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How Inflation's Sting Hurt More Than First Anticipated

How Inflation's Sting Hurt More Than First Anticipated

The current round of inflationary pressure isn't a body blow to food retailers. Moreover, there are indications that inflation concerns are easing for the overall economy.

Nevertheless, inflation has become a bigger worry for the largest supermarket operators than was expected just a short time ago.

As recently as late June many retailers were expressing confidence about their ability to pass along the recent round of inflationary costs without consumers balking, and there was even talk of the whole scenario being a positive.

But that was before the big three distributors — Kroger, Safeway and Supervalu — weighed in with their cautious outlooks of the past month. These large chains pointed to challenges in passing along price increases, and warned of the impact on financial performance.

Kroger was the first to break the news, noting that in the first quarter it temporarily held back on passing along some price increases on commodities such as milk because of competitive situations. The result was that profit as a percentage of sales declined.

Safeway was next, saying that inflation was a key reason it was delivering a more conservative estimate of earnings for the year, despite good sales trends. The “lag” in passing along price hikes for milk, meat, produce and other items impacted earnings by 2 cents a share in the second quarter, the company said, creating a cloudier outlook.

Finally, Supervalu unveiled a cautious forecast late last month, underscoring some consumer resistance to inflation and reporting that same-store sales may weaken, a warning that led to a quick sell-off of the company's stock.

That was enough to lead John Heinbockel, an analyst with Goldman Sachs, New York, to remark to SN, “Investors have concluded food inflation is not nearly as bullish as the sector previously thought.”

The current cycle of inflation has some unique factors. Surging demand for ethanol has impacted corn-based products and livestock feed, which in turn boosts the prices of dairy and meat items. This comes at a time when turbulence in the housing and credit sectors threatens to soften consumer demand.

Does the news from the big three mean inflation is now a major cause for concern in food retailing? Last week, SN gathered a team of financial analysts for our annual wide-ranging roundtable that will be featured in the Sept. 3 issue. Here's a sneak preview of the analysts' discussion of inflation. Participants fell into two camps:

One group, seemingly the minority, believed food inflation will pose a challenge for some time, with a possible extreme scenario in which consumers trade down because of price resistance.

The other group asserted that inflation will be a short blip and that positive economic news involving unemployment, wage growth and retail sales will win the day.

I agree with the latter view, but this period of inflation caught operators by surprise and concerns won't be erased overnight. Chains need to figure out how to pass along price hikes while keeping their competitive edge.

An important point is that retailers need to educate consumers on why prices are higher. One analyst noted recent signage at a retailer explaining the link between corn, ethanol, cows and milk. That's the kind of message that will help speed the transition back to normality.