The grocery sector seemed downright schizophrenic on Wednesday, as SuperValu (NYSE:SVU) shares plummeted more than 15%, while Whole Foods’ (NASDAQ:WFM) lofty earnings report drove its shares up nearly 11%.
Besides the obvious differences in earnings and stock performance, the grocery sector dynamics that are buoying Whole Foods and burying SuperValu have broad application for other supermarket stocks, like Kroger (NYSE:KR) and Safeway (NYSE:SWY).
For starters, the sector is struggling to beat back rising competition from Wal-Mart (NYSE:WMT) and Target (NYSE:TGT), which have beefed up their grocery departments. Ditto for pharmacy chains like CVS Caremark (NYSE:CVS) that are advertising more grocery items these days. And shoppers’ clubs such as Costco (NASDAQ:COST) and retail discounters such as Family Dollar (NYSE:FDO) are posing a growing competitive threat to traditional grocery chains as well.
Another trend: frugal shoppers. Many consumers who scrimped during the recession have remained price-conscious even after the recovery, according to a new report by the Food Marketing Institute. This summer’s drought will make it even tougher for grocers as the scarcity of commodities like corn drives prices higher.
But healthy, local and organic products are gaining favor from shoppers, too. And that’s a trend upscale chains like Whole Foods and smaller rival The Fresh Market (NASDAQ:TFM) are profiting from.
Let’s cut to the chase: With tougher competition and contradictory trends, how can investors play the grocery sector now? Let’s break down three grocery stocks: one fresh, one stale and one “wait for a sale”:
Kroger. This grocery chain of 2,400-plus stores doesn’t have Whole Foods’ style, but there’s a lot to like about its substance. So far this year, KR has boosted traffic, generated higher profit and increased same-store sales by more than 4%.
Sales of its profitable store-brand products now account for more than one-fourth of total grocery sales. KR’s pharmacy segment got a double-digit boost from Express Scripts (NASDAQ:ESRX) customers who switched from Walgreen (NYSE:WAG) during its recent contract feud with the pharmacy benefit provider.
With a market cap of $11.7 billion, Kroger has a price to earnings growth (PEG) ratio of 0.9, indicating that the stock is slightly undervalued. It has a very attractive forward P/E of less than 9, and it offers a current dividend yield of 2.2%. The stock was unfairly punished by investors’ wrath over SVU, setting a new 52-week low of around $21 this week.
I think Kroger is a bargain now and a good long-term play in the grocery sector. I like KR with a price target of $27.
SuperValu. Earlier this month, SuperValu released quarterly earnings that smelled more than a little past the sell-by date. The parent company of Jewel-Osco and Albertson’s reported earnings of a scant $41 million on $10.6 billion in sales. Compare that to last year’s $74 million profit on $11.1 billion in sales.
SVU, whose same-store sales dropped 3.7%, also suspended its dividend and announced it would consider suitors — the stock lost half its value on the news. SVU plunged further this week on the heels of new stock options the company doled out to executives to keep them from bailing.
This stock is the classic case of trying to catch a falling knife. With a market cap of just $414 million, SVU has a PEG ratio of –0.6 (reflecting its negative earnings growth). The company is heavily debt-burdened — much of it stemming from its 2006 acquisition of the Albertson’s chain.
SuperValu will have to cut prices further now — at a time of rising commodity prices. Even at less than $2 a share, I can’t rank this stock a buy.
Wait for a Sale
First, let’s give Whole Foods its well-earned kudos. The chain’s third-quarter earnings soared by 32% to nearly $117 million — and revenue grew by 13.6% to nearly $2.8 billion. Whole Foods’ same-store sales — an extremely important measure of retail health — grew by 8.2% in the quarter.
The 329-store chain also opened a record nine new stores during the quarter, as WFM advanced its plans to have 1,000 stores within a decade. The company is opening more stores in suburban markets and has benefited greatly from affluent customers who don’t mind paying a little more for fresh, wholesome quality.
That’s all good news, obviously. But despite another great earnings quarter, I’m concerned about sustainability. And although most chains would kill for 8.2% same-store sales growth, that growth rate has trended down in each of the past three quarters.
With a market cap of nearly $17.3 billion, WFM is trading only about 4% below the new 52-week high it set a month ago. Its PEG ratio of nearly 1.9 is one of the highest in the sector and indicates the stock is overvalued. Its forward P/E is nearly 30 — another indicator of its premium price.
Although I love the store and like the stock’s fundamentals, the price is a little too rich for my taste right now. I’d rather check back later when it goes on sale — maybe around $87.
As of this writing, Susan J. Aluise did not hold a position in any of the stocks named here.