Aldi's on point, Walmart's not: Part three of SN's roundtable series

Aldi is on trend and beginning to resonate more with consumers while Walmart is missing key trends and resonating less, according to participants in SN’s 20th annual Analysts Roundtable. What follows is the text for the third part of the discussion.

SN: There are more and more small discount stores opening, particularly Aldi and, soon, Lidl. How will the supermarket industry deal with those?

Meredith Adler, managing director, Barclays Capital: It’s just amazing how much customers like Aldi. Its success is clearly about price while not disappointing people on quality. I think its produce is really limited, and if you really like to cook and if you like to cook interesting foods, you’re not going to go to Aldi to shop for ingredients. But what it has is high quality and an amazing value, and there's a market for that.

Scott Mushkin, managing director, Wolfe Capital: I think Aldi is an operator that offers extreme value, and I see it as more of a threat to the discounters than to traditional supermarkets.

Meredith Adler

: I agree that Aldi is a problem for conventional grocers because it’s also partly a convenience shop. It's a format that would appeal to the same people who would go to a Kroger or any other store on a convenience basis, or a drug store or any other store that’s more convenient than a supercenter.

Bill Kirk, analyst for RBC Capital: And since the stores are smaller, Aldi can get closer to the customer than a 70,000-square-foot conventional store can.

Adler: But in a lot of markets, the real estate where people live is already taken, and there are a lot of zoning regulations. Lidl is talking about opening 30,000-square-foot stores. That’s going to be a hard box to find, especially if it wants to be close to where people live. That’s one of the reasons you don’t have a lot of these entrants in established markets.

Mushkin: I think it’s fascinating to see the way Aldi merchandises and prices. It’s all about private label, including really on-trend offerings like Simple Nature. Walmart is approximately 29% above Aldi on price, according to our recent pricing survey in Connecticut. We were just stunned by those results.

Adler: Aldi has a lot of brand names as well — maybe almost too many names.

Mushkin: We were surprised that Aldi was way more on trend than Walmart, and they're both going after the same customer.

Adler: Based on surveys we’ve seen, the customer view of Aldi is way more positive than you would expect, with quality rated pretty high. The only real criticism is sometimes service, though that seems to be for individual stores only. But it is really remarkable, given how low the prices are. And it isn’t just a matter of price making up for everything else.

Mushkin: Aldi goes right into Walmart country, with a lot of development in the South.

Bill Kirk

: And its standards are pretty good, and it’s improved them. The same with Trader Joe’s. Trader Joe’s used to legitimately get slammed by Whole Foods for having non-organics and products with GMO’s in them that were made by the big CPG companies. Take an item like private label Spaghetti-O's, which I buy for my kids. It was gone for two months, and when it came back, it was organic and Trader Joe’s didn’t raise the price. I think it’s done that across its product portfolio. So companies that are trying to get on trend know what to do and how to take care of the customer. It's Marketing 101 — listen to your customer.

Kirk: It’s going to be interesting to see what Aldi does as it expands to Southern California — to see whether it takes into account the fact it’s way more expensive to operate out there.

Adler: Doesn’t it just have to be lower-priced relative to the competition? That isn’t hard to do, given Aldi’s business model. I still am shocked that Walmart didn’t do better in California.

Walmart

SN: What’s going on with Walmart?

Mushkin: One problem Walmart’s having now is a lack of follow-through. It wanted to get better in fresh so it did a meat initiative for nine months and then forgot about it. It wanted to go into California and it didn’t get it exactly right, though it was getting there, and now it’s not doing it anymore. There’s just not much follow-through. Right now Walmart has flat-lined on comps. It was once the big, feared evil, but it has not been resonating in this current economy and Kroger, which has adapted and used data to its advantage and made price investments, is certainly resonating.

Mushkin: Walmart’s price gaps have narrowed, and it doesn’t do fresh well at all.

Mark Wiltamuth

: And store standards have gone down.

Mushkin: And it doesn’t do local well.

Wolf: Every time I go into Walmart now, I realize it's doing what the supermarkets did when they were struggling with comps — taking out labor, which is exactly the wrong thing. It's like Walmart is saying, “Hey, we’ve got to make our P&L, so let’s make these stores even less appealing by figuring out how to take out more and more labor.” As a result, Walmart has become an even worse shopping experience than it was. Nobody wants a bad shopping experience, not even the people who are kind of stuck shopping at Walmart, and it’s losing traffic.

Adler: Walmart has no culture of service, no culture of selling.

