Strong pandemic response and sales drive supermarket renaissance

Supermarkets showed their mettle as primary food shopping destinations during the coronavirus pandemic and stand to emerge from the crisis in a stronger competitive position, panelists said at the 25th annual SN Financial Analysts Roundtable.

With consumers looking to reduce their COVID-19 exposure via fewer shopping trips and store visits, the local market provided a safe haven for purchasing groceries and key supplies, according to analysts. Conventional supermarkets benefited as food shopping occasions that might have included multiple trips — perhaps to a warehouse club, mass merchant, discount grocer, specialty retailer and/or dollar store — were consolidated into a visit to the neighborhood grocery store.

What’s more, analysts said, supermarkets proved adept at rapidly launching or expanding online grocery shopping, delivery and pickup services to cater to customers averse to coming into the store.

“Supermarkets moved very quickly to put in safety protocols. We’ve been doing some extensive consumer surveying — we call it the ‘comfort index’ — and the consumer is by far the most comfortable going to a grocery retailer,” said Scott Mushkin, founder and CEO of R5 Capital. “They’ve done an outstanding job. That’s part of what we call the ‘supermarket renaissance,’ where, especially for younger shoppers that maybe were going to five or six different venues, all of a sudden they find the one-stop shop more appealing. The traditional grocery store, we think, is going to come out of the pandemic a lot greater.”

Related:It’s a new scene for grocery shopping as pandemic changes behaviors

Analysts participating in SN’s 2020 roundtable also included Robert Ohmes, managing director of food and discount retail at BofA Global Research; Rupesh Parikh, managing director and senior analyst for food, grocery and consumer products at Oppenheimer & Co.; and Robert Moskow, senior analyst for packaged food and food retail at Credit Suisse Equity Research.

Rapid Response

The roundtable analysts agreed that, as COVID-19 cases surged in many parts of the country early in the pandemic, grocery retailers acted decisively to enact comprehensive safety measures in stores and facilities. Efforts included deeper cleaning, sanitization of high-touch areas, plexiglass barriers, social distancing indicators, distribution of personal protective equipment (PPE), customer capacity restrictions, and hiring more workers (including from other industries) to help clean and stock stores.

“I thought the companies did a really great job right away. They implemented limits on the number of the people in stores. There really isn’t anybody that I thought didn’t do a good job of meeting guidelines,” BofA’s Ohmes said. “What was interesting about the way they approached the pandemic was the retailers that had the highest volumes during the stock-up phase probably were the most negatively impacted from the social distancing they implemented and were willing to do that and sort of cramp traffic.”

Related:Grocery shoppers shift to less-expensive brands amid pandemic

As COVID-19 cases surged in many parts of the country early in the pandemic, grocery retailers acted decisively to enact comprehensive safety measures in stores and facilities.

Retailers and CPG suppliers also worked hard to shore up inventory and supply. Oppenheimer’s Parikh noted that decisions to put limits on high-demand products and reach across industry segments paid dividends.

“The grocers did quite well. I think the club channel was probably the best out of the entire food retail landscape. Look at Costco. They were able to procure alternative supply fairly quickly. The area that food retailers in general did well with were limits. They learned early on when they did not place limits on a number of products,” he explained. “If you look at the meat category as an example, by placing limits on meat, they were able to get supply and demand in the right balance fairly quickly. That was a real positive change throughout the pandemic.

“And the food suppliers did a good job of focusing on their core SKUs,” he added. “That helped to better meet the demand out there and increase overall production. Companies have also done a good job of shifting some of their capacity from foodservice over to retail. So that’s been quite helpful in being able to meet demand.”

On the packaged foods side, grocery retailers saw “more spotty incidents of shortages,” said Credit Suisse’s Moskow, who pointed out that pandemic-triggered demand spikes from stockpiling shoppers caught suppliers off guard.

“It was exacerbated by the fact that a lot of these food companies, especially in soup, had been cutting capacity for several years in response to declining demand for their categories. And this caught them unawares or by surprise,” he said. “They’re just now starting to re-establish a lot of the SKUs they had to cut in order to be able to efficiently meet consumer demand. I think you’ll still see spottiness in terms of shortages across multiple categories. But the most interesting thing is that a lot of these categories that had been left for dead are now seeing stronger demand and probably will continue to be at an elevated level for the next year.”

Comeback for Promotions?

Amid the flood of panic-buying grocery shoppers in the pandemic’s early months, supermarkets and other grocery retailers were quick to phase out most promotions to avoid aggravating the supply crunch. Though this hoisted food pricing for consumers, analysts differed on where retailers will stand on the promotions front in 2021.

