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‘Wild Cards’ at Play for Supermarket Stocks

‘Wild Cards’ at Play for Supermarket Stocks

  “If household income takes a knock right out of the gate in January, the question is, what does that mean for supermarket demand? It’s bound to be a negative." — Andrew Wolf, analyst, BB&T Capital Markets

The impact of the restoration of the Social Security tax and the potential for merger-and-acquisition activity are “wild cards” facing the supermarket industry in 2013, as one analyst described the situation.

The 2% Social Security “tax hike” for workers — after a two-year suspension — is akin to a $1 per gallon increase in the price of gasoline, as far as its potential impact on consumer spending, said Andrew Wolf, a Richmond, Va.-based analyst with BB&T Capital Markets.

“If household income takes a knock right out of the gate in January, the question is, what does that mean for supermarket demand? It’s bound to be a negative,” he said. “It’s not going to be as bad as it was early in the recovery when the price of gas went up, but it will be a negative.”

Gradual improvements in the economy and in employment could serve to dampen the impact of the tax, he said, although probably not right away.

According to Wolf, real sales — adjusted for inflation — improved in the industry in the third quarter of 2012, and likely improved in the fourth quarter as well.

“I think in the first quarter we will see a slowing in the rate of real sales growth from the fourth quarter, but gains in employment should offset that 2% tax over the longer term,” he said.

The other wild card, he said, involves merger and acquisition activity — both known, as in the pending sale of several Supervalu retail banners, and unknown, as in reports of the potential sale of Safeway’s Canadian assets and speculation about other companies.

“That’s generally a positive,” said Wolf, both because of the premiums paid to the sellers, and because of the potential for such deals to result in competitive store closures.

In the case of the Cerberus acquisition of Albertsons, Jewel, Acme and Shaw’s/Star Market, Wolf said he expects some store closures — to the potential benefit of some competitors — but on the other hand, the chains could end up being better managed than they had been recently, presenting new challenges to rival operators.

“Cerberus will look to maximize the real estate value of those stores, which means in some cases they will end up not being supermarkets any longer,” he said. “But the stores they keep could be run better, so it is not a pure gain for competitors.”

Other factors potentially impacting supermarket stock performance in 2012 include inflation, and the ability of chains to drive earnings growth.

Stock Table 1: How Supermarkets Fared

Whole Foods Tops 2012 Stocks

One company that has enjoyed success on both the top and bottom lines has been Austin, Texas-based Whole Foods Market, which was the top-performing stock among food retailers tracked by SN for the fourth straight year in 2012. The stock gained nearly 35% for the year, to close at $91.61.

It was followed by its primary supplier, Providence, R.I.-based United Natural Foods Inc., which saw a 34% gain in its share price in 2012, to $53.49.

Rounding out the Top 5 were Costco Wholesale Corp., Issaquah, Wash., up 28.4%, to $98.73; Ingles Markets, Asheville, N.C., up 25.07%, to $17.26; and Village Super Markets, Springfield, N.J., up 23.39%, to $32.86.

Karen Short, a New York-based analyst with BB&T Capital Markets, remains bullish on Whole Foods’ stock, with an “outperform” rating.

In a report last week, she outlined three “core tenets” of her support for the stock: sustainable traffic and share gains due to attractive price points relative to competitors; the potential for a cutback in some price investments due to higher-quality product, raising comparable-store sales; and the potential for margin expansion from reduced price investments.

2013 Top 75: Whole Foods Ranks No. 19

Whole Foods “is a best-in-class retailer, with self-funded, accelerating and sustainable unit growth, no debt and improving [return on invested capital],” she said.

Wolf noted that Whole Foods has been rewarded for its efforts at expense reduction, by cutting shrink and reducing store labor costs. It also has been managing its rapid expansion well, something he said it must continue to do.

2013 Top 75: UNFI Ranks No. 31

“Whole Foods and UNFI both have to manage capacity expansion,” he said. “It’s a big opportunity and a big management challenge.”

The ongoing labor strike at UNFI’s distribution center in Auburn, Wash., could be costly in the short term, although Wolf said he views it as a “one-time event” that won’t impact the company’s share price over the long term.

Short also is bullish on UNFI, citing projected margin improvements from systems upgrades at its warehouses and strong sales trends.

Stock Table 2: Winners and Losers

Traditional Chains Mixed in 2012

Overall, 16 of the 24 food retailers and wholesalers tracked by SN saw gains in 2012. The SN Composite Index, calculated by Data Network, Huntington, N.Y., was up about 9.29% for the year, compared with a gain of 7.26% for the Dow Jones Industrial Average and a 13.5% increase in the S&P 500.

Cincinnati-based Kroger Co. gained 9.7% for the year, to close at $26.02, and Safeway, Pleasanton, Calif., was down 10.75%, to close at $18.09.

Both companies have the potential to gain some sales in 2013 from the pending breakup of Minneapolis-based Supervalu, which was the worst performer of 2012, down 68.6%, to close at $2.47. Its stock has since jumped about 44% from that point following the announcement of the pending sale to Cerberus Capital Management and its partners.

2013 Top 75: Nash Finch Ranks No. 32

Rounding out the bottom five performers in 2012 were:

• Delhaize Group, Brussels, down 23.71% after a relatively weak sales performance throughout the year and the closing of some 151 stores, mostly in the Food Lion banner. It recently revamped and streamlined senior management, and unveiled plans to close another 33 stores in the Sweetbay banner in Florida.

• Minneapolis-based Nash Finch Co., down 24.89%, to $40.55, after weakness in its military division pressured results.

• The Fresh Market, Greensboro, N.C., which fell 32.69%, to $48.09, after a weaker-than-expected third quarter exposed the company’s sales and margin challenges.

2013 Top 75: The Fresh Market Ranks No. 71

“While we see the long-term store-growth thesis as intact, we do not see an urgency to own the stock, as tougher comparisons lie ahead,” said Edward Aaron, an analyst with RBC Capital Markets, Denver, following the third-quarter earnings call.

• Roundy’s Supermarkets, Milwaukee, which fell 46. 39%, to $4.45, following its initial public offering last Feburary. Its Mariano’s banner in Chicago is performing well with eight locations, but its largest chains, Pic ’n Save in Wisconsin and Rainbow Foods in Minneapolis, are facing tough competition, analysts said.

“In Roundy’s core markets, it must defend market share against formidable entrants in its core Wisconsin and Minnesota markets and win the war of attrition against weaker supermarket operators,” noted Wolf in a research note. “In contrast, Mariano’s trends in Chicago remain strong.”

Same-store sales for the three stores open at least a year “are running low double digits,” Wolf said, “and the chain’s overall profitability is better

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