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Supermarket Sales Show Inflated Results

Supermarket Sales Show Inflated Results

“Retailers were achieving decent, nominal sales and earnings during the second half of 2011, though there was actually a slowdown in real sales growth because of inflation.” — Andrew Wolf, BB&T Capital Markets   The second half “was a period of tough sledding for the industry as a whole because inflation was running amok." — Scott Mushkin, Jefferies & Co., New York

The willingness by supermarket operators to pass through price increases from food inflation enabled them to achieve nominal sales gains during the second half of 2011, though there was little real sales progress, according to industry analysts.

The combination of inflation in food and gas prices for the next few months is likely to mean more of the same for supermarkets during the first half of 2012, they told SN.

Food inflation amounted to approximately 6% in 2011, meaning second-half sales for the top 10 chains with public equity or debt were essentially flat — up 6% on a weighted average, compared with gains of 1.85% in the second half of 2010.

On a comparable-store basis, sales rose an average of 3.7% in the third quarter of the calendar year and 2.8% in the fourth quarter — impacted to some extent by unseasonably warm weather in many parts of the U.S., analysts pointed out — compared with an average decline of 0.4% in the third quarter of 2010 and an increase of 0.9% in the prior year’s fourth quarter.

Operating income improved during the half, with the weighted average for the 10 chains down just 0.8%, compared with a drop of 5.4% for the same period a year earlier.

As retailers move through the first half of 2012, they are keeping pricing rational and seeing a slight uptick in consumer confidence, though rising gas prices could have a significant impact on where the numbers end up, the analysts said.

“Retailers were achieving decent, nominal sales and earnings during the second half of 2011, though there was actually a slowdown in real sales growth because of inflation,” Andrew Wolf, managing director for BB&T Capital Markets, Richmond, Va., told SN. “With inflation, real sales growth actually worsened between the third and fourth quarters.”

Inflation at the producer level was running at just over 4% through the first quarter of 2012, “so supermarkets are still passing those costs on with higher retail prices, but the gap is closing in favor of the retailers,” Wolf said, “and while there will continue to be weak real sales trends through the first half of this year, gross margins may firm.”

Scott Mushkin, managing director for Jefferies & Co., New York, said the second half “was a period of tough sledding for the industry as a whole because inflation was running amok, which created volume challenges throughout the industry as consumers in the $50,000-a-year range began to struggle.”

He said he does not see much change during the first half of this year, “unless inflation calms down and we see more middle-class wage growth, though gas prices will keep the pressure on.”

Chuck Cerankosky, managing director for Northcoast Research, Cleveland, said consumers were cautious during the half “because inflation in both food and gas prices remained highly bothersome.”

He anticipates a slow improvement in the economy during the first half of this year, “but that’s likely to be helpful to only those companies that had sales momentum entering the year — Kroger, Whole Foods, Harris Teeter and Costco, all of whom have strong value credentials.”

Wolf said there is “a strong correlation between gas prices and real sales growth for supermarkets. In a stagnant economy like the one we’re in, a consumer who has to put $50 to $100 more in his gas tank and then spend $50 more at the supermarket to cover food inflation will be under a real strain.”

Gary Giblen, an industry analyst, offered similar comments. “Gas is a non-discretionary expense because people need what they need to get to work and do everything else they must do, and that could force some consumers to trade down. Some economists say people are used to high prices, but as those prices keep going up, it’s bound to have a negative impact on shopping habits.”

The following pages include an analysis of the financial performance of each of the 10 chains in the second half of 2011.

The Big Three

Kroger Co., Cincinnati, whose second-half sales rose 9% to $42 billion, while identical-store sales, excluding fuel, rose 5% in the third quarter and 4.9% in the fourth and operating profit declined 3.4% to $932 million (excluding the impact of Kroger’s consolidation of union pension plans during the half but including a LIFO charge of $73.4 million in the fourth quarter of 2011, compared with a charge of $18.8 million a year earlier).

Giblen said he attributed Kroger’s strong second-half results to “its low prices and reasonable profits.”

According to Wolf, “Kroger has been gaining market share and implementing programs with predictable earnings, and it’s working for them. It’s the only major conventional chain with a strategy and execution that fulfills its role as a traditional supermarket, which is to be defensive in its approach.”

He said the chain’s strong sales gains included “a lot of gas inflation,” while comp sales excluding inflation were basically flat.

Safeway, Pleasanton, Calif., which saw second-half sales climb 6.6% to $23.7 billion, with comps up 1.5% in the third and fourth quarters and operating income down 15.5% for the half.

