Grocery Stocks: 3 to Buy, 3 to Shelve

by Susan J. Aluise | February 25, 2013 10:00 am

If retailing is a zoo, the grocery business is the wild kingdom. Supermarket chains face cutthroat competition and tiny margins, plus higher commodity and fuel prices. If that weren’t tough enough, big-box retailers like Walmart (NYSE:WMT[1]) and Target (NYSE:TGT[2]), warehouse clubs like Costco (NASDAQ:COST[3]) and discounters like Dollar General (NYSE:DG[4]) are upping the ante.

Then, there are changing customer tastes and shopping trends to consider. Consumers have embraced organic foods and natural products in recent years — a dynamic that has fueled the meteoric rise of Whole Foods Market (NASDAQ:WFM[5]). But even as shoppers crave healthier products, they’ve also adopted new “value-seeking” habits since the recession.

According to research from the Food Marketing Institute, 78% of surveyed shoppers say they seek discounts often and will continue to do so even after times get better. FMI also says technology is reshaping the shopping experience, as 52% of consumers use technology either before or during their shopping trips and 54% at least occasionally buy groceries online.

With these trends in mind, not all supermarket stocks are created equal. In fact, here are three to buy and three to leave on the shelf:

Buy

Safeway (NYSE:SWY[6]): Safeway shares soared over 13% last Thursday on a monster earnings beat, sending the stock to a new 52-week high of $23.96. Net income for the quarter increased by 13% and beat Wall Street’s estimates by nearly a dime.

SWY is cashing in on two of the aforementioned trends with its “Just For U” program, which offers digital coupons based on a shoppers’ buying patterns. The deals can save shoppers 10% to 20% off regular loyalty club pricing. So far, Safeways says the program has delivered 50% more weekly sales than anticipated.

Even with its recent climb, though, Safeway looks undervalued  It has a PEG ratio of 0.92 and a forward P/E of under 10. Plus, a current dividend yield north of 3% sweetens the deal.

Kroger (NYSE:KR[7]): The nation’s largest grocery pure-play reported a 62% jump in net income in the third quarter, while beating analyst estimates for profits by 3 cents. It also raised expectations for the coming quarter, which will be reported on March 7. Things have been going strong as Kroger experiences gains in its pharmacy, organics and fuel sales.

KR also has an aggressive plan to spend $200 million a year to boost square footage, while rumors abound that KR could be pursuing an acquisition of rival Harris Teeter (NYSE:HTSI[8]). Such moves could send the stock even higher.

Ingles Markets (NASDAQ:IMKTA[9]): Ingles is small — just a couple hundred stores compared Kroger’s more than 2,400 and SWY’s and SVU’s over 1,400 — but that’s part of its winning formula. The North Carolina-based company grew earnings by nearly 10% in the most recent quarter, despite aggressive competition. Better yet, the supermarket chain increased sales and improved its gross profit margin by 30 basis points to more than 22% of sales.

Oh, and IMKTA just celebrated its 48th successive year of sales growth. Plus, Ingles’ has a PEG ratio of just 0.7 and a forward P/E of only 9, suggesting the stock is undervalued … despite trading near the new high it set on Feb. 4. The stock also has a current dividend yield of 3.4%.

Leave

SuperValu (NYSE:SVU[10]): The company deserves some credit for its turnaround efforts. Wayne Sales replaced Craig Herkert as SVU’s president and CEO last summer, while the company entered into a $3.3 billion deal to sell-off of several units last month[11]. But in today’s cutthroat grocery market, it may be too little too late.

SVU’s last quarterly earnings, showed some improvement, but that’s not saying much. Net income increased to $16 million or 3 cents a share — better than the $750 million loss a year earlier, but less than analysts expectations of 5 cents. Revenue also dropped a little more than 5%.

I think the odds are long that SVU will be able to swing to revenue growth in the next couple of quarters.

Whole Foods: The good news is that Whole Foods’ earnings released earlier this month showed 20% year-over-year growth. The bad news is that  the chain revised its full-year guidance downward and cautioned investors not to expect the same rate of earnings growth for the remainder of 2013.

The company also plans to lower prices to fend off competition — a strategy that is more likely to hammer margins. Plus, WFM faces increased competition not only from The Fresh Market (NASDAQ:TFM[12]), but from traditional grocers like Kroger, which last fall expanded and re-branded its organic food lines.

Although I still believe in WFM’s underlying value proposition, this stock has had a very long and lofty run and is expensive now. Whole Foods’ PEG ratio of 1.60 suggests it’s overvalued, while WFM also trades at 25 times forward earnings and has a stingy current dividend yield of less than 1%. Wait for this stock to fall out of the rafters — which could happen by the third quarter.

The Fresh Market: Goldman Sachs upgraded the stock from “neutral” to “buy” last week — and raised the price target from $57 to $60 — but I sure wouldn’t add it to my cart.

The Fresh Market is likely to give Whole Foods a run for its money as it expands in California and the Northeast this year, but a PEG ratio of 1.53 and the sector’s highest forward P/E at over 28 make for a stock much more expensive than I like.

As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.

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