2012 Outlook For Food And Drug Retailers, Part 2

 |  Includes: ESRX, KR, MS, RAD, SVU, SWY, SYY, WBA, WMT
by: Insider Monkey

Morgan Stanley’s research analyst Mark Wiltamuth and his team published a report titled “Retail, Food and Drug - 2012 Outlook: Stock Picks for Another Tough Year” on Dec 15, 2011. The report isn’t publicly available but we will summarize the main points.

Morgan Stanley analysts have analyzed US based retailers and have identified stocks amid tough industry dynamics. Their report screens defensive, growth and value stocks in the industry. Morgan Stanley believes that under weak economic environment, defensive stocks should be chosen, while TGT remains the most attractive value buy at this point in time. Here are six of the stocks discussed in the article (see part 1).

Rite Aid (NYSE:RAD) has been given an ‘Underweight’ rating by Morgan Stanley (NYSE:MS), with a price target of $1. Rite Aid can benefit if Walgreens’ and Express Scripts’ (NASDAQ:ESRX) partnership breaks. The company has 28% of its stores in Walgreens’ (WAG) vicinity. The company is underperforming its peers; it is over-levered and already trading at expensive relative valuations. Moreover, long-term concerns may materialize in case the Express Scripts-Medco merger goes through.

Kroger (NYSE:KR) has been given an ‘Equal-weight’ rating by Morgan Stanley, with a price target of $23. Morgan Stanley believes that grocery industry will not be able to promptly pass increases in food prices which are likely to persist in 1H12. This inability of the grocers will shrink margins, while rise in food prices would keep volumes flat. Kroger is outpacing the industry with 5% same store sales growth and its strategy to invest in low price mix products will maintain the growth going forward. Kroger is most likely to post 8-10% growth in 2012 EPS, however risk/reward does not seem attractive.

Safeway (NYSE:SWY) has been given an ‘Equal-weight’ rating by Morgan Stanley, with a price target of $21. The company has been focusing on remodeling its stores and reduced prices in its key markets. Company pursues a differentiation strategy which is not likely to yield sustainable results, unless the economy improves. The stock has an attractive 10% free cash flow yield. Safeway can buy back shares too. However, company’s EBIT has been on a declining trend and valuations remain very low (EV/EBITDA at 5.0x).

Supervalu (NYSE:SVU) has been given an ‘Under-weight’ rating by Morgan Stanley with a price target of $7. The company has been facing sequential declines in traffic over the last 11 quarters. Sales volume decreased by 6.3% in the last quarter. The company has also been working on maintaining competitive pricing. Supervalu isn’t expected to experience financing problems due to the near term debt maturities. Elm Ridge Capital is bullish about Supervalu though. Ron Gutfleish’s hedge fund had $33 million in SVU shares and $13 million Supervalu call options at the end of September.

Wal-Mart (NYSE:WMT) has been given an ‘Equal-weight’ rating by Morgan Stanley. The comparable sales are improving for Wal-Mart, helped by SKU add-backs and price increases. However, the pressure on gross margins, negative growth in traffic at its stores, and industry-wide inflation will prove to be bigger challenges for 2012. Billionaire Warren Buffett had more than $2 billion in Wal-Mart at the end of September (see Warren Buffett’s top stock picks).

Sysco (NYSE:SYY) has been given an ‘Equal-weight’ rating by Morgan Stanley. Sysco faces challenges similar to those faced by its competitors. Its sales volume is flat and its inability to pass on food inflation effectively compresses its margins. Sysco’s SAP spending is also hitting its bottom line in 2012. The company’s business transformation spending will negatively impact the earnings by ~0.27$/share in 2012 vs. $0.11/share in 2011. However, ERP spending will eventually yield cost savings to the company. First Eagle Investment Management had more than $500 million invested in Sysco at the end of September.

Disclosure: I am long MS.