Grocery Stocks: Fallout Coming in Highly Competitive Industry

Grocery store stocks do not receive a lot of coverage in the market, and have underperformed in the recent rally for the most part. This trend is likely to continue as rising commodity costs crimp margins and hurt earnings across the board, while a few should be able to gain market share and set apart from the rest.

Although food is a necessity in any economic condition, consumer spending is a major determinant in the quantity bought, as well as where shoppers head. Less traditional grocers such as WalMart (WMT) and Target (TGT) will continue to put pressure on the conventional grocery stores that are unable to compete on a pricing basis. Also, the bulk distributors such as CostCo (COST) and BJ’s Wholesale (BJ) are also a going concern for the traditional grocers.

The fierce competition, slowing consumer spending, and rising commodity prices further constricting gross margins are unable to withstand the benefits from consumers choosing to have more meals at home, a factor that has hurt many of the restaurant stocks.

Looking at many of these companies it appears that the impact of the conditions described above has not been priced into future earnings expectations, and the stocks have room to fall. The main things to look for in the individual companies are competition, product mix, target market, and supplier price negotiation. The well managed companies will be less impacted by rising commodity costs, and will not pass as much on to customers due to above par operational efficiencies.

There are 10 grocer stocks that have a market cap exceeding $300M and trade more than 50,000 shares a day; Casey’s General (CASY), Pantry (PTRY), Kroger (KR), Ruddick (RDK), SuperValu (SVU), Safeway (SWY), Whole Foods (WFMI), Winn-Dixie (WINN), Weis Markets (WMK), and a Brazilian firm, Companhia Brasileira de Distribuicao (CBD).

On a strict valuation basis, Whole Foods trades 22X forward earnings and Winn Dixie trades 34X forward earnings, the two most expensive in the group although many see Winn Dixie as a potential acquisition target and Whole Foods is a niche player. Therefore, Weis Markets, Ruddick, and Casey’s General look to be the priciest on an earnings basis.

Pantry looks to be a nice value and growth play in the group trading 5X trailing earnings, 0.05X sales, 1.66X cash, and a PEG of 0.35. However, the firm is highly leveraged with Debt/Equity of 2.88, which could be a concern as earnings growth slows.

Kroger, Pantry, and Casey’s General look to be the most well managed firms based on profitability ratios such as ROA, ROE, and margins.

Through the process of elimination, Ruddick, SuverValu (SVU) and SafeWay look to be the names in trouble, and therefore the best targets to short. Weis Markets is one to be shorting on a technical analysis basis, as shares are showing bearish divergence and have gotten way ahead of itself.

CBD would be the high risk/high reward play as it is growing extremely fast in Brazil, and has rallied substantially off its lows.

While Grocery Stores may not be the flashiest group of stocks to trade, there is the potential of nice gains based on a simple comparison in the group. A pair trade strategy could be employed, going long a non-traditional name like CostCo and short one of the weaker names like SuperValu.

Whether the economy is recovering or not, it is clear that struggles are ahead for the traditional grocery stores, and the valuation is not reflective of that yet, giving investors the potential to be ahead of the Street.

Disclosure: No ownership of the stocks mentioned above.

Comments

[User 402353:]

Obviously including PTRY and CASY as full line groceries shows how littel research went into this article

Jun 15 09:12 AM

[Joe Kunkle:]

Will face the same problems...that is why they are included


On Jun 15 09:12 AM User 402353 wrote:

> Obviously including PTRY and CASY as full line groceries shows how
> littel research went into this article

Jun 15 12:54 PM

[CBTeas:]

"By process of elimination" now qualifies as research? At least in the case of SVU, they have taken advantage of the recent improvement in the capital markets to rework their balance sheet. I am not sure how you come up with your pair trade idea other than throwing a few wet fingers in the air. Pass.

Jun 16 12:13 PM

[satyr:]

There are several points here which are either unsupportable, or have been arrived at through faulty logic. I will not attempt to address all of them, but here a few.

