After years of outperforming the market, stocks of publicly traded grocers and food wholesalers are suffering from a massive case of indigestion.
Wall Street has taken a giant bite out of stocks of some of the industry’s major players, including Kroger (New York Stock Exchange: KR), Albertson’s (NYSE: ABS), Safeway (NYSE: SWY) and Winn-Dixie Stores (NYSE: WIN). The stocks of these publicly traded grocers have lost anywhere from 12 to 50 percent of their value over the past 12 months.
Is this a temporary hiccup or indications of more permanent heartburn?
“There have been a number of events that scared investors out of the group while money was flowing away from modest- to medium-growth stocks into the technology sectors,” explained Charles Cerankosky, an analyst with McDonald Investments in Cleveland. “Food retailers, after years of outperforming the market, had a terrible year.”
The industry as a whole continues to consolidate as larger grocers swallow smaller chains in an effort to gain economies of scale. Wholesalers are also getting into the retail business, buying small- and mid-size grocery chains in an effort to secure their distribution base.
No one seems to have much appetite, though, for buying cans of peas and Cling peaches via the Internet. Web-based grocers such as Webvan Group Inc. (Nasdaq: WBVN), Streamline.com Inc. (Nasdaq: SLNE) and Peapod, Inc. (Nasdaq: PPOD), now owned by Royal Ahold of Holland and facing a spate of shareholder lawsuits. Cerankosky said that on-line buying is “horribly overhyped” and “horribly complex,” but that hasn’t stopped Safeway from investing a cool $30 million in groceryworks.com.
“All the grocery stores are testing it, but nobody’s making any money at it, and they don’t have a prayer of making money anytime soon,” Cerankosky said. “If anybody succeeds, it will be the food retailers who have these old-fashioned things called stores.”
The grocery industry, which topped $450 billion last year, is growing at a rate of 2 percent. Analyst Mark Husson with Merrill Lynch in New York said that’s not surprising in food retailing. “People aren’t eating more than they were last year, and if they are, it’s in restaurants.”
That partially explains why the valuations of food retailers hover at 20-year lows while the real earnings growth of this sector continues to post 20-year highs, he said. Retailers also face a lack of inflation in terms of food prices and tight labor markets, which pushes up their costs of doing business. Neither is an appetizing prospect for investors.
“What is very exciting is there are a few large companies that are consolidating the industry,” Husson said. “The top five food retailers only account for about 33 percent of grocery sales in America.”
And that means there’s plenty of room for further mergers and acquisitions, Husson and other experts say. Cerankosky said that wholesalers are also getting into the act and buying retail food chains as the industry’s major players invest in operating systems, front-end merchandising and logistics that lead them to realize “considerable economies of scale” that weren’t available even a decade ago.
“Kroger bought Fred Meyer, Safeway is looking, and Food Lion has the acquisition of Hannaford Brothers pending,” Cerankosky said. “I think we’ve probably done most of the big deals, but we’re still going to see the regional markets consolidate.”
Ohio-based Kroger has spent the past eight months integrating 140-plus stores acquired when it bought Fred Meyer in Oregon. Cerankosky rates Kroger a strong buy, praising the Fred Meyer acquisition as a truly synergistic move that “combines the strengths of both companies.”
Husson rates Kroger a buy, noting that the nation’s largest food retailer has very strong return on assets and continues to perform well.
Food Lion’s parent company, Delhaize America Inc. (NYSE: DZA, DZB), expects to finalize its acquisition of Hannaford (NYSE: HRD) in the second quarter, after completion of the federal antitrust review process. Cerankosky gives his nod to that deal as well, noting that Hannaford brings strong management, a great store format and solid market share in New England to Delhaize, further strengthening its position.
Traditional grocers have been increasing their merchandising categories by executing what Cerankosky calls a “food and drugstore format.” The offering of non-traditional products and services, such as prepared foods, video rental, pharmacy and seasonal products, has become sophisticated over the years and evolved to serve specific niche markets.
“You’ve seen a lot of non-grocery offerings enter the mix of products offered,” Cerankosky said. “That combination food and drugstore format is much more than just a supermarket; it touches consumers with a lot of offerings. Systems are allowing chains to get better at fine-tuning that mix, to make sure they hit a particular price point or that they have the breadth of product for a specific ethnic mix in a market.”
He pointed to Jewel-Osco, the Midwest retailing arm of Albertson’s, as one retailer that does a particularly fine job in this arena. But Idaho-based Albertson’s has had some difficulties with its integration of American Stores.
Analyst Allison Hamilton from Pacific Crest in Portland, Ore. rates Albertson’s stock as “market perform,” noting she’s doubtful whether the grocer has the experience to integrate an acquisition on “such a huge scale.”
Andy Wolf, a research analyst for BB&T Capital Markets in Richmond, Va., holds Albertson’s in a much higher regard, rating the stock as a strong buy and his top pick in the grocery industry.
“It’s in an interesting position because it’s an out-of-favor stock and it has the cheapest valuation, but I think it did the best acquisition so I think it actually has the most upside,” Wolf said. “It’s the one stock with really significant appreciation potential.”
Grocery retailers have all begun experimenting with on-line selling, joining the ranks of Webvan.com, Peapod.com and Streamline.com. Hamilton said that brick-and-mortar retailers are in a much better position than pure-play Internet companies to capitalize on Internet grocery buying. She sees it as an additional sales channel, though one that won’t add 10 percent to any company’s top-line growth.
Peapod.com’s stock has plummeted in the past few months, down $6 from March and more than $10 from a year ago. It also faces several shareholder lawsuits. But the downslide in value doesn’t have analyst George Dahlman worried long term. The analyst for Minneapolis-based Piper Jaffray, Inc. rates the stock at neutral.
He said that the focus on technology has hurt the on-line grocery sector for the time being, but he’s confident that investors will see the value in companies like Peapod.com down the line.
“On-line grocers are grabbing very little of the market right now,” Dahlman said. “But in four to five years, I see them attaining a significant share. It’s going a lot slower than people thought.”