Mushkin: And no culture of fresh. You’re not going to Walmart for meal inspiration — you’re going there strictly for price. Walmart lacks all these things we've ticked off that are important to grocery shoppers these days, especially fresh foods.

And although it does carry Wild Oats organics, it's not like similar offerings at other companies, such as Simple Truth at Kroger or Simply Balanced at Target. There were only 10 Wild Oats items at a Walmart we looked at in Southern Connecticut, compared with 110 available on the internet and something like 500 at Kroger and over 300 at Target. Walmart is just really off track.

Mark Wiltamuth, managing director for Jefferies & Co.: We did some consumer surveys that indicated Walmart wasn’t really showing up in the consumer’s decision-making set for purchasing natural and organic — it just was not even considered — and that says something right there.

Wolf: What I’m saying is the standards in the Walmart Supercenters have really declined in the last two or three years. The stores used to look okay, and they were on a positive trend for awhile when the company was trying to make them better — and it actually somewhat got there, uncluttering the front end a little bit. And though it didn’t work out, at least the concept of having a more presentable store was a good idea. Now the stores have really gone downhill. It’s got to be the result of cutting labor to try to make a P&L where you don’t have good customer traffic, especially when you can’t raise prices.

SN: Walmart would tell you the exact opposite. It would say it’s changing the structure of how it operates the stores to put more employees on the floor.

Mushkin: Walmart says a lot of things. It said it’s been doing a little bit better in fresh, and I think that’s true, but when you start poking at it, it’s also been rationalizing fresh and taking out some SKU's. So you have a 180,000- or a 190,000-square-foot supercenter with less than 10% of the space dedicated to fresh items, and if you compare that to an H-E-B across the street from a supercenter in Texas and you look at fresh versus fresh, you can’t compare them. And H-E-B is priced with Walmart on the Cheerios and Oreos. So it’s amazing to me sometimes that its comps aren’t worse when you look at the trend.

Kelly Bania

: I agree. If you think about how it’s doing in fresh and how it’s doing with Neighborhood Markets, you would think Walmart should be comping well, which kind of tells you that supercenter comps, the core of the store, must really be negative — assuming all the other things are working well.

Adler: I find it interesting that dry grocery has been really soft, which I think is just a reflection of what’s going on in the entire industry.

Mushkin: It’s the CPG malaise. The packaged-food companies are viewed as the wrong trend for the consumer who’s focused on health and the desire for a simpler ingredient list.

Adler: But Walmart’s sales are tied to the economic conditions of a large part of the population. Maybe it could buck the trend, but it’s so big.

SN: Do you see any signs yet that the higher wages and the training initiatives underway at Walmart are going to have any kind of impact on the stores?

Adler: I think that’s the kind of thing that takes a really long time. What I hear is, Walmart has taken a lot of labor hours out of the store, but it's not clear right now that it’s putting much in the way of labor hours back in. It’s raising wages, but it’s also asking people to do more. It also said it was going to add 8,000 new department-head positions and re-assign some other store associates to that role. Still, with 3,300 supercenters and multiple departments, that's not a lot of people. Most of us would say more department managers make sense, but Walmart is not even doing that fully. Is it just 8,000 this year and then another 8,000?

Mushkin: It's on a net basis, and it’s re-purposing some people. We do have concerns that turning around Walmart may be much harder than we realized. We used to think there was a path for Walmart to turn itself around more quickly by focusing on the supercenters, stopping the madness with the small boxes and the e-commerce and the spending it’s doing there, and slimming down international. But the more we look at consumer trends in the U.S. and what the woman shopper wants, the more out of step we feel Walmart is.

For example, I was in a cereal aisle at a Walmart in Houston thinking cereal is in decline, and here’s Walmart with an aisle and a half of cereal. So with sales of branded packaged goods declining — and those are your main traffic drivers — your space allocation and merchandising appear off.

Adler: And to change the space takes labor, and it takes labor away from serving customers.

Mushkin: Walmart has no expertise in fresh, and it’s so out of step that it’s going to be hard to fix. It’s lucky comps are positive, and barring a steep economic downturn, we believe supercenter traffic is going down, and comps will be hard-pressed to be positive over the medium term.

Adler: I believe the management team there is being realistic — that they get it. That does not mean the company can execute. I thought the scariest thing management said recently was that Walmart needs to be more innovative and take more risks, yet at senior management meetings nobody will bring up a new idea until they check with everybody before the meetings start. That's going to make it very hard to change anything. I think Doug [McMillon, Walmart’s CEO] gets it. But I think the company doesn’t really want to spend the money to change how it operates and meets customer needs.