1) There is an implied assumption that retailers cannot raise prices or size down product in order to favorably impact margins.

2) The statement that "it appears that the impact of the conditions described above has not been priced into future earnings expectations" might have made some sense had it been written 6 to 12 months ago. We are currently living in recessionary times, so unless you are predicting that the economy will weaken significantly from here, it is more appropriate to use current conditions as a proxy for short-term future conditions.

3) Wal-mart and Target have been competing with mainstream grocery for quite some time. They have something to offer (price), but don't compete well in terms of convenience or quality. There are very large market segments that will not purchase groceries (or anything else) in those stores, because of the negative customer experience.

4) Whole Foods has essentially been pardoned in this analysis because they are a niche player. How does being a niche player justify a higher valuations? If you are going to use PEG, ROA, PE, et cetera to make decisions, the use them.

5) I am not familiar with some of these companies, so I can't speak to whether or not they are well-managed or what their prospects might be. I do follow SWY, and while I would not necessarily suggest that they are the best long play in the market, I think that they are one of the worse choices available as a short.

Jun 16 03:47 PM

[NeverShort:]

"Grocery store stocks do not receive a lot of coverage in the market, and have underperformed in the recent rally for the most part. This trend is likely to continue as rising commodity costs crimp margins and hurt earnings across the board, while a few should be able to gain market share and set apart from the rest."

You are correct; grocery store stocks do not receive a lot of coverage in the market. I don't know where you've been, but this is nothing new. That you still throw Wal-Mart and Target into a conversation about traditional grocers makes me wonder if you even did any research. First the SuperCenter was absolutely going to sound the death knoll. "...Grocers on life support... just a matter of time. Short is a sure bet..." Wal-Mart's Neighborhood Market grocery stores were next. They were so sure of themselves, the blueprints for each store came attached to a crate of vultures to be released over the competition. Need I go on??

An important point you failed to make is that Kroger (and to a much lesser extent, Safeway) manufactures many of its private label products in company-owned facilities. This economic environment moves consumers toward those products, which have a lower transactional price, but contribute much more profit. People who don't understand this dynamic get lost in the "grocery-store-comps-s... short's-a-good-bet Wal-Mart's-got 'em-nailed-to-the-floor" mindset and keep writing the same crap over and over again.

Is it really that difficult to do a little research?

Jun 23 07:38 AM

[Joe Kunkle:]

SVU cuts Q1 guidance today, shares fall 11%+

Jun 24 08:57 AM

[Canstacker:]

Ruddick is a sinking ship - the high end grocer is taking on water fast

Jun 30 01:55 PM

[Delta Don:]

EXPLAIN PTRY DROP OFF IT''S YTD HIGH/?

Jul 04 08:29 AM

[H.J. Huneycutt:]

Good attempt here, but I think the author neglects a lot. On a valuation basis, the three grocers that the author mentions as being 'in the most trouble' happen to be the three most attractive buys in the sector. Ruddick (RDK), in particular, looks very cheap to me and has been growing over the past few years, with strong cash flows.

You have to pay a ridiculous premium to get into Whole Foods (WFMI) right now. Winn Dixie (WINN) stores are terribly run and that once great chain has been run into the ground. The author fails to mention the Great Atlantic & Pacific Tea Company (GAP), which has been in considerable trouble, but may pull out.

The Pantry (PTRY) isn't a grocery chain; they are a convenient store chain and face different risks. In particularly, PTRY doesn't really compete with Wal-Mart or Target; they market themselves on "convenience" (as the name implies) so they really compete more against the economic conditions and other convenience stores; not Wal-Mart or grocers.

I think long Ruddick and short Whole Foods might not be a bad pair trade right now. Shorting RDK, SWY, or even SVU right now would not be a great bet. I realize the author wrote this in June when they were a little more expensive, but I think it's completely possible that all three are undervalued right now.

Aug 09 02:55 PM