Note: All data are as of market close, Wednesday, October 22, 2014.
The grocery store industry's behavior both during and after the recent economic crisis is a fascinating one to watch, as it perfectly illustrates how consumers' habits change during hardships.
Although the grocery store industry belongs to the Services/Consumer Staples sector of the market, not all store chains within the space behave like consumer staples. Some of the more specialty grocery stores - such as those that focus on organic foods - actually behave more like consumer discretionaries in that they are often sacrificed during times of economic hardship, something you wouldn't expect from a staple but would from a discretionary.
This is clearly evidenced by the following graph spanning the economic crisis from June 2007 to March 2009. Where the broader market S&P 500 index [black] lost 55% of its value during that time, the SPDR Consumer Staples ETF (NYSE: XLP) [blue] lost only 30% of its value, consistent with what you would expect from the less volatile and more necessary staples sector.
Yet over that period, the three largest U.S. Grocery Store companies - The Kroger Company (NYSE: KR), Whole Foods Market, Inc. (NASDAQ: WFM) and Safeway Inc. (NYSE: SWY), which are all components of the SPDR Consumer Staples ETF - ended up separating themselves according to which was considered a consumer need and which was considered a consumer want. Where consumer need chains like Kroger [beige] and Safeway [orange] fell less than the S&P with losses of 37% and 52% respectively, organic specialty chain Whole Foods [purple] behaved more like an expendable want, falling more than the broader market with losses of 71%.
Source: BigCharts.com.
The opposite occurs when the economy revives, as consumers feel more confident with their income and will once again splurge on their wants, as evidenced in the graph below. Since the economic recovery began in early March of '09, where the S&P and consumer staples fund XLP have risen 187% and 135% respectively (again, staples are less volatile, losing less going down and gaining less going up), Safeway rose 120%, Kroger rose 178%, while Whole Food catapulted 550%.
On an annualized basis, where the S&P broader market has averaged 33.49% and the consumer staples fund XLP has averaged 24.18%, Safeway has averaged 21.49%, Kroger has averaged 31.88%, while Whole Foods has averaged 98.51% per year!
The lesson for investors, of course, is that even within the staples sector, companies will perform according to how specialized they are. The more niche their market is, the more discretionary-like they will perform.
Source: BigCharts.com.
Looking forward, the grocery store industry is expected to outperform the broader market S&P substantially over the near term and moderately over the longer term as tabled below, where green indicates outperformance and yellow denotes underperformance.
Zooming in to the industry, our three highlighted stocks of Kroger, Whole Foods, and Safeway are expected to put-in a split performance, with the once lagging Safeway outperforming the others in 2015. Yet all three chains are seen underperforming their industry peers over the next five years.
Compared to the overall broader market, however, our three largest grocery store chains are seen faring much better. Whole Foods' underperformance over the near term is likely an indication that the economy is expected to tighten up just a little in 2015, likely due to the expected first rise of interest rates. Yet once the markets settle down into a steady rising interest rate environment, all three chains should gradually outperform the broader market, with Whole Foods once again leading its peers with higher growth.
But there is more than earnings growth to consider when sizing up a company as a potential investment. How do the three compare against one another in other metrics, and which makes the best investment?
Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best performing company will be shaded green while the worst performing will be shaded yellow, which will later be tallied for the final ranking.
A) Financial Comparisons
Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.
Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.
In the most recently reported quarter, Kroger provided the greatest revenue and earnings growth, while Safeway saw its earnings shrink.
Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes and depreciation.
Of our three contestants, Safeway operated with the best profit margins by a wider degree, while Whole Foods had the best operating margins. Kroger and Safeway split the last place spots between them.
Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.
In returns on assets, Whole Foods' management team outperformed the others by a significant degree, while Kroger's management team outperformed the others significantly in returned on equity. Safeway's team, however, generated the least returns in both categories.
Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders, as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.
Of the three companies here compared, Safeway provides common stock holders with the greatest diluted earnings per share gain as a percentage of its current share price, and to a substantial degree, while Whole Foods provided the least DEPS percentage with Kroger not far ahead.
Share Price Value: Even if a company outperforms its peers on all the above metrics, however, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value come under scrutiny, as well as the stock price relative to earnings relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.
Among our three combatants, Kroger has the cheapest stock price relative to forward earnings and 5-year PEG, while Safeway has the cheapest price relative to company book value. However, the two companies swap standings as most overpriced stocks in the reciprocal categories.
B) Estimates and Analyst Recommendations
Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell recommendations.
Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.
Of our three specimens, where Safeway offers the best earnings percentages over stock price in the current quarter, it offers the worst earnings percentages beyond where the best percentages are with Kroger.
Earnings Growth: For long-term investors this metric is one of the most important to consider, as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.
For earnings growth, Safeway offers the best growth rate over the immediate term and in 2015, while Whole Foods offers the best growth over the next five years, indicating the relative strength of the economy overall going forward due to Whole Foods' behavior as more of a discretionary than a staple as explained above.
Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.
For their high, mean and low price targets over the coming 12 months, analysts believe Safeway's stock has the least upside potential and also the least downside risk, while Whole Foods is seen having the highest upside potential where Kroger has the greatest downside risk.
Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up are analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.
Of our three contenders, Kroger is the best recommended with 8 strong buys and 6 buys representing a combined 63.63% of its analysts, followed by Whole Foods with 7 strong buy and 5 buy recommendations representing 35.30% of its analysts, and lastly by Safeway with 0 strong buy and 1 buy rating representing 8.33% of its analysts.
C) Rankings
Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.
In the table below you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.
The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes count as demerits.
And the winner is… Kroger by a narrow lead, outperforming in 11 metrics while underperforming in 9 for a net score of +2, followed closely by Whole Foods in second place, outperforming in 7 metrics and underperforming in 7 for a net score of 0, and by Safeway not far behind, outperforming in 13 metrics while underperforming in 15 for a net score of -2.
Where the grocery store industry is expected to outperform the S&P broader market substantially this and next quarters, and moderately in 2015 and beyond, the three largest U.S. companies in the space are expected to continue the growth they have experienced since the recovery began several years ago. Yet the high flying Whole Foods will likely not soar as high above the others as the economy tightens a little from gradually rising interest rates over the next few years. Even so, as all three chains outgrow the broader market, Whole Foods is still expected to lead them by a slight degree.
Yet when taking all company fundamentals into account, Kroger stands first among its peers given its best stock price value, best trailing revenue and earnings growth, best returns on equity, best earnings per share as a percentage of current stock price, and best analyst recommendations - handily winning the grocery store companies competition.
