior year and losses related to its acquisition of Richmond, Va.-based Ukrop’s at the end of 2009.

That acquisition helped Ahold boost its U.S. sales, Wolf pointed out, “but the company lost profits because it paid a lot and had to invest a lot in price. So operating income took a hit from that deal at the same time the company was trying to maintain market share over earnings.

“Aside from the Ukrop’s situation, the good news is, Ahold’s price-value positioning continued to be good. It halted its market-share losses in the Washington D.C. area by investing in price at Giant Foods, as it’s done — with positive results — at Stop & Shop in New England over the past few years.”

DELHAIZE AMERICA, Salisbury, N.C., whose sales for the half dropped 0.4%, while comps fell 1.8% in the third quarter and 0.8% in the fourth and operating income rose 10%.

Delhaize attempted to maintain earnings at the expense of sales momentum during the half, Wolf pointed out, “though the company has talked about improving pricing.”

Giblen said Delhaize was impacted by serious competition, principally in its Food Lion division from a re-awakened Publix and a more stable Winn-Dixie.

WHOLE FOODS MARKET, Austin, Texas, where overall sales jumped 14.2%; ID sales rose 8.7% in the company’s fourth quarter and 9.1% in the first; and operating income climbed 46.5%.

Whole Foods’ financial results “show the strength of its customer franchise,” Cerankosky said. “I believe Whole Foods benefitted faster than most chains from the economic recovery as its customers benefitted from the recovery of the equity market, which affected their net worth in a positive way, and that’s been reflected in good comps and good traffic at Whole Foods.”

Short said she agreed that Whole Foods has had a lot of success re-gaining lost traffic. “It’s been able to win back many customers it lost in the downturn, and it’s been able to get customers to see the stores through fresh eyes as it has moved away from gourmet back to its root

A&P, Montvale, N.J., which filed for Chapter 11 bankruptcy protection in early December, concurrent with the end of its third quarter. Sales for the half fell 7.8%, while comps fell 6.6% in A&P’s second quarter and 4.9% in the third, and adjusted EBITDA fell 67.6%.

According to Giblen, one of the reasons for the bankruptcy filing was A&P’s inability to get the cost breaks it was seeking from its principal supplier, C&S Wholesale Grocers, Keene, N.H.

“So A&P was forced to sacrifice a lower cost of goods and the ability to be price competitive, and that cost burden and the perpetual operating struggle was reflected in the results,” Giblen explained. “And the acquisition a few years ago of Pathmark, rather than helping to pull A&P up, simply brought Pathmark down.”

WINN-DIXIE STORES, Jacksonville, Fla., where sales for the half fell 0.9%; comps fell 2.8% in the company’s first quarter and 0.3% in the second; and adjusted EBITDA dropped 64.2%.

Winn-Dixie was late to invest in price as it tried to protect earnings, Wolf pointed out — until it saw comp sales drop 5.2% in the spring quarter of 2010. “That’s when it decided to become more aggressive on price and promotions.,” he said. “But it’s a slow process, and while progress has not been great, the share loss is waning.”

The chain got more promotional during the summer quarter, Short noted, “but it didn’t get the sales to offset the investments so it turned out to be a ‘mea culpa’ quarter , which it corrected in the fall with more rational promotions.”

HARRIS TEETER, Matthews, N.C., which saw second-half sales grow 9.3%, comps drop to negative 0.1% in the fourth quarter and rise to positive 2.2% in the first quarter, and operating income rise 9.6%.

According to Mushkin, Harris Teeter tends to attract consumers whose annual incomes run around $70,000 — “better than Winn-Dixie’s demographic but not as high as Whole Foods’ demographic. But the core Harris Teeter customer is going back to work, so results there showed improvement during the second half,” he explained.

For Cerankosky, Harris Teeter responded well to the difficult economy. “With the bulk of its competition — primarily Walmart and Food Lion — competing as price operators, Harris Teeter management appropriately slowed down capital spending and used the money for smart promotions.

“And, despite the cost of a rapid expansion program — with only Whole Foods opening more new stores — it was able to start showing earnings growth again, along with positive comps, by focusing on market share, substantial promotions and a good private-label program.”

STATER BROS. MARKETS, San Bernardino, Calif., where sales for the half fell 4%; comps declined 3.3% in the company’s fourth quarter and 2.3% in the first; and operating income rose 8%.

Stater’s sales decline in the second half resulted from competitive pressures and the weak Southern California economy, Hunt explained.

However, operating income improved because gross margin rose — to 27.1% in the second half of last year, compared with 25.9% in the second half of 2009 — as Stater was able to invest in cost-savings programs and engage in more forward buys because of the new distribution center it opened in 2009, Hunt said.