Retailers are building themselves into trouble

This post is part of the 10 Items or Less blog.

That retail grocery is “overstored” these days is a such a common perception it goes virtually without debate, but how overstored are we really?

According to one recent study, the answer is a quite a bit. And it’s bound to get worse.

Barclays Capital analyzed the top 50 TV markets in the U.S. and found that 38 of them would see food retail square footage growth outpace population growth between 2015 and 2018. These upside-down locations include perceived hot growth markets like Denver (which is seeing 2.1% population growth but projected 2.7% retail square footage growth); Austin, Texas (3% population growth, but 4.8% retail square footage growth); and Tampa-St. Petersburg, Fla. (1.8% population growth, 4.1% square footage growth).

More favorable markets include a mix of fast growing cities like Las Vegas, projected for 2.1% population growth but a 6.5% drop in retail square footage, and markets like Cleveland, where stores are going away even faster (-4.9%) than the populations are declining (-0.1%).

Where do you least want to be? So-called “Rust Belt” cities like Buffalo, N.Y., Grand Rapids, Mich., and Milwaukee are among the most unfavorable, with slow growing populations, fast-growing store bases and heavy penetration by discounters.

“To state the obvious,” analyst Karen Short, who authored the report said, “markets that become less saturated (i.e.: population is growing faster than square footage) are the most attractive markets because they have more capacity to support growth, while markets that become more saturated are less attractive given that there are fewer opportunities to increase square footage without increasing the competitive dynamics of the market, and likely reducing the returns.”

Short noted that returns on invested capital among food retailers are already declining industrywide, leading to recent decisions by companies like Walmart and Sprouts to reel in their typical building pace.

Data source: Barclays Research, Metro Market Studies

Others it would seem came out of the recession with a pent-up confidence to bet on winning battles in the more competitive markets they’ve been creating. From 2013 to 2015, retail square footage grew at a compound annual growth rate of 1.5%, while overall populations grew by 1%, the study said. From 2010 to 2013, population grew at the same 1% rate, but retail square footage lagged slightly, at 0.8%.

“Perhaps not coincidentally, the 2010-2013 period was a healthy, robust era for conventional food retailers,” Short noted.

Looking at a group of publicly traded retailers, Barclays noted that only Smart & Final, and to a lesser extent, Costco and Sprouts, could justify unit growth based on their exposure to the 12 markets expected to be less saturated by 2018. Healthy growth will be less easy to come by for those with a majority of their stores in the 38 more saturated markets. While still unfavorable, Sprouts, Costco, Whole Foods, Target and Walmart are better positioned than Sam’s Club, Kroger, Spartan Stores and Natural Grocers, the study indicated. The latter company, Short said, should “significantly” slow unit growth given the high saturation levels of its existing markets.

E-commerce, which the report estimated would grow at a 23% annual growth rate from 2015 to 2020 and a 19.5% rate from 2020-2025, will exert still more pressure. “Using very realistic assumptions, it is feasible that sales will begin to decline on a year-over-year basis for traditional bricks-and-mortar food and consumable retailers within the next 10 years,” Short said.

Large, dense markets are most at risk in e-commerce intrusion, she added, “and if already saturated, could experience the perfect storm.”

This supports the notion espoused by many analysts that retailers need to figure out their own e-commerce strategies right away, while making sure their physical plants are in shape.

“What I would look for is, who has not kept their box in good working order?” Mark Thompson, managing director of Crossman & Co., a real estate service firm in Orlando, Fla., said. “You cannot have an antiquated store and expect not to get blown out of the water. If your store is antiquated, you’re toast.”