Andrew Wolf

: It’s very hard to cut price in that environment.

Adler: And very hard to add more labor hours.

Mushkin: I think if you look at the ecosystem of a supercenter, it was built on ubiquitous packaged goods being priced below everybody else to drive general merchandise. Now all of a sudden your branded packaged food is probably not even cheaper anymore.

Wolf: It’s cheaper than most companies. But it's cheaper on items that matter less.

Adler: Traffic to the food section used to drive sales of general merchandise, which subsidized the prices on food, but traffic remains pretty weak.

Mushkin: But the whole thing starts to unwind if you can’t get shoppers in because your traffic driver is breaking down and sputtering. So with a slow-turning item like a battery, the supercenter guy running the department may not stock it, and then you have an out-of-stock while at the same time you have too many fast-turning soft lines. So the whole thing just starts to really come unglued if you lose your traffic driver, which we think is what's happening.

Wolf: When Eduardo Castro-Wright was there, I thought he was on to the right idea, which was to make the stores nicer — to make the whole store experience closer to Target. Walmart is never going to be a Target, but it needs to close that gap so it can keep its customers, though that doesn’t solve the merchandising issues with food. Walmart probably never thought it would come to this — that the demand for major branded cereals and beverages and other products would ever go down. It’s obvious the stores are not built for that. It’s sort of like the Whole Foods thing with 365 — you’re asking the company to perform a trick it doesn’t necessarily know.

Labor investments

SN: Do you see any signs that paying its people more and offering more training is having any kind of impact on Walmart’s sales?

Wolf: I think the company is on the right track. But food, the main driver in the supercenter, is not a loss leader — it's simply the wrong merchandise. And Walmart apparently doesn’t know how to re-merchandise that store, which is true for a lot of supermarkets too. It’s not like every supermarket out there is kicking it either. I mean, how many supermarkets other than Kroger have said they're up in the grocery aisle, even with branded goods? Kroger is the exception.

Bania: I think the timeline for expecting to see some noticeable improvement by the holidays at Walmart is very aggressive. I think this could be something it talks about for years.

Scott Mushkin

: I also think it’s got a brand problem. Given what’s going on with the employment markets, the middle class definitely wants to trade up. We did a survey of Target shoppers, and one of the major reasons people like Target so much, they said, is that it’s not Walmart.

You asked if we’re going to see any improvement at Walmart? We think traffic is going to go negative and stay negative. The economy is too strong for Walmart right now, so a trade down is probably not happening. It’s actually the reverse. Walmart was saying back in 2006 and 2007 that its growth consumer was someone making $75,000 a year and up. But I would say that group is the No. 1 traffic decliner right now because there are so many choices available that have the same prices with a much better shopping experience.

Wolf: The market is competitive, and Walmart has just sat on its laurels. So even if you say it still wins on price — because it does, generally — the stores have gotten worse and there's been no change in merchandising. And when you take hours out, everything gets worse. We used to call that a death spiral, and that usually started by having lousy pricing, which would be the reason people didn’t go to the store. It would be insane to say Walmart’s in a death spiral, but certainly getting its trends going is going to take a lot of money — not to invest in price but in the other attributes of demand that are lacking.

Adler: I have a question — how risky would it really be for Walmart to give up competing with Amazon? So much money is being poured down that black hole.

Mushkin: We think what Walmart is doing to compete with Amazon is crazy. As we’ve said, the idea of consumables delivered to your home is still a very unproven business model, and people complain about Amazon’s pricing not being realistic on consumables, but Wal-Mart's pricing is worse.

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Adler: It’s not doing much, but even on the general merchandise side, it’s trying to compete with Amazon. Can it afford not to compete?

Mushkin: I think the better question is, can it afford to compete? It would be much better off driving people to its Supercenters and figuring out ways to make those assets more productive rather than destroying them, which is effectively what it’s doing with e-commerce and the small box. You have an incredibly high-return asset that you’re letting atrophy, and you’re replacing it with an unproven business model.

Wolf: But click-and-collect is a win/win. If the store doesn’t carry an item, Walmart ships it to the store, and if you don’t like it, you return it to the store. That works, and that's why Kroger is going after click-and-collect.

In the final roundtable installment, the analysts discuss e-commerce, industry consolidation and a variety of chains and independents.

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