It’s crunch time for grocery retailers, analysts say

Retail grocery will experience a further shakeout as the effects of the cataclysmic Amazon-Whole Foods merger reverberate across the industry, panelists said at the 23rd annual SN Financial Analysts Roundtable.

Since the August 2017 deal, supermarket chains and other grocery retailers have scrambled to get online grocery shopping, pickup and delivery services under way or quickly ramp up their existing programs. This urgency to “go omnichannel” has pushed operators large and small to figure out how to make the e-commerce investments to compete and adjust their brick-and-mortar space accordingly. In the process, some are also rethinking their business model and go-to-market strategy.

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And the kicker to all of this: Omnichannel economics remain unclear, and not all grocery retail players will be able to adapt, analysts at the roundtable said.

Scott Mushkin, managing director of consumer research at Wolfe Research, described the situation as “Destination Unknown,” after the 1980s pop song.

“We have no idea where we're going. It looks like it's going to be omnichannel. But it's so expensive for home delivery, and no one has solved it,” Mushkin said.

Panelists at this year’s roundtable also included Andrew Wolf, managing director in the equity division at Loop Capital Markets; Christopher Mandeville, equity analyst at Jefferies; and Karen Short, managing director for equity research at Barclays Capital.

Amazon Prime Now has expanded to Whole Foods stores in 53 U.S. cities, while grocery pickup has also been extended to eight markets.

Wolf said Amazon’s announcement early this year that it planned to go national with Prime home delivery through Whole Foods Market triggered swift action by giants Walmart and The Kroger Co., which promptly unveiled their own plans for large-scale rollouts of online grocery delivery.

“I've done a lot of work on the cost of home delivery. And I can tell you, you're just cannibalizing your store base. It’s awful. If you're getting new customers, it's not so bad. But it's not a great thing because it's so expensive,” Loop explained.

“I think that with the cost of home delivery, as it starts to grow, we're going to see how expensive it is for these retailers,” he added.

Conventional supermarket chains will be hard-pressed to balance the changes required in today’s retail grocery environment, Mandeville (left) noted.

“The traditional grocers, specifically, they'll continue to struggle, especially the regional independents that lack scale,” he said. “There's a need to invest in wages for your employees and in your store footprint. And then, of course, you need some type of offering from an online perspective, in which case the only alternative they really have at this juncture is partnering with a third party, which I think poses quite a bit of risk in and of itself.”

Battle at the top: Amazon vs. Walmart

Unsurprisingly, the deep pockets of Amazon (now the world’s second company with a trillion-dollar market capitalization) and Walmart (the world’s largest company by sales) put those two retailers in a league of their own in the online grocery arena. Both are razor-focused on establishing their own e-grocery infrastructures and logistics and have been able to rapidly scale their offerings, putting the pressure on food retail rivals to keep pace.

“Amazon's like an ATM machine. They have so much money to throw at consumables, and they're going to throw it hard. They make money in so many different ways that none of the other retailers do,” Mushkin said.

“They have such a huge scale advantage on last mile,” Wolf pointed out, “that theoretically adding some food, at least you already have some density of delivery, which is obviously the biggest economic factor in making money on delivery.”

Through early October, Amazon Prime Now had expanded to Whole Foods stores in 53 U.S. cities — and counting. Prime Now grocery pickup was extended as well, making it available in eight markets. Amazon’s Prime member benefits program has been integrated at all Whole Foods stores nationwide since late June.

“Part of the reason why they needed that footprint of Whole Foods was to be more adjacent to the customer, to learn from the customer and to get greater insights now that they've got Prime as their loyalty program effectively,” according to Mandeville. “And that's really wherein lies a lot of the risk over the longer term, having the data and the insights on the Whole Foods customer base where you can continue to target them with promotions and drive them into the four walls of Whole Foods, whether it be for perishables or even some type of device of Amazon's.”

So far, there has been little visibility into Whole Foods’ performance since it was acquired by Amazon, making it difficult to accurately gauge the lift from the transaction, he added. “I don't think that necessarily, from a sales perspective, Amazon-Whole Foods has been overly successful. I think it has been more about dictating the game and the narrative with respect to how much all of the incumbents need to invest and how Amazon has AWS [Amazon Web Services] to rely upon in terms of driving profitability.”

Grocery powerhouse Walmart has set a goal of making online grocery delivery available to 40% of U.S. households by the end of this year.

