Supermarket chains look for better 2010 - Market Watch

Supermarket chains look for better 2010 - Market Watch


SAN FRANCISCO (MarketWatch) -- Supermarket chains, ground down by a year of price wars aimed at keeping hard-pressed customers, are starting 2010 wondering how much longer they can go without further harming their share prices.

Grocery-sector stocks have taken a drubbing the past three months, with Kroger Co. /quotes/comstock/13*!kr/quotes/nls/kr (KR 20.69, +0.06, +0.28%) down 14%, Supervalu Inc. /quotes/comstock/13*!svu/quotes/nls/svu (SVU 14.32, -0.02, -0.11%) down 11% and Winn-Dixie Stores Inc. /quotes/comstock/15*!winn/quotes/nls/winn (WINN 10.01, -0.08, -0.79%) down 27%. Safeway Inc. /quotes/comstock/13*!swy/quotes/nls/swy (SWY 21.29, -0.12, -0.56%) is down 7%.


By comparison, the S&P 500 Index /quotes/comstock/21z!i1:in\x (SPX 1,136, -12.46, -1.09%) is up 4% over the same period.

Steep discounts, which have been eating away at profit margins and forcing some grocers to change their promotional tactics, show no signs of abating.

"In my 30-plus years in retail, I've never witnessed the intense level of price reductions and promotional activity now occurring," Supervalu Chief Executive Craig Herkert said this week.

Behind all this are tight-fisted consumers, deflation and the highest U.S. jobless rate in a generation. The pain from weak growth in same-store sales goes straight to the stock price.

At the same time, the established players are facing stiff competition from discounters like Wal-Mart Stores Inc. /quotes/comstock/13*!wmt/quotes/nls/wmt (WMT 53.67, -0.54, -0.10%) , Costco Wholesale Corp. /quotes/comstock/15*!cost/quotes/nls/cost (COST 58.78, +0.06, +0.10%) and Target Corp. /quotes/comstock/13*!tgt/quotes/nls/tgt (TGT 50.19, +0.09, +0.18%) , who have been adding groceries aggressively to their overall line of merchandise.

Hapoalim Securities analyst Ajay Jain isn't betting on a swift recovery. "For food retailers, [sales trends] tend to be very closely linked to the employment cycle. Without significant improvement in the nonfarm payroll data or wage growth, a sales or margin recovery is unlikely to shape soon," he said.

Stock valuations are nearing 2001-02 levels, the last time grocers hit rock bottom after consumer spending slowed. Yet Wall Street analysts remain cool to the sector.

Price wars will weigh on supermarkets for at least another six months, commented Pali Capital analyst Bob Summers: "Everyone will continue to fight for that dollar."

Based on consensus long-term stock-price targets, analysts are forecasting slim gains over the current share price levels for Safeway and Supervalu. Kroger is considered more of a safer bet, with 61% of analysts covering the grocer recommending the shares.
Who's shopping

It's a tough stock call on the grocery business, according to Vitaliy Katsenelson, portfolio manager at Investment Management Associates, a value investor. He is considering whether to invest in the sector again; his firm sold its Supervalu shares when the chain cut its dividend 50% in October.


"The price wars concern me the most," said Katsenelson, author of the Contrarian Edge blog. "It seems that the rest of the retail industry is stabilizing, but I'm not sure if it is getting better or worse" in the grocery business.

There have been some recent buyers of supermarket stocks. On Friday, Supervalu's Herkert purchased 25,000 shares of his grocery chain in an open market transaction.
In another regulatory filing Friday, investment firm Manning & Napier Advisors disclosed it purchased 7 million Kroger shares and 6.8 million Safeway shares during the quarter ended Dec. 31. The firm couldn't be reached for immediate comment.

A big question is how much the price wars eat into future cash flows at supermarket chains, added Katsenelson. Supermarket chains have been using existing cash to run promotions and lower shelf prices on everyday foods.

Supervalu, which runs the Albertsons, Jewel-Osco and Sav-A-Lot chains, gave investors something to cheer about Tuesday. It reported its gross margin was more stable for the quarter ended Dec. 5 compared with the past two periods.

But sales at stores open one year worsened, falling 6.5%. Minnesota-based Supervalu said customer count declined 2% and the average basket size fell 4.5%.


The company decided to forgo some promotions to preserve its operating margin. Supervalu also is in the process of cutting back on the number of products it keeps on its shelves.

"Price tactics once used to drive foot traffic and tonnage are now driving lower transaction size and margin erosion," Herkert said.

Shoppers are cherry-picking promoted items, according to the Supervalu chief executive. In the past, grocers used to lure in shoppers with a big sale on meat or fish and count on the shopper to pick up other items before heading checking out.

The hyperpromotional climate is forcing Greater Atlantic & Pacific Tea Co. /quotes/comstock/13*!gap/quotes/nls/gap (GAP 8.76, -0.41, -4.47%) , which runs chains A&P and Pathmark, to overhaul its pricing strategy.