Supermarket stocks are on trial by securities analysts, and so far the verdict is guilty until proven innocent.
Recently some analysts have been quicker to slash stock ratings on a number of food retail companies.
At first glance that's not surprising given that a wide variety of retailers -- from booksellers to apparel merchants -- are being judged more harshly by the financial community. This follows from a decline in consumer confidence, troubled economy and heightened scrutiny of corporate America in general.
But it would be wrong to assume that food retail stocks are merely the victims of an investment community souring on retailers in general. That's because the problems of supermarkets are greater than just the economy. They are battling in a more competitive environment against Wal-Mart and other price-oriented discounters incorporating food into their assortments.
So analysts are less inhibited about issuing downgrades, even if they must quickly reverse themselves if a company's earnings surprises the Street. Also, there's less reticence about using the once rare "S" word -- sell.
Let's look at some of the recent activity:
J.P. Morgan on Aug. 29 downgraded its rating of Kroger, the largest conventional supermarket retailer, to "market performer" from "buy." The move followed Kroger's cancellation of two industry presentations without reaffirmation of sales and earnings guidance. Analyst Stephen Chick's report stressed the new operating environment for the industry: "Over the last 12 months, with consolidation slowing, it appears the [food retail] group has shown its true colors, as same-store sales have slowed for the group overall."
C L King & Associates' analyst Gary Giblen on Sept. 3 cut Pathmark's rating to "neutral" from "strong buy," citing heightened competition in the New York region. But Merrill Lynch analysts reversed their course on Pathmark by raising the rating to "buy" from "neutral" on Sept. 6 after having lowered the rating just two weeks earlier. The analysts cited a better-than-expected second-quarter earnings report for the about-face.
The two main players in the natural foods retail sector, Whole Foods and Wild Oats, were the victims of recent ratings deflation by Merrill Lynch. Whole Foods was reduced to "hold" from "buy" based on moderating (while still good) comps and reductions in consumer spending. Wild Oats' rating was slashed to "sell" from "neutral" in the face of dilution from an equity offering and because the "valuation looks rich" despite the company's operating turnaround. Merrill said Wild Oats and Whole Foods are two of the food retailing companies that would be the most negatively affected if options were counted as compensation expenses, a growing trend among corporations.
What should supermarkets do if they fear being targeted for a rating cut? They might want to take a page or two from the discount retailers' operating handbook.
Recently, when Merrill Lynch analysts cut ratings on a wide assortment of retailers, it left alone firms including Wal-Mart, Dollar General and Family Dollar, all rated as "buys."
The fact that these low-price specialists escaped the ratings ax speaks volumes about how financial analysts believe consumers will be spending their dollars in the coming months.