Nobody ever said the grocery business was easy. A witches’ brew of cut-throat competition, razor-thin margins, rising fuel and food prices and changing consumer tastes is giving the sector — and its investors — a bad case of heartburn.
Plus, competitors like Walmart (NYSE:WMT), Target (NYSE:TGT), Costco (NASDAQ:COST) and Dollar General (NYSE:DG) are moving aggressively into the grocery business and such discount chains are popular since, as a Food Marketing Institute report earlier this year revealed, consumers have become more price conscious since the recession.
At the same time, shoppers also are going for higher-margin organic foods and greener, “natural” products — which explains the meteoric rise of Whole Foods Market (NYSE:WFM) and also adds to the squeeze of traditional supermarket chains.
Safeway’s (NYSE:SWY) earnings report, which the supermarket chain released on Thursday, is a microcosm of the challenges facing traditional grocers now. While third-quarter earnings rose by more than 20% to $130 million — 45 cents per share and better than Wall Street was expecting — sales struggled.
The total came in at $10.05 billion instead of the $10.24 billion analysts expected, and same-store sales increased by a measly 0.1%. The stock was down about 5%, despite news that Safeway is launching a new customer loyalty program aimed at reversing the slip in sales.
But even in an industry where it’s notoriously difficult to make money and competitive threats abound, there will still be winners. Plus, since many stocks in this sector have been battered, there’s an opportunity to hunt for bargains that deliver value today and growth over the longer term.
With that in mind, here are three grocery stocks to buy and three to leave on the shelf:
Walmart. Make no mistake: this retail powerhouse isn’t just in the grocery race to stay, but is in it to win it. The company has the size, pricing power and sweet supplier deals to undercut traditional grocers and still make money. It’s also announced plans to double the number of its grocery-centric Neighborhood Market grocery stores by 2016.
Over the last year, Wal-Mart has cranked out an impressive return of 40%. That’s given it a price to earnings growth (PEG) ratio of 1.8 and a forward P/E of 14 — both a bit high — but I still view WMT as a growth play. A reliable 2.5% current dividend yield doesn’t hurt either. It’s currently trading at $76 and my price target on WMT is $80.
Costco. Costco has a track record of nurturing high expectations, but its quarterly earnings released earlier this week blew the doors off analysts’ expectations for the big-box retailer. Its EPS of $1.39 a share not only beat the Street’s $1.30 estimate, but was nearly 29% higher than the same quarter a year ago.
Add to that more than 14% growth in sales and membership fee revenue year-over-year and it’s clear this company is doing a lot of things right. InvestorPlace’s Will Ashworth gives a full breakdown of Costco’s success story here.
Kroger (NYSE:KR). When it comes to traditional grocers, size matters. And Kroger is, after all, the largest traditional supermarket chain in the U.S. and the fifth largest retailer in the world, according to Deloitte’s 2012 Global Powers of Retailing report. Kroger’s customer-centric business model likely will help as it tries to fend off price-based competition from discounters like Wal-Mart and Dollar General. KR is also taking aim at Whole Foods by beefing up its organic and natural products strategy.
While Kroger only has a one-year return of 4.5%, it’s only trading at only 9 times earnings — a bargain if the company manages to grow its operations over the next two-to-three quarters as I believe it will. Its current dividend yield is 2.6% is solid as well.
SuperValu (NYSE:SVU). SVU, which next reports earnings on Oct. 18, is facing ferocious headwinds. So far this year, SVU’s profits are down 45%, revenue slipped 5% and the company has suspended its dividend, as InvestorPlace’s Alyssa Oursler writes here.
Safeway. SWY’s revenue miss is not the only factor to prompt investor concern. A potentially bigger challenge is the fact that this was the grocer’s fifth straight quarter of declining gross margins. The drought-related challenges of higher prices on food will further strain margins for the chain, although time will tell whether the new loyalty program will win shoppers’ hearts — and dollars.
Whole Foods Market. Don’t get me wrong, WFM is a great company and its stock has outperformed in recent years. It has a leg up on the market, strong margins and a compelling value proposition. But it’s trading at nearly 34 times forward earnings and has a PEG ratio of nearly 2. Despite the strength of its business model, WFM is too rich for my blood.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.