Walmart in recent years has deftly and rapidly shifted its expansion gears from brick-and-mortar to e-commerce. Throwing down the gauntlet to Amazon and large food retail chains, Walmart has set a goal to provide online grocery delivery to 100 metropolitan areas, covering 40% of U.S. households, by the end of 2018 through its own services and third-party providers. The company said it had online grocery delivery in over 50 markets and more than 2,000 grocery pickup locations as of late September.

By the close of its fiscal year at the end of January, Walmart projects that it will have 2,140 grocery pickup sites in 430 markets, covering 69% of U.S. households.

“The other scary monster is Walmart, because they're gaining so much volume share,” Mushkin said. “Walmart, in some ways, is the Amazon of the 2000s, where investors are willing to look through — at least to a degree — all of these investments. That's a big advantage for Walmart,” he explained. “But the scariest thing is that Amazon is not in that position. Their profitability is going through the roof, and they're investing more.”

Kroger works to keep pace

Kroger hasn’t shied away from the moves made by Amazon and Walmart. The nation’s largest supermarket company has begun building its own e-commerce capabilities and spurring the rollout of online grocery pickup and delivery.

“Kroger is, by far, the best of the unionized [supermarket] businesses. Look how well they're doing in comparison [to other grocery chains],” Wolf said, also calling the company “the best adapter” of the big supermarket operators.

In August, Kroger launched its own online grocery delivery service, dubbed Kroger Ship.

In May, Kroger unveiled an exclusive U.S. partnership with U.K.-based online supermarket Ocado. They plan to build three automated e-commerce warehouses this year and identify up to 20 potential sites in the first three years of their pact. Then in August, Kroger launched its own online grocery delivery service, dubbed Kroger Ship, and kicked off a pilot of driverless delivery vehicles in Arizona with technology partner Nuro.

More recently, Kroger and Instacart expanded delivery to another 500 supermarkets, making the service available at more than 1,600 of the retailer’s stores. That built on an expansion in March, at which time Kroger also said it offered ClickList (now Ship) curbside pickup at 1,091 stores, with another 500 locations to be added this year.

Analysts applauded Kroger’s e-commerce efforts but wonder if the company — with solid but slow-growing financial results and besieged by regional competitors — is stuck playing catch-up to Walmart and Amazon in online grocery.

“One of the challenges Kroger has is they compete with Walmart more than anybody. That's true of Aldi, too. And how about Target? Them, too. So they see very significant regional competition, from the likes of H-E-B in Texas. Publix is no shrinking violet either, and they see Publix coming up in core markets in the Carolinas and in Tennessee. And we talked about Hy-Vee,” said Mushkin (left).

“So they're fighting a multifront war. You have to say they're doing a laudable job, but you also have to say, ‘Is this something they're going to be able to win?’” he continued about Kroger, adding, “You have to wonder if we might see some bolder moves from the M&A side because Kroger has a $115 billion in revenues, but do they really have the scale to compete with the likes of Amazon and Walmart?”

Are other supermarkets making the grade?

The second-largest U.S. supermarket retailer, Albertsons Cos., is regrouping after its $24 billion deal to acquire Rite Aid Corp. was called off in August. The transaction would have formed a company with about $83 billion in sales, 4,900 stores and 4,350 pharmacies across 38 states plus meal-kit provider Plated — ostensibly creating the scale to take on bigger players.

Now, Albertsons’ high debt load and underinvestment in its stores and pricing make the retailer a question mark going forward, analysts noted.

“On Albertsons and Rite Aid, it’s hard to say who is worse off. But I think Rite Aid is probably worse off. I don’t know if it’s doable, but the [Rite Aid] shareholders who punted on the deal should probably crawl back because I don’t think there’s another dance partner for Rite Aid,” Wolf said. “They are probably better off together, and it’s hard to say what their future is.”

The termination of the Rite Aid deal also negated another move by Albertsons and private equity owner Cerberus Capital Management to take the retailer public.

“The thing that people have to remember about Albertsons is that there’s still a lot of owned real estate. So as far as Albertsons’ flexibility goes, they definitely have other options from a monetization perspective,” Barclays’ Short said. “I’m not saying that puts Albertsons as a conventional [grocer] in a good position, but it certainly means the company has another arsenal at its disposal to make themselves whole on their original investment,” she added.

