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Moody's predicts that sales of natural and organic foods will continue to rise.

Moody’s predicts easing deflation, return to profits for grocers

Agency projects 1% price gain, continued strength from natural/organic, private label

U.S. supermarkets' operating profits will grow at a fairly healthy rate again this year after a disappointing 2016, Moody's Investors Service said Wednesday.

Profitability last year was crimped by an unprecedented level of deflation for an economy not in recession, but as downward pressure on prices wanes, things will pick up in the latter half of this year, the rating agency said.

"We expect the US supermarket sector's operating profits to grow about 8% in 2017, compared with an approximate 5% drop last year," Moody's analyst Mickey Chadha said in a statement. "As deflation subsides, growth will be skewed toward the second half of the year, driven by improvement at Albertsons, Kroger Co. and Whole Foods Market."

Contrary to last year, when the U.S. Department of Agriculture estimated food-at-home prices declined by 1.3%, Moody's expects prices to rise about 1% this year, relieving some of the pressure on supermarkets' top line. Operating profit declined about 5% in 2016 and was below the agency's expectations as the predominantly fixed-cost structure of the sector exacerbated the negative impact of deflation.

Sales of natural and organic foods, as well private-label food products, will keep rising, Moody's projected. With more people opting to eat healthier meals at home, the U.S. natural and organic food market is growing in the high single digits annually. Meanwhile, private-label products are today vying with their name-brand counterparts with splashier packaging and a growing number of organic and all-natural options, at prices on average 23% cheaper than national brands.

And unlike other sectors of the U.S. retail market, brick-and-mortar grocers are relatively less threatened by online competitors, Moody’s said. Online food purchases have gained in popularity, but still accounted for less than 1% of the U.S. retail food market in 2016, Moody’s said.

Moody's expects the overall food retail market to grow on average 2%-3% annually and online penetration to be less than 3% of the total food retail market in the next five years. Nevertheless, the rating agency does expect further consolidation in an over-stored industry, as regional chains look to extend their geographic reach and unprofitable stores are divested or closed.

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