Only a handful of industry stocks have shown gains in their share prices in 2010, as the faint glimpses of economic recovery have so far only been a tease and retailers battled to retain customers.
Many of the food retailing and wholesaling stocks tracked by SN have had a slightly better year than the stock market overall, however, after the industry had trailed both the Dow Jones and S&P 500 indices in 2009.
“Things haven't gotten any better — they've just stopped getting worse, and the stocks haven't gotten any better,” said Andrew Wolf, a Richmond, Va.-based analyst with BB&T Capital Markets, who forecast that industry stocks could begin gaining ground in the second half of the year and into 2011.
Through June 30, only nine of the 22 North American food retailing and wholesaling stocks tracked by SN showed a gain in share price, led by Austin, Texas-based Whole Foods Market , which was up just over 31% for the year-to-date, to $36.02.
Of the remaining eight stocks that showed gains in the first six months of the year, four of them were Canadian stocks — Loblaw Cos. , Metro Inc. , Empire and Northwest Cos. — which benefited from a strong Canadian dollar and a more retail-friendly economic environment (see sidebar, Page 14).
Most of the stocks that lost value, however, were within range of the market overall.
The SN Composite Index, a weighted average of all 22 stocks compiled by Data Network, Huntington, N.Y., showed a decline of 6.28% for the first six months — almost identical to the 6.27% decline of the Dow Jones Industrial Average, and better than the S&P 500 Index, which was down by 7.57% for the year.
In 2009, amid a strong stock market recovery, the SN Composite Index inched up by barely more than 1% as the industry struggled with deflationary food costs and a margin squeeze brought on by pressure to drive sales growth.
So far this year, sales growth has begun to return, but for some, margins remained under pressure.
Wolf said his analysis of sales growth among food retailers showed nominal sales growth of 2.6% through May, after rising only 0.6% in 2009, and real sales growth — adjusted for inflation — of 1.8%, compared with a decline of 1.2% in 2009.
“Both nominal and real sales growth have recovered, and that's a proxy for customers,” Wolf said. “So customers are coming back to the channel. That's the good news. The bad news is that it took continued investment in gross margin, which took earnings down, to get that market share back.”
Pleasanton, Calif.-based Safeway , for example, said during its first-quarter earnings conference call in April that it had expected earnings to be under pressure in the first half of 2010 as the company sought to bring prices in line with competitors in order to drive sales.
“We accelerated our price investments in the second half of 2009 so we could end the year at price parity with our conventional competition, and it's like lowering the water level in a glass; that now has to play out in the first couple of quarters of 2010, which it in fact is doing,” said Steve Burd, chairman, president and chief executive officer. “And in essence, that puts downward pressure on gross margin in the first half of 2010.”
The earnings report, which included a 3.1% decline in first-quarter identical-store sales, also appeared to put downward pressure on Safeway's stock price, as shares slid by more than 20% since then. Year-to-date, the stock has lost less than 8% of its value, to $19.66, after starting the year at $21.29 and enjoying a considerable run-up before its first-quarter earnings report.
“It was unfathomable why Safeway was going up to $26 in the first place,” said Gary Giblen, an analyst with Quint-Miller, New York.
One possible explanation — other than simple investor faith in Burd's abilities to drive strong earnings — was the fact that early in the year, consumers were showing signs that discretionary spending might be returning, Giblen explained.
“One reason it might have been going up early in the year was because it might have been seen as a discretionary play, and people thought discretionary spending was coming back,” he said. “There was general rosy optimism that the consumer was picking up because January and February showed some faint signs, and March sales were good with the benefit of Easter.”
Wolf noted that Safeway is “in a middle period” where its investment in pricing has not yet driven sales gains.
“It is starting to show up a little bit, but it takes time,” he said.
Negative sentiment on Safeway's stock might have been compounded by the fact that the company said it was having a difficult time passing along inflation in the form of higher retail prices on certain fast-moving items in the first quarter, although it said it expected those pressures to be short-lived.
The prospect of inflation returning to the industry, combined with indications that consumer spending was picking up, might have been one of the reasons for early optimism on the industry early in the year, but neither factor has so far helped most of the stocks.
“At the beginning of the year, the hope was that food inflation would come to the rescue and bail everyone out, but that didn't happen,” said Giblen. “Inflation is good if it can be passed on, and that requires a robust economy.”
Karen Short, a New York-based analyst with BMO Capital Markets, agreed that the prospect of inflation might have buoyed industry stocks early in the year.
“The stocks definitely rose on false expectation of inflation,” she said. “As inflation kept getting pushed out further and further, there was more selling pressure on the stocks.”
She said while some inflation in food costs could help the industry drive sales growth, the conditions have to be right for that to happen.
“The only thing that will help are low levels of consistent inflation, and very little volatility, in an environment where you can pass it through [to retail prices],” she said. “So, even if we had inflation right now it's questionable whether they could pass it through.
“Until we have an environment where that can play out, you can't own these stocks for an inflation thesis, and we never recommended these stocks based on the hopes of inflation.”