“Everybody scaled back on promos simply by not using coupons or running two-for-ones and things like that. It created unbelievable inflation in food retail, which is still happening now. The promos and the Nielsen data are tracking down pretty dramatically versus last year,” Ohmes said. “And it looks like the high-low grocers are probably seeing the most item inflation, supporting their same-store sales. From what we’re looking at, the EDLP players saw a lot less of that inflation. So it’s going to be interesting when we anniversary that process next year. The lack of promos was because you really didn’t have the stock levels to justify the promotion. You didn’t have the things to promote. But that’s been a huge driver to same-store sales and to profitability as well.”

According to Nielsen, consumers paid 3.5 percentage points more in September for the same popular grocery items than they did a year earlier. The market researcher attributed the higher pricing mainly to fewer promotional offers being extended to shoppers. As of the end of September, 25.9% of U.S. grocery units were sold on promotion, down from the national average of 31.4%. Nielsen reported that units sold on promotion were down in grocery, frozen and household categories, with meat recently seeing a resurgence but still lower versus pre-COVID levels.

“There’s just been this huge delta between what’s gone on in the high-low grocers and what’s gone on at EDLP [retailers] because of this dynamic. And what's amazing is the price spreads with Walmart are just blown out, but it hasn’t led to Walmart picking up volume,” Mushkin said. “Volumes are likely going to exit the pandemic a little higher for a lot of the CPG companies. But I’m not sure you’re going to see promos the way we did going in.”

Parikh, however, sees potential for a more promotional grocery sales environment.

“If you go back to the last downturn in 2009, as you lapped some of the strong inflation, some of the grocers got more promotional. The risk next year is that as you lap all the inflation that you have this year, grocers will start to see negative growth. Right now, given the strong demand and supply constraints out there, it’s hard to promote. But I actually think that coming out of this, it could become even more promotional,” he said.

“Look at grocery versus restaurants. There’s no capacity that exited the industry. If anything, you’ve added a lot of online capacity. So you’re going to have a much more competitive backdrop coming out of this,” Parikh noted. “I would think by early next year, once you start to get supply in categories, it will again start to normalize.”

Pressure on grocery retailers to rekindle promotions also will depend on how they see themselves positioned in a marketplace still influenced by the COVID-19 crisis.

“As long as the grocery retailers feel comfortable with how they’re priced against hard discounters or e-commerce competitors, and against each other, we’ll see a normal promotional environment and maybe even a little more benign than normal based on supply constraints,” Moskow said. “Certainly, the food vendors I speak to have no interest in returning to a hyper-promotional volume grab in most categories.”

E-commerce Acceleration

The explosion in the use of online services — shopping, delivery and curbside pickup — following the coronavirus outbreak signals a sea change for grocery retail, according to the roundtable analysts.

Consumers’ shift to online purchases pushed grocery retailers to quickly launch or expand their e-commerce offerings, and the trend continues to fuel triple-digit digital sales gains at many chains. The result: What was once deemed an incremental business has transformed into a core strategy, as the pandemic has revealed U.S. shoppers’ preference for an omnichannel approach.

“Retailers were very rapid to institute online offerings, whether it was just signing up with Instacart or doing more on the pickup front. Generally, we saw the biggest growth in pickup. If you look before COVID-19, the pickup numbers were pretty strong at Walmart, Target got more aggressive in pickup, and you saw it more in grocery stores. You can see that pickup is the biggest driver of online growth on a percentage basis. It’s the biggest part of their digital grocery business,” Ohmes said. “I’m expecting that to remain important. Consumers have gotten pretty used to pickup and like it a lot. And if they can get general merchandise with their groceries, they like that, too. A lot of retailers have been saying this [pandemic] really accelerated the goals they already had in terms of driving pickup, which is way more profitable than delivery.”

Brick-and-mortar consolidation won’t be a likely consequence of the supercharged e-commerce growth, but the industry will see greater adoption of online fulfillment models like “dark stores,” such as this Whole Foods in Brooklyn.

Retailers also have made online grocery services more attractive to consumers who might be hesitant to visit stores because of the virus.

“The other big positive, at least from the grocers’ side, and even Amazon, is the value they’re giving consumers with some of their offers. Kroger and Albertsons went to free click-and-collect. I think that was a very big deal. If that continues, it really changes the dynamics going forward. And with Amazon, free two-hour delivery is another big deal for consumers,” said Parikh. “So the value that grocery retailers and Amazon are offering on delivery and pickup has been incredible. We’ve seen in recent months that online has remained quite strong. You’re still seeing triple-digit growth out there. That bodes well for the future of online in the sustainability of some of the gains we’ve seen.”

Ohmes expects online grocery penetration to remain elevated. He said recent Bank of America card payment data shows grocery online spending “still running above 10%,” whereas online penetration “has dropped back to single-digit levels” at other retail segments like department and apparel stores.

“I think we’re going to see higher online grocery penetration,” added Mushkin. “If you look at some of our data going into the pandemic, about 15% of the people had tried delivery or pickup, another about 20% wanted to. Those numbers are so far off now. We now have about 20% to 25% have tried and almost another 25% would like to. You’re talking about 50%. That doesn’t mean all the sales will go to this channel, just that the interest in pickup and delivery is sky high.”

