The grocery sector is a tough place to make money: high competition, low margins, vulnerability to commodity and fuel prices — not to mention the vagaries of food and merchandising trends. Still, grocery stocks are usually stable, conservative dividend-paying stocks — which makes these dull darlings worth browsing.
As always, consumer trends affect the health of this sector, and a growing desire for better-quality, healthier foods is reshaping the competitive landscape. That said, consumers haven’t cast off Recession-era frugality — they are still “intensely focused on value”, according to a report in Progressive Grocer.
But as the traditional lines that separate grocers from general retailers blur, supermarkets are increasingly battling restaurants for consumers’ “share of stomach”, according to a new survey by AlixPartners. “Grocery and convenience stores present a real threat to the traditional restaurant segments as more and more consumers are purchasing prepared meals at these stores,” the researchers said.
So how do investors cash in on these trends? For starters, it pays to be picky when shopping for stocks. Here are two stocks to buy and two to leave on the shelf:
It has been an eventful four months for Kroger (KR), the nation’s largest grocery pure-play. In September, KR announced that David Dillon, CEO for the past decade, will hand off the scepter to COO Rodney McMullen on Jan. 1. This came after Kroger announced a $2.5 billion deal to acquire the 212-store Harris Teeter (HTSI) chain.
When Kroger last reported earnings in September, it met Wall Street’s profit expectations of 60 cents per share, 9 cents higher than the same quarter last year. Its revenue came in at $22.7 billion — a hair above the consensus estimate and an increase of 4.6% from the prior year.
There are three reasons why I like KR now: size, the Harris Teeter deal and Big Data. Kroger was the second-largest food retailer/wholesaler in the U.S., behind only Walmart (WMT) — and in low-margin businesses like grocery, economies of scale are critically important. And the Harris Teeter deal gives KR a franchise that is perceived by customers as more upscale and better able to execute “fresh” and gourmet baked goods and prepared foods — in line with consumer trends. Finally, Kroger is betting big on Big Data — and the ability to mine data and personalize offers is so powerful it’s scary.
Oh, and the current 1.5% dividend yield doesn’t hurt.
Safeway (SWY) shares have gained more than 12% over the last month amid speculation that the Pleasanton, CA-based chain was a buyout target. The rumors pegged Steve Feinberg’s Cerberus Capital Management as a potential suitor, just weeks after Barry Rosenstein’s Jana Partners LLC disclosed a 6.2% stake in the supermarket chain.
SWY already was streamlining its operations to run leaner and meaner — it sold off its Canadian operations to Empire Co., owner of Nova Scotia-based Sobey’s, for a cool $5.7 billion. Safeway plans to use $2 billion of the sale’s proceeds to pay down debt; it also announced plans to leave the Chicago market by early 2014. Safeway operates 72 Dominick’s stores in the area — the departure will generate a cash benefit of $400 million to $450 million.
Those announcements softened the blow of SWY’s big quarterly earnings miss last month (an EPS of 10 cents instead of the 16-cent profit analysts expected). SWY continues to gain traction 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.
I think Safeway’s streamlining efforts will be a boon for shareholders and have the potential to boost shareholder value considerably. Even with its recent gains, though, Safeway looks to be valued in line with the sector average — it has a PEG ratio of 1.34 and trades at 20 times forward earnings. The current dividend yield of 2.3% sweetens the deal.
WFM’s earnings, released after the market closed Wednesday, beat the Street by a penny (32 cents a share, compared to the 31-cent consensus). The bad news: Revenue came in at only $2.98 billion, below the expected $3.04 billion. But investors weren’t so much spooked by a penny here or there — the bigger issue is what the outlook for the chain is going forward.
WFM scaled back both full-year estimates for earnings and same-store sales. The chain had previously expected earnings to come in between $1.69 and $1.72; those estimates have been lowered to between $1.65 and $1.69. Same-store sales fell from 8.5% to 5.8% year-over-year. On Wednesday, Whole Foods revised its full-year projections downward to 5.5% – 7% from earlier estimates of 6.5% – 8%.
Let’s cut to the chase: WFM’s phenomenal growth is slowing — in large part because of competition. On the organic side, smaller players like Sprouts Farmers Market (SFM) and The Fresh Market (TFM) are gaining ground. WFM also faces price competition from mainstream grocers like Kroger and Safeway — not to mention mega-retailers like WalMart and even Amazon (AMZN) that are upping the ante in the grocery business.
The sky isn’t falling, though; WFM is just beginning to feel some of the pressures traditional grocers have had to contend with for years. Add to that the platinum valuation (it trades at nearly 37 times forward earnings) and a miserly current dividend yield of 0.6%, and I’d rather shop the store, not the stock.
If you’re looking for the polar opposite of KR in the grocery sector, Ingles Markets (IMKTA) is pretty close. The company boasts 204 stores, all of which are located within 250 miles of its Asheville, NC distribution center.
On the face of it, IMKTA looks like the rare jewel in this sector — a fairly valued grocery stock. It has a price to earnings growth ratio of less than 1, and it trades at just 10.6 times forward earnings. The current dividend yield of 2.5% is among the highest in the sector.
But here’s where it starts to get challenging: Ingles’ profit margins are among the slimmest in the sector, and same-store sales growth for the third quarter was only 1.4%.
And IMKTA is saddled with a lot of debt. Although the company is aggressively paying down that debt, prepayment penalties pushed the chain to a $14.4 million net loss in the quarter. It doesn’t help matters that Kroger’s acquisition of Harris Teeter brings the grocery Goliath into its market as a more direct and daunting competitor.
Ingles, which began as a family-owned business some 50 years ago, is a lovely supermarket chain for consumers, many of whom are loyal to the quality store-brand items and dairy. But the chain risks being squeezed out by larger, more aggressive competitors.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.