Like Albertsons, regional operators Ahold Delhaize USA and Southeastern Grocers are feeling the squeeze on multiple sides: larger competitors boosting their investments in e-commerce and their stores and pricing, fast expansion by hard-discount grocers Aldi and Lidl and strong local chains with loyal customer bases in attractive markets.

“I think a lot of analysts who cover Ahold don’t understand what’s going on in the U.S. in general. I would say their results are fairly weak overall and an indication that they are definitely not gaining share, even if comps aren’t negative,” Short said. 

“Just to take a sidebar, what happens if Kroger decides to pick the Northeast as one of its first locations for Ocado? My guess is that Kroger could probably come in with an Ocado offering and undercut Ahold pretty meaningfully in price,” she explained. “Ahold is one of those retailers on the Eastern seaboard that I would say are ripe for picking for the likes of Lidl. But unfortunately, in some markets, consumers just don’t really have much choice. I don’t see how things get better for Ahold going forward.”

According to Wolf, Ahold Delhaize USA has done a good job upgrading Food Lion stores and runs “highly productive stores” in the Northeast but faces stiff challenges in the marketplace. “They make good money, but they’re under attack,” he said.

Added Mushkin, “Whether they understand it or not, they’re really in for a dogfight to sustain the likes of Stop & Shop, Giant Landover and Giant Carlisle.”

Ahold Delhaize USA hasn’t been resting on its laurels, however. In early October, the company unveiled a $70 million capital plan to upgrade all Stop & Shop stores, including an improved shopping experience. It also hatched plans to launch an urban store format — sized less than 10,000 square feet — through its Giant Food Stores chain in Carlisle, Pa. The company, too, announced that it has remodeled 712 of its 1,030 Food Lion stores over the last four years, most recently in Roanoke, Va.

During the roundtable discussion, Mandeville predicted that Ahold Delhaize USA would soon announce an initiative in automated fulfillment. Lo and behold, as part of the Stop & Shop refresh, the retailer said Peapod online and mobile grocery orders will be assembled by a mini robotic warehouse under a new partnership with Takeoff Technologies.

“They’re not going to sit still and just allow for everyone to eat their lunch,” Mandeville said.

Analysts agreed that Southeastern Grocers, parent of the Winn-Dixie and Bi-Lo, has its work cut out. Although the company exited Chapter 11 bankruptcy quickly and has made strides in relaunching its rewards program and updating Winn-Dixie stores, it lacks the financial resources to invest in pricing, e-commerce and store upgrades to keep up with competitors and has seen its scale dwindle through store closings and selloffs, they said.

“It’s been mismanaged for way too long,” according to Mushkin. “You can underspend cap-ex and overprice for a number of years, but the chickens eventually come home to roost.”

Southeastern Grocers, too, has increasingly come up against Publix Super Markets, which has expanded up the East Coast toward the Carolinas and Virginia. With nearly 1,200 stores, Publix has more than twice as many locations and receives kudos from customers and industry observers for its stores and service. It also has opened the first of several GreenWise Markets, a natural, organic and specialty foods format.

“Southeastern Grocers, Winn-Dixie and Bi-Lo, those are the low sales-productivity guys who never were particularly good. They were just the first guys in their market. Winn-Dixie was an early player in Florida and the same for Bi-Lo in the Carolinas,” Wolf said. “What’s their future? They’re never going to get their sales per square foot up. What do they have to offer?”

Smaller regionals like H-E-B, Wegmans Food Markets and Hy-Vee have more than held their own and steadily enlarged their market areas, analysts said. These chains have differentiated themselves with innovative stores, strong brands, and enticing fresh and prepared food offerings. They’re also regularly cited as among the best grocers in the business.

“They’re going to be just fine. They are very staunch with defending their own market share and regions. Their formats have proven successful. I would imagine that they will also get themselves involved in the likes of automation in some regards,” Mandeville said. “There’s a company, Common Sense Robotics, that is specifically targeting regional operators to provide such services. So there’s a way of defending from an online threat for the H-E-Bs and Wegmans of the world. They’re just purely great merchandisers. Many of them have particularly strong private-label offerings. That brings with it great brand loyalty.”

Other well-established, savvy grocery chains with loyal followings in key markets include Schnucks Markets, Roche Bros. and Market Basket, analysts said. “Ask any one retailer who you probably don’t want to go up against, and it may in fact be WinCo,” Mandeville added.