Price cuts:
A looming grocery-store price war could be good for shoppers but hard on retailers
A looming grocery-store price war could be good for shoppers but hard on stores.
Back around 2009, when the rest of the nation was distracted by the steep recession and the threat of a financial meltdown, supermarket chains slugged it out in a price war focused on grabbing market share even at the expense of profit margins. Some grocery-industry observers see another price war looming, which could benefit shoppers but would be tough on retailers. ¶ Research analysts at Credit Suisse this month pointed to a “much more aggressive promotional environment” at grocery stores amid what has been a year of flat to lower prices. “The current landscape is now beginning to look a lot like 2009, when meaningful deflation resulted in an industry price war and multiple quarters of declining earnings,” the analysts warned. ¶ While a price war could be good for shoppers, retailers already are struggling. Sprouts Farmers Market, the Phoenix-based chain of stores focused on fresh, healthy and organic foods, this month warned of “significant ongoing deflation” that has resulted in more profit-eroding promotions and a tempered outlook for the rest of 2016, and perhaps beyond. The trend imperils the company’s streak of 37 consecutive quarters of sales increases at comparable stores, excluding expansions.
Grocery-store deflation already is happening. Average prices for the food that Americans consume at home slipped 1.9 percent over the past year through August, the U.S. Bureau of Labor Statistics reported. Prices have been especially weak for meat, poultry, fish, eggs, dairy products, cereals and bakery items. In contrast, restaurant prices, for food consumed away from home, have risen 2.8 percent over the past 12 months.
Familiar trend in economy
Persistent low inflation over the past several years isn’t focused solely on the supermarket industry. Stagnant wages have kept workers from gaining ground economically. Retirees have struggled to make ends meet with low yields on deposit accounts. Corporations have labored to maintain profit growth amid flat revenue. But flat to declining prices pose a special challenge in the grocery business, where sales volume counts heavily because profit margins are so thin.
Perhaps the silver lining for retailers is that they have been through it before.
“At Sprouts, we have operated and managed through similar competitive and deflationary periods,” said Amin Maredia, the company’s chief executive officer, in a statement earlier this month. Sprouts is focused on “accelerating traffic and sales in the current environment,” he added.
The tough competitive landscape is likely to lead to more promotions, retail analysts say. For example, special sales at Sprouts include those centered around vitamins, “buy one, get one free” offers, frozen foods and double the normal value of coupons on Wednesdays. “Up to one-third of the store is on promotion at any time,” said Diego Romero, a Sprouts spokesman.
The Phoenix corporation is one of Arizona’s top 100 non-government employers, with just under 4,000 in-state jobs and about 24,000 across the nation. The company remains relatively healthy, with double-digit sales and profit growth, helped by store expansions, noted Zachary Fadem, a senior analyst at Wells Fargo Securities. Still, he calls the current environment “challenging” and recently cut his profit outlook for Sprouts, for this year and next.
Anxiety wasn’t apparent last week in Mesa, when Sprouts cut the ribbon on its 250th store nationwide, offering extra savings to customers who arrived early. Several-dozen people lined up for special promotions before the store opened at 7 a.m., and hundreds more dropped by later in the day. Shopper Pam Bartlett, a programmer who lives in Gilbert, said she likes the produce and vitamins at Sprouts and prefers to shop on Wednesdays, when the company offers extra value on coupons. Jeanette Galindo, a Mesa social worker, cited fresh meats and produce and low prices as factors that attract her. Dorothy Corell, a Gilbert retiree, mentioned a Christmas roast she bought at Sprouts last year as an example of high-quality meats.
Sprouts opened its first store 14 years ago in Chandler. Despite the tougher pricing climate, the company remains on track to expand to more than 1,200 locations over the next 15-plus years as it branches out beyond its traditional base in the Southwest.
Growth slowing
In his Sept. 7 warning, Maredia, the CEO, said Sprouts’ comparable-store sales growth for the current quarter is expected to be “approximately flat.” That’s a sudden downshift from the 4.1 percent comparable-store sales growth logged just last quarter and 7.4 percent over the final three months of 2015. The company blamed the deflationary environment, intense competition and other factors for “heavy promotions across the industry.”
The grocery business has been in flux anyway. Industry researcher Kanter Retail cites ongoing trends that include a focus on fresh, local, organic, natural and healthy foods. Shoppers are gravitating toward smaller stores, and discounts remain important. Technology has brought mobile coupons, pricing scanners for in-store shoppers and other changes.
Many of those trends favor Sprouts. The Phoenix company features natural, organic and healthy foods at competitive prices. The floor plans of its stores are configured around an open central area that resembles a farmers market. Sprouts caters to a diverse customer base in terms of age and ethnicity, but one characterized by middle to upper incomes and average to higher educational attainment. The company touts its lowenergy-use stores, recycling efforts, sale of cage-free eggs and other forward-looking policies.
Sprouts offers an array of groceries, some of which are difficult to find elsewhere. It doesn’t carry a lot of mainstream packaged products, such as Doritos chips, Tide laundry detergent and Lucky Charms cereal, that are universally found in conventional supermarkets. That suits shopper Nancy Ferguson, a small-business owner in Mesa, just fine. “It would be a shame if they started carrying Tide,” she said. “That’s not what Sprouts is about.”
Ferguson, who has been shopping at Sprouts since some of the stores were called Sunflower Farmers Market years ago, said she especially likes the produce and vitamins, along with oils she uses to make her own liquid soaps and cleaners. “This is my go-to store,” she said.
Stocks on sale
The food-deflation trend has dimmed the appeal of supermarket companies across the board. Sprouts ranks as the third most valuable pure-play grocery retailer among companies that have shares trading in the stock market — behind Kroger, the parent of Fry’s, and Whole Foods Market. Reflecting the subdued pricing outlook, all three stocks are trading near their 52-week lows.
Walmart Stores, Costco, Target, Amazon and various other retailers, including dollar stores, also derive significant slices of revenue from groceries. Albertsons Cos., which includes the Albertsons and Safeway chains, is another big player. It’s owned by private-investment firm Cerberus Capital Management and doesn't have publicly traded shares.
General retailers including Walmart, Target and Costco “use food as a loss leader to drive traffic into stores,” said Zain Akbari, a retail analyst at Morningstar. That makes it harder for traditional grocers to keep prices competitive while preserving profit margins.
Akbari feels margins could remain under pressure for the next decade. He follows Whole Foods and Kroger (but not Sprouts) and gives each of those companies a three-star rating for investment potential, out of five possible. For companies in the organic and natural foods niche, he cites deep discounting and potentially weak traffic as obstacles, with upside potential if more consumers embrace healthier foods. Akbari said Whole Foods primarily competes in the natural and organic arena against Sprouts, Trader Joe’s and the Fresh Market, a privately held grocery chain operating in the eastern half of the country. Whole Foods has more stores than Sprouts, and they are larger in square footage.
Cognizant of what happened years ago, the Credit Suisse analysts say they are neutral on whether to buy shares in Kroger, the largest grocery-focused retailer. “We do think there will be a time to own this industry leader again, but it still seems too early,” they wrote in a recent report. In the 2009-10 period, Kroger’s stock didn’t bounce back until the food-deflation numbers turned upward.
Both Credit Suisse and Wells Fargo see Sprouts, despite the challenges, as a stock they think can outperform. Sprouts continues to compete mainly against traditional supermarkets, gaining three of every five new customers from this channel. An industry price war might give Sprouts a chance to win over more new shoppers, though competitors will be eyeing the same opportunity against it.