The “volatile” pattern of inflation the industry has seen so far this year “is not helpful,” she pointed out.
Cincinnati-based Kroger Co. , in its first-quarter earnings conference call, cited food-cost inflation of 700 basis points in produce, for example — partially attributable to severe weather in the Southeast — but said grocery-department costs experienced deflation of about 180 basis points in the quarter. Overall food-cost inflation averaged across the store was up 90 basis points, or less than 1%, for the quarter.
In Safeway's first-quarter conference call, Burd said he expected some inflation to begin to return in the second half of 2010, but “normal” levels of about 3% inflation would not come back to the industry until 2011.
Kroger Drives Sales
Kroger Co. had the most success in driving same-store sales of any of the traditional supermarket operators, but it also struggled with its margins in the first quarter of this year and fourth quarter of a year ago, which analysts said helped keep its stock down through the first half of 2010. The stock fell by just over 4% for the year-to-date through June 30, to $19.69, despite a strong run-up through early April.
“Kroger has successfully maintained the best same-store sales in the industry,” said Giblen, “but it's like they are treading water, with barely flat bottom-line earnings, and that is disappointing some people.”
Last month, the company reported comparable-store sales growth, excluding fuel, of 2.4%, and projected growth in the range of 2% to 3% for the full year as it cited some signals of an uptick in consumer spending. Although the company said it needed to invest less in gross margins to drive sales than it did in the preceding quarter, earnings were still off by 14% for the period.
Unlike some of the other traditional supermarket players, “Kroger never lost their market share,” Wolf explained.
“They have had robust sales, but investors just grew impatient with them investing in margins to achieve that,” he said. “They now need to show some earnings growth against some very easy gross margin comparisons [later this year].”
Minneapolis-based Supervalu , parent of the Albertsons chain and the weakest of the “big three” traditional supermarket operators in terms of same-store sales, also saw the biggest share-price decline among them. Its stock price fell 14.71%, to close on June 30 at $10.84.
“Supervalu is still losing market share, and therefore continued to underperform not just the group but the stock market overall,” Wolf noted.
In the company's fourth-quarter conference call in April, Supervalu said it had lost market share — which it calculates according to total volume from retail and wholesale volumes, including its Save-A-Lot chain — in 60% of its 90 largest markets. Identical-store sales for the quarter were down 6.8% compared with year-ago levels, but the company projected that IDs would recover to about negative 2% for the current fiscal year.
Giblen noted that higher food inflation might have benefited Supervalu to some degree in recent periods because of its large wholesale operations, where cost increases are generally passed along directly.
Despite missteps among many of the traditional operators, the natural and organic segment — led by Whole Foods and wholesaler United Natural Foods — showed ongoing signs of recovery in 2010.
“Of all the retail groups and sectors, I think the natural-food sector is as close to pre-recession levels of growth as any of them,” said Wolf, citing the appeal of the natural and organic niche to higher-income, better-educated consumers.
“Once the recovery occurred — it might not be a very robust recovery, it may be a jobless recovery — the higher-income, well-educated demographic realized they can easily afford the 15% or so premium for natural and organic foods, and they went right back to it.”
In Whole Foods' second fiscal quarter, which ended in April, the company reported a 7.7% gain in identical-store sales, but still managed to improve gross profit by 37 basis points, to 35.1% of sales.
Short of BMO Capital Markets noted that Whole Foods executed well in improving its pricing without hurting gross margins.
“Whole Foods was very creative in lowering their costs, whether they did it through vendor support, or their [supply] contract with United Natural, so that they were not the ones eating their gross margin,” she said.
The stock has also benefited from what she called management's “new religion” of being cautious in its guidance so as not to under-deliver on analyst and investor expectations.
In addition, analysts pointed out that as a nonunion operator, Whole Foods has been better able to better control labor costs than some of its traditional supermarket counterparts to fund its pricing initiatives.
“We're continuing to see lower costs of goods driven by better purchasing and distribution disciplines, as well as improved store-level execution,” said John Mackey , CEO, during the most recent conference call.
He also cited the recognition by the public of the company's work at improving its price image.
“Based on our strong sales growth alone, it appears we're getting credit for our hard work, and that people are beginning to look at us differently in this area,” he said.
Giblen noted that Whole Foods, in improving its price image, has become a more viable competitor for traditional supermarket operators as well.
“Whole Foods showed that you can get it right,” he said. “They have somewhat high prices that you would think that would be bad in this economy, but they have steadily improved same-store sales and kept their margins, and basically reinvented the company to become an excellent, and fairly reasonably priced, player.
“They really took a serious approach to working on price, whereas Safeway talked a lot about price, but didn't make as earnest an attempt to lower prices,” he added. “Whole Foods really did it, and delivered the message.”
Along with Whole Foods, United Natural, its primary supplier, has been delivering strong results, and just last month completed the acquisition of the Canadian food distribution business of SunOpta, which Giblen said offers potential upside for United Natural. That business had sales of about $170 million in 2009.