Wolf said Safeway’s earnings results, like Kroger’s, included a large LIFO charge. “But unlike Kroger, whose results had a large productivity component, Safeway was investing in price and got sales to a level that was basically flat when compared with other supermarkets, which means it was losing market share — probably to discount stores like Costco on the West Coast, as well as Wal-Mart.”

According to Giblen, “Safeway has been making a big investment in price, though it was a little late bringing prices into line. But it did a lot of things right during the second half, though it is still coming from behind, with a high price perception among some consumers and mediocre execution in some acquired divisions, particularly in Chicago.”

Cerankosky said Safeway “needed to do better in the second half than it did, though it experienced some improvements in sales momentum. But its pricing programs have yet to be fully understood by consumers.”

According to Mushkin, Safeway is continuing to struggle with perception problems. “Right now its value equation is not enough to overcome the challenging environment. Many people think of it as an upper-middle-class chain, though it’s really very much middle-of-the-road. But with more middle-income consumers struggling, that’s not a good place to be, and sales sputtered in the fourth quarter.”

Supervalu, Minneapolis, whose retail sales fell 2.6% to $12.9 billion in the second half of the calendar year (the company’s second fiscal quarter plus third fiscal quarter), while comps fell 1.8% in the fourth quarter and 2.9% in the first and operating profit rose 0.9% to $325 million.

For Wolf, Supervalu has “the worst fundamentals and the worst market share in the industry — and given the impact of inflation, its real comps are running at a negative 6%-plus, which is a big problem.”

According to Giblen, “Supervalu has been investing in price, but it’s starting from so far behind that it will take a long time to get the full benefits. Like Safeway, it’s cut prices a great deal, but unlike Safeway or Kroger for that matter, it doesn’t have as much private label to offset the drop in profits.”

The ongoing decline in comps demonstrates the lack of an immediate consumer response to its price investments, Giblen added, “and it’s losing share because its competitors are better operators.”

Cerankosky said Supervalu’s sales momentum “continues to lag, with four or five quarters of negative same-store sales. It puzzles me how to explain management’s patience with those top-line trends when it should be dealing with the situation with a lot more alacrity.”

Mushkin said part of the problem is Supervalu’s capital structure, “which is problematic because it has too much debt.”

Ahold USA, Delhaize America

Ahold USA, Quincy, Mass., whose second-half sales rose 7.3% to $11.7 billion, with comps up 6.8% in the third quarter and 2.9% in the fourth, while operating profit rose 22.9% to $462 million in the half.

Wolf said Ahold USA has taken a page from Kroger “in terms of getting serious about selling value over the last few years, and by the second half of last year, Ahold was at the point where it was beginning to reap the benefits of several years of price repositioning.”

Katie Mathis, a retail analyst for Planet Retail, London, said Ahold USA’s sales rose during the half “on the back of infill acquisitions and a focus on lowering costs and reducing debt, which allowed for better synergies across banners with a sophisticated private-label program.”

Patrick Roquas, an analyst with Amsterdam-based Rabobank, said Ahold had a sound second half, “reflected by market-share gains and a higher underlying EBIT margin — the result of its ongoing focus on cost savings, price investments, investments in the store base and the rollout of own brands. The Ahold banners also benefited from operational and financial issues at some of its local peers.”

Delhaize America, Salisbury, N.C., where second-half sales were up 2.3% to $9.7 billion, comps rose 1.9% in the third quarter and declined 0.4% in the fourth, and operating income fell 9.7% to $495 million.

According to Mathis, Delhaize struggled during the half from “a combination of underperforming store locations and store formats that don’t fit the current economic climate. It was not competing on price in the majority of its banners, and it failed to provide the store environment and customer service shoppers expected from those price points,” she said.

According to Giblen, “Delhaize is harvesting high prices and suffering the consequences in terms of comp sales,” with Food Lion being negatively impacted during the half by competition from dollar stores, and Hannaford Bros. in the Northeast encountering more competition from supercenters and Wegmans Food Markets.

“For a company that goes to market on price, Food Lion has really been one of the last of the large chains, along with Supervalu, to look at price and adjust downward to protect its market share,” Wolf said. “It’s making those adjustments on a market-by-market basis now, and I would expect to see a lot of price investment this year.”

According to Mushkin, “Food Lion is adrift. It’s trying to get pricing in line, but the results don’t show it, and it still has a long way to go. Its core customer is under enormous pressure, and its store locations are at the forefront of the new Wal-Mart onslaught.

“Hannaford has a totally different demographic and continues to do well, while Sweetbay is struggling because of its legacy from Kash n’ Karry of store location issues, plus the competitive strength of Publix in Florida.”

