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(Pat Sullivan)
(Pat Sullivan)

VOX

The great U.S. grocery rally hits a soft patch Add to ...

It was double-coupon days for U.S. grocers last week, as concerns about the nation’s consumers clipped a buck or two from the prices of the major food retailers’ shares – yet it may not be the buying opportunity you think.

Kroger Co., Safeway Inc., and Supervalu Inc. have been, to varying degrees, on the recovery path since the Great Recession, all improving their sales records as shoppers moved past the worst of the downturn. And investors have given them credit for it: All three were up at least 25 per cent from their 52-week lows, with Kroger and Safeway near their highs before last week’s pullback.

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Yet their comeback trail is far from clear. Even if you view last week’s disappointing U.S. jobs figures as an anomaly, all three now must continue to manage commodity inflation by deciding how much of the rising costs can be passed on to their grumpy customers. So far, they have met that recent challenge by absorbing some of the pain in their own margins.

At the same time, the great competitive threat of Wal-Mart Stores Inc. and Target Corp. is still not fully realized, as the retail giants continue the renovation and building campaigns that are making them major sellers of edibles. (Alton Stump, an analyst at Longbow Research, estimates Target has been remodelling roughly 400 stores per year to introduce perishable food, while Wal-Mart has completed the task at half of its store base and is moving even faster.)

The one-two punch of cost inflation and discounter competition may prove to be painful. Analyst Scott Mushkin of Jefferies & Co. Inc. tracks grocery prices in large American cities; he says his May survey shows Wal-Mart is “holding the line” on price increases, with April-to-May declines in Atlanta, Boston, Chicago and Philadelphia.

The pricing environment has led Kroger, Safeway and Supervalu to suck up some of the wholesale price increases themselves. Mr. Stump of Longbow said Kroger and Safeway have successfully passed on “vendor-driven list increases” in dry food and household and personal product categories, but all three have had to absorb some of the increases in perishables such as produce, dairy and meats. Supervalu passed along “far less” of the perishables’ price increase than the other two in a mixed effort to boost traffic.

Kroger, of the three, is seen by many as the best near-term and possibly long-term play. It has a reputation for value in its stores, having been among the first to react to Wal-Mart’s grocery entry through price-cutting of its own. “Kroger is one of the few grocers that has been able to sustain industry leadership over time,” says Deborah Weinswig of Citigroup Global Markets Inc., noting the company has maintained a No. 1 or No. 2 position in each of the markets it competes in since 1987.

Kroger posted positive same-store sales growth throughout 2010, while comparable figures for Safeway turned positive in the first quarter of this year. (Supervalu’s same-store sales numbers still have not turned positive.)

Safeway was perceived as slow to react to consumer distress in 2009 with lower pricing – it was the second-biggest loser of market share that year, after Supervalu, according to Citigroup’s Ms. Weinswig. At the same time, however, the company “skews to the above median income consumer who is more able to withstand higher prices,” says Jefferies’ Mr. Mushkin.

The near-term trouble spot for Safeway is its California base, where it has one-third of its stores. The company faces competition from higher-end grocers on one side and a Wal-Mart rollout on the other.

Supervalu has the most problems. It has significant debt from its 2006 purchase of hundreds of Albertson’s locations, making it less nimble than its peers.

While nearly half the company’s stores are from their discount chain Save-A-Lot, the other half have problems being price-competitive. (Mr. Mushkin said his survey suggests the company’s chains Acme in Philadelphia, Shaw’s in New England and Jewel in Chicago are priced 21 per cent, 20 per cent and 14 per cent, respectively, above Wal-Mart, and the spread has been widening.)

With last week’s pullback, Kroger is now trading about 12 times forward earnings, according to Standard & Poor’s CapitalIQ, a little less than Safeway. That suggests Kroger is the choice if you want to put a U.S. grocer on your next stock shopping list, with California grocer Safeway more suitable for a later trip to the store. Supervalu, while comparatively cheap at about seven times earnings, may be past its sell-by date.



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