In a conference call last month discussing earnings for the third fiscal quarter, United Natural said it saw strong sales gains at all three of its customer segments — with supernatural sales up 17.7%, independent sales up 6.9% and supermarket sales up 12.2%.
Although Harris Teeter has not seen the sales gains of Whole Foods, its parent company's stock was among the best performers in the first half of calendar 2010, up more than 20%, to $30.99.
Short upgraded the stock last month, citing indications that customers had begun trading up at the chain and noting that the company should be viewed more like Whole Foods than like a traditional supermarket operator because of its differentiated format and somewhat higher-end customer base.
In April, Ruddick reported that same-store sales were down slightly — just under 2% through the first two fiscal quarters — but operating income was up in the second quarter and flat for the fiscal year-to-date.
Wolf noted that like Whole Foods, Harris Teeter benefited from having flexible work rules.
“They are able to fund more of their price initiatives with labor-cost reductions,” he said.
In addition, Ruddick has seen improved results at its industrial thread business, American & Efird, where a shift to overseas production has helped improve costs.
“Now, [the thread] business has been right-sized, and costs have gotten in line,” he said.
While each of the “big three” traditional supermarket chains saw share-price declines in the first half of calendar 2010, some analysts said they think the share prices might have “bottomed out,” although some uncertainty remains.
“Industry stocks are at trough valuations,” said Wolf. “We're not expecting miracles — things happen gradually in this industry — but we are expecting a gradual recovery in 2010, and then 2011 should shape up to be a pretty good year, but the stocks should start to perform ahead of that.”
Short, however, cautioned that Kroger and Safeway might have a difficult time meeting full-year earnings targets, which could exert negative pressure on industry stocks.
“But at these levels, there's not a ton of downside in either one,” she concluded.
“They need fundamentals to improve for these stocks to work.”
Giblen cautioned that although stocks might already be seeing pressure from Wal-Mart's increased promotional pricing, “It could get worse because there haven't been any really intense price wars yet, but there could be.”
The following five food retailing and wholesaling stocks saw the biggest percentage increases in share price in 2010 through June 30:
Whole Foods Market , Austin, Texas, up 31.22%, to $36.02, following a gain of 190.78% in 2009.
“Whole Foods operates a differentiated format, and there is a need for it, because there are very few retailers who execute at the same level,” said Short of BMO Capital Markets.
Ruddick Corp. , Matthews, N.C., up 20.44%, to $30.99, after a decline of 6.94% in 2009.
“Harris Teeter's performance has been exceptional as it relates to containing costs, preserving margins and growing share — all within an extremely challenging environment,” said Short.
Loblaw Cos. , Toronto, up 13.96%, to $38.61, following a decline of 3.12% in 2009.
“They took advantage of lower costs [from a strong Canadian dollar], and managed to hold their prices fairly in line, and were able to put that to the bottom line,” said Perry Caicco, an analyst with CIBC World Markets, Toronto.
BJ's Wholesale Club , Natick, Mass., up 13.15%, to $37.01, following a decline of 4.52% in 2009.
BJ's had been performing well before the July 1 announcement by Leonard Green & Partners that it had acquired a stake in the club operator, which drove BJ's stock up further.
United Natural Foods , Providence, R.I., up 11.74%, to $29.88, following a gain of 50.06% in 2009.
“We know that Whole Foods is doing well, but sales to supermarkets and independent natural-food stores also accelerated considerably, and that's news,” Giblen of Quint-Miller told SN.
The following five food retailing and wholesaling stocks saw the biggest percentage decline in share price in 2010 through June 30:
Arden Group, Los Angeles, down 8.1%, to $87.87, following a decline of $24.11% in 2009.
Same-store sales at the 18-unit Gelson's Market operator fell 3.7% in the company's fiscal first quarter, despite the benefits of an early Easter and Passover, the company said.
Weis Markets , Sunbury, Pa., down 9.49%, to $32.91, following a gain of 8.12% in 2009.
Despite a 3% gain in comparable-store sales for the first quarter and higher net income, the stock was down for the year-to-date. “The only thing that seems to move that stock is buyout rumors,” said Giblen.
Wal-Mart Stores , Bentonville, Ark., down 10.7%, to $48.07, following a decline of 4.66% in 2009.
Four consecutive quarters of same-store sales declines in the U.S., plus a reversal on some key initiatives related to its sweeping Project Impact initiative, might have hurt this stock in the first half of 2010.
Supervalu , Minneapolis, down 14.71%, to $10.84, following a decline of 12.95% in 2009.
Supervalu's stock had risen on industry talk of a possible leveraged buyout, but it never materialized and the company continued to post weaker sales results. “They are not an expensive stock, but they are poorly positioned,” said Short.
A&P , Montvale, N.J., down 66.92%, to $3.90, following a gain of 88.04% in 2009.
Because the float, or number of shares available to trade, is relatively low, “it doesn't take much to have pretty wide swings,” Short pointed out. Meanwhile, performance has been “dismal,” she said — in May the company posted a loss of $171.4 million on a comparable-store sales decline of 4.8% for the fourth quarter, and a loss of $876.5 million for the fiscal year.