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The grocery and supermarket industry continues to be highly competitive with rising commodity prices and competition for shopper traffic serving as strong headwinds to improved profits. However, the consumer does appear to be willing to spend more and that has many retailers and food companies being generally optimistic for 2011.

Through our work with leading food industry companies we have identified six major trends or themes that we believe will most impact the supermarket industry in 2011. While we are generally positive about prospects for food retailers and food manufacturers (not so much for consumers), we do believe the successful companies will have to positively navigate these issues in order to deliver above average profitability. The consumer is still king and the inclination to “buy on deal” is as strong as ever.

Food Is Everywhere
The long term macro trend of “Channel Blurring” continues to gain traction. Food and grocery products are everywhere and are being sold in almost every store format including dollar, drug and general mass merchandise stores. Dollar store leaders Dollar General (NYSE:DG), Dollar Tree (NASDAQ:DLTR) and Family Dollar (NYSE:FDO) continue to expand their food offerings. Leading drug stores CVS (NYSE:CVS) and Walgreens (NYSE:WAG) have been featuring more fresh items like milk and bread to drive store traffic. Target (NYSE:TGT) continues to expand its Pfresh format to its general merchandise stores and it Is clear the company is impacting sales at many of Super Valu’s (NYSE:SVU) stores in the Midwest. With food being everywhere the options for consumers are many. This competitive activity should help keep a lid on food inflation in 2011.
Rising Prices Are Here to Stay
Since the summer of 2010, food commodity prices for grains, dairy, coffee, sugar and other key ingredients have been on a tear. Total basket of commodity costs used in the making of food products is up over 20% vs. 2009 levels. Most food companies were hedged in 2010 thereby delaying the impact of rising commodities. Unfortunately most of those hedges are now expiring so they have no choice but to pass on price increases to the consumer. Many of the major food companies including Kraft (KFT), General Mills (NYSE:GIS) and Kellogg’s (NYSE:K) have announced price increases and we expect another round in the second half of 2011 if commodities stay at or above current levels. Private label also faces the same commodity pressures so you can expect retailers and private label guru’s Treehouse (NYSE:THS) and Ralcorp (NYSE:RAH) to pass through higher prices.
Private Label Goes More Upscale
Continue to expect food retailers to act more like brands with their product offerings. This includes higher quality and higher priced private label along with more upscale packaging and variety choices. Retailers will continue to push private label so they can attract value orientated consumers but in many cases private label will not only be the “extreme value” option but will also have a” brand alternative” and a “super premium better than the brand” product line. Many of the Natural and Organic products from Whole Foods (WFMI), Safeway (NYSE:SWY) and Kroger (NYSE:KR) fit this description. The success of these products will depend on how well the products deliver on the value equation.
Value = Quality + Price
Health and Nutrition Products Go Mainstream
The consumer finally appears ready to put their money where their mouth is when it comes to buying “better for you “products. Some of it may be that food companies finally have got the taste factor right to go with the better nutrition products. We are also seeing an improvement in trend in Natural and Organic products and we think this is closely related. Consumers are willing to pay a premium for differentiated brands that provide a meaningful benefit and usually that is in the form of better nutrition and quality. Snack Food manufacturer Diamond Foods (NASDAQ:DMND) has done a nice job expanding its Kettle Foods Potato Chip and Emerald Nuts brands showing that you don’t have to be Organic to command premium prices vs. competition. The yogurt market from by General Mills and Dannon has also grown strongly through the introduction of probiotics that help the immune system. Even Wal Mart (NYSE:WMT), the low price leader, has announced that it will be stocking more better for you products available to consumers. Americans are finally starting to eat more nutritious food products.
Safety First
The new FDA legislation and regulation for the food industry will be a dominant theme for food manufacturers and retailers in 2011.Expect all major food companies to get ahead of the key provisions of this legislation. This will mean more food safety testing, plant inspections and tracking of ingredients from foreign sourcing. Testing companies like 3M (NYSE:MMM), Dupont (NYSE:DD), Neogen (NASDAQ:NEOG) and many others should see increased activity as major food manufacturers triple check that all their manufacturing processes are state of the art. We also see some additional costs for major ag services companies like ADM (NYSE:ADM), Corn Products (CPO), Cargill and Bunge (NYSE:BG) but ag services and food ingredient companies should do well in this environment, driven by the need for higher quality ingredients with better nutrition characteristics.
Mergers and Strategic Acquisitions Will Increase
Competition remains intense. One of the best ways to drive profits and lower operating costs is to make 2+ 2= 5. Green Mountain (NASDAQ:GMCR), Treehouse Foods, Diamond Foods, Ralcorp and Kraft have all grown through strategic acquisitions. Look for several large food companies to divest non strategic businesses while also pursuing acquisition candidates that are better strategic fits.
Companies like Smucker’s (NYSE:SJM), General Mills, Campbell Soup (NYSE:CPB), Green Mountain and whatever is left of Sara Lee may also be considered as targets by global giants Nestle (OTCPK:NSRGY) and PepsiCo (NYSE:PEP).The coffee market looks especially ripe for activity and consolidation with Starbucks (NASDAQ:SBUX) flexing its muscle and midsize companies like Peets (NASDAQ:PEET), Green Mountain and Caribou (NASDAQ:CBOU) having the need for strategic partners.
All in all we are generally very positive on the outlook for consumer food, food ingredient, agricultural services and even some food retailers for 2011.The return to normal (albeit likely at the high end) food inflation levels of 2-3% annually is a better pricing environment than the heavy price competition of 2009 and 2010. Most companies should be able to navigate through higher commodity prices by improved productivity programs as well as pass through pricing to the consumer. Good for food manufacturers and retailers ... Not so good for the consumer.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Source: 2011 Supermarket Trends: Good for Food Manufacturers and Retailers, Tough for Consumers