Brick-and-mortar consolidation won’t be a likely consequence of the supercharged e-commerce growth, but the industry will see greater adoption of online fulfillment models like “dark stores,” Moskow said.

“Getting to 10% in penetration for online, I think that’s pretty much done, and it’s very sticky. The question is, will it get to 20%? And if it does get to 20%, is the grocery industry ready for that?” he said. “It seems like we’re still in the very early stages of testing different methods of fulfillment. There’s Ocado out there, which is a central fulfillment center, and then there are the microfulfillment centers and all kinds of different methods for last-mile delivery.”

Consumers’ shift to online purchases pushed grocery retailers to quickly launch or expand their e-commerce offerings, including delivery and curbside pickup.

Retailers already have been rethinking the online grocery profit equation as they’ve planned for more capacity, said Mushkin. “It has become such a big business now that it’s going to force profit discipline on the industry. These companies can’t lose money on 15% of their business. It makes no sense, and that goes for the Walmarts of the world and everybody else. So I think this will improve the economics faster, because it has gotten so big so quickly. Consumers truly want omnichannel — they want to be able to have it delivered to their home, they want to be able to pick it up and they want to be able to go into the store.”

Is Food at Home Here to Stay?

Looking ahead, grocery retailers and suppliers face some turbulence next year in the form of difficult year-over-year comparisons as they cycle the booming sales gains ignited by the panic buying early in the pandemic.

“From an investor perspective, it’s kind of tough buying grocery stocks right now. You’re facing much tougher comparisons in 2021,” Moskow said. “The speed for which people regain consumer mobility is a real question mark, and the commercialization of a [COVID-19] vaccine is a real question mark. Most investors I speak to are staying on the sidelines on the sector as a result. That’s kind of what Wall Street is thinking.”

Sales growth has begun to moderate in recent months, as more public venues and businesses — notably dine-in restaurants — have reopened, according to analysts. And while supermarkets have clearly benefited from food inflation and customers seeking close-to-home, one-stop grocery shopping, mass merchants could see more upside coming out of the pandemic, they said.

“The retailers that sell general merchandise in addition to food look like they may be in a better position going forward because the grocery spending continues to slow and restaurant spending keeps improving. General merchandise spending is really strong right now, and I think the market is properly anticipating continued improving momentum for discretionary retailers, relative to consumer-staples retailers. That is what’s playing out so far,” Ohmes said.

“There’s risk to that if you get resurgence of the virus, with colder weather,” he added. “That could push back to the supermarkets. But I would also put Walmart, Target and the warehouse clubs, BJ’s and Costco, as potentially benefiting more than the market expects from the fact that they sell food-at-home and seem to be in the sweet spot on general merchandise.”

Retailers have begun reopening service areas of the stores, albeit with new, added protections for customers and workers alike.

Much will hinge on how consumer food-at-home versus food-away-from-home spending pans out. Headlines across the media spectrum highlighted how millions of U.S. households “rediscovered” cooking at home and sharing a family meal during the pandemic, with many consumers — notably younger Americans — learning how to cook and experimenting in the kitchen. Those trends were borne out by surging growth in grocery retail sales.

Yet, after months at home during the crisis, cooking-it-yourself fatigue could be setting in, noted Parikh. “Coming out of the pandemic, there’s very much a possibility that you see this pent-up demand for eating out. I agree there could be more at-home occasions, but you also have the reality of pent-up demand out there. So it may not be as much of a boom for grocers,” he said.

The indoor lifestyle also may be getting to consumers. “If you look at the occasions for eating out like travel, leisure, conventions, etc., when you get all that back, that also leads to increased food-away-from-home spending,” Parikh added. “So it’s not only the restaurant part of it, but it’s also just being able to go out.”

Food-away-from home spending has taken share from food-at-home expenditures for decades, with the split at about 55% to 45%, respectively, before the pandemic, Mushkin explained. Consumer stockpiling behavior during the COVID-19 crisis shifted the split to 45/55 — and at one point to 40/60 — in favor of food-at-home, he said, adding that many Americans under 40 went to the grocery store for the first time and liked the experience, including the omnichannel options. Meanwhile, pricing at recently reopened sit-down restaurants has trended up, and some consumers — particularly older Americans — might still be wary about dining out. And indeed, a recent surge in coronavirus cases nationwide may lead to more restaurant closings or limited options.

“Are we going to exit the pandemic with more food-at-home occasions?” Mushkin said. “If you put some numbers to that, and if you think there are two more food-at-home occasions per household, per week, it’s not a huge stretch. If you bring that to Kroger’s numbers, you’re looking at a company exiting the pandemic with someplace between $250 million to $500 million more in embedded EBIT. All else being equal, obviously no margin destruction there. So this could be a very significant event for the traditional grocery industry, if we indeed get more food-at-home occasions exiting the pandemic.”

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