Whole Foods, Winn-Dixie, Harris Teeter

Whole Foods Market, Austin, Texas, with sales in the second half up 12.6% to $5.7 billion, comps up 8.7% in both the fourth and first quarters, and operating income up 23.8% to $307.6 million.

“The success Whole Foods is having illustrates the bifurcation between upscale consumers and others,” Giblen said. “Among upscale shoppers, spending has been very strong, and Whole Foods has done an excellent job of bringing pretty low prices to organics and other quality merchandise.

“As a result, even less affluent consumers who want better merchandise understand they will not be overcharged at Whole Foods.”

According to Wolf, “As Whole Foods continues to improve its value image, it is unequivocally gaining share. Even removing 5% or 6% for inflation, it is doing very well in sales, and the real gains in comp sales of 3% are terrific.”

Cerankosky said Whole Foods “has clearly differentiated its stores in terms of price and product mix, with the emphasis on quality over price, so that even customers watching their nickels and dimes like going to Whole Foods because of the quality they get for their money. And the stores continue to offer great service levels and a pleasant shopping environment.”

According to Mushkin, “The story at Whole Foods is the yin and yang of John Mackey and Walter Robb as co-CEOs — a combination that is working. And the degree of store-level execution, which was always strong, has been stepped up to the point that it’s almost embarrassing to other chain operators.”

Winn-Dixie Stores, Jacksonville, Fla., whose sales for the second half of the calendar year rose 2.7% to $3.7 billion, with comps up 3.3% in the company’s first quarter and 2.5% in the second, and EBITDA rising 41.2% to $28.8 million. Winn-Dixie is in the process of merging with Bi-Lo Foods, Mauldin, S.C., and has become a private company.

“Winn-Dixie’s price investments totally started to take hold within the last year or so,” according to one analyst.

Giblen added, “By the time it agreed to be acquired by Bi-Lo, Winn-Dixie had achieved that delicate balance between good prices and good comps.”

According to one analyst, “As much as everyone wanted Winn-Dixie to get turned around and given the wonderful job by management to keep it afloat, its pricing was off and most of the second-half numbers came off easy comparisons and were not sustainable.”

Harris Teeter Supermarkets, Charlotte, whose sales for the half were $2.2 billion, up 3.8%, with comps up 5% in the company’s fourth quarter and 5.3% in its first, while operating income declined 1.6% to $89.3 million.

“Like Whole Foods, Harris Teeter is going after an upscale customer,” Giblen said. “But unlike Whole Foods, its profits declined as it was forced to invest in price because Whole Foods has been so effective at bringing reasonable pricing to high-quality foods — an adjustment Harris Teeter is still in the process of making.”

Wolf said Harris Teeter’s price investments have helped the chain maintain its market share “and increase it a little bit. And profits are starting to get better,” he said, noting the drop in operating income for the half was due to an extra week in 2010’s second half.

Cerankosky attributed part of Harris Teeter’s strong results to its multi-coupon promotions once a quarter, which helped boost sales but impacted operating income, “though it made some adjustments late in the year that strengthened earnings. But the company is very aware of the need to build sales among a broader mix of customers.”

Mushkin said Harris Teeter has “a very focused strategy that includes very good store execution. It tweaked pricing down, and it also benefited from the fact its core customer is in a recovery mode.”

Roundy's, Stater Bros.

Roundy’s, Milwaukee, whose sales rose 3.1% to $2 billion for the second half, with comps up 1.7% in the third quarter and down 1.2% in the fourth, and operating income up 34.1% to $36.6 million.

Most of Roundy’s real sales growth is coming from the five Mariano’s stores the company operates in Chicago, Wolf pointed out, “while its comp sales are being impacted by inflation, which is emblematic of most of the industry.”

Mushkin said Roundy’s fell victim to the impact of inflation in the fourth quarter. “Most of its core markets cater to that middle-class customer that’s really struggling,” he explained.

According to Giblen, “Roundy’s operates in a very stable, very competitive environment. In Wisconsin it operates good high-quality stores that are not unionized and that offer good service and good perishables, and in Chicago it has the upscale Mariano’s format that’s going up against two sleepy competitors in Dominick’s and Jewel.”

Stater Bros. Markets, San Bernardino, Calif., whose sales rose 5.9% to $1.9 billion during the half, with comps up 5% in the chain’s fourth quarter and 6.9% in the first, and whose operating income rose 4.5% to $51.6 million.

“Stater is in a snap-back situation,” Giblen noted. “As the housing industry in the Inland Empire of Southern California has started to come back, so have financial results at Stater Bros., which is the area’s low-price leader.”

Mushkin said he was struck by how strong Stater’s comps were during the half. “It’s amazing to see how well it’s been able to reposition pricing and invest gross margin to get a great consumer response.”

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