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07/02/2012

Catching the Fresh Wave

Fresh is in. At a time when conventional supermarkets are being pressured by higher costs and greater competition, a wave of new fresh markets offers promise. "I think you have kind of a situation where opportunity meets need, and it's driven by shoppers," says Jim Hertel, managing partner at Willard Bishop in Barrington, Ill.

"The fresh markets are capitalizing on the fact that especially among the better-educated folks, there's a much greater appreciation for things like organic and fresh and probably a heightened level of suspiciousness or weariness around processed foods," Hertel says. "That sets the table for them."

The trend also has set up fresh markets for sizeable economic gains, as consumers are willing to pay higher prices for fresh foods, boosting margins. The Fresh Market Inc., which went public at $22 a share in November 2010, reported a whopping 43 percent increase in net income in its first fiscal quarter of 2012, ended April 29, on a 23 percent increase in revenue to $325 million. The stock closed at $51.90 July 20. The Greensboro, N.C.-based retailer, with 117 stores in 21 states, is on pace to open 14 to 16 new locations by the end of the year, boosting its total count 13 percent, says Michael Vodicka, in a June 18 iStockAnalyst.com report. The company's gross profit also is climbing due to the company's "strong pricing power and scalability," Vodicka says.

Meantime, rival Whole Foods Market, based in Austin, Texas, posted net income of 31 percent to $117.7 million in its second fiscal quarter, ended April 8, while sales climbed 14 percent to $2.7 billion in the quarter. The company's stock closed at $84.03 July 20. Looking ahead to the rest of the year, Whole Foods is expecting revenue growth of 12 percent to 14 percent and earnings per share growth of 23 percent to 25 percent, according to financial analyst Vytautas Drumelis in a July 22 Seeking Alpha earnings preview.

Sunny Forecast

And the fresh wave is gaining momentum. "In our opinion the best years of these formats are in front of them rather than behind them," says Scott Mushkin, equity analyst at Jefferies in New York. A more educated consumer and growing concern about food safety and nutrition have elevated the fresh movement.


"In our opinion the best years of these formats are in front of them rather than behind them."

–Scott Mushkin,

Jefferies

It's a global trend with Tesco and Wm. Morrison Supermarkets in the U.K. piling on fresh products. "We've got 40 percent more space dedicated to fresh than you see elsewhere in the market, and what we're saying is convenience doesn't have to be compromised," Wm. Morrison Chief Executive Officer Dalton Philips told Bloomberg earlier this year. The retailer's fresh-food concept includes more produce, made-to-order pizza and new seafood stations.

In the United States, demographic shifts and lifestyle trends are fueling the fresh wave and promising to shake up conventional grocery retail, analysts say. An industry update published in June by Jefferies and Alix Partners predicts "a transformation that has the potential to create a chaotic marketplace that markedly changes where and how consumers shop for groceries as well as what products they bring home."

Overall, 31 percent of grocery shoppers say they will buy more produce in the future, but among the millennial generation of young adults, the proportion is 37 percent, according to the report, which is based on a survey of 2,000 adult grocery shoppers. That difference will become even more significant to retailers, Mushkin says, because millennials older than 25 are expected to comprise 20 percent of the U.S. population in 2020, up from about 5 percent in 2010.

Currently, 48 percent of millennials on average buy fresh products at specialty stores, though the proportion climbs to 67 percent for those millennials with more than $100,000 in annual income. That compares with 36 percent of baby boomers who buy fresh foods at specialty stores, rising to 45 percent for those boomers earning more than $100,000.

In general, millennials also are more willing to pay more for fresh foods, which is significant given that their incomes are likely to rise dramatically in the next 10 years, Mushkin says.

Emphasizing Service

While the fastest-growing fresh markets emphasize service and often have higher prices than competing grocery channels, the fresh trend cuts across demographic sectors. "This movement does transcend incomes. You are seeing the mass merchants trying to elbow their way into that business," Mushkin says.

Conventional supermarkets, such as Publix Super Markets, Wegmans, H-E-B and Fairway Market, are paying attention to the fresh markets' success, says Mushkin. They're stocking more natural, organic and specialty items to encourage shoppers to bypass the specialty markets and spend more time and money in their stores.

Value-priced supercenters also want a piece of the action. "On the flip side, Walmart is dedicating resources to getting fresh right," Mushkin says.

At Milwaukee, Wis.-based Roundy's Supermarkets Inc., which reported a decline in same-store sales in fiscal 2011, the retailer's Mariano's Fresh Market banner is a bright spot, says Karen Short, analyst at BMO Capital Markets Corp. in New York. Mariano's locations ring up estimated sales of $938 per square foot compared with $393 per square foot for Pick 'n Save, its largest banner, according to a March 19 BMO report.

The company has five Mariano's locations in the Chicago area with several more in the works, and it plans to open four to five new stores a year for the next five years, the report says. The 60,000- to 70,000-square-foot stores carry more than 1,000 SKUs in produce, including 200 SKUs in organics. Mariano's perishable mix of 45 percent to 50 percent is substantially higher than Roundy's overall 33 percent, though the company plans to boost the proportion of perishable products at all of its banners.

While Mariano's might draw customers away from Whole Foods, the Fresh Market and Trader Joe's, its blended format is geared toward "the shopper who wants natural and organic but also wants to buy their Cheerios and Diet Coke," Mushkin says.

Compared with Roundy's other banners, "The biggest difference with Mariano's is going to be the amount of the specialty items [such as] the beers from around the world. The blend of that store is different from traditional stores," Mushkin says.

Price Comparison

As the channels blur, watch for the fresh markets to lower prices of branded items to prevent shoppers from splitting their grocery shopping between stores. "They have to price the Diet Cokes with the mass merchants. What will happen is people will cherry-pick you," Mushkin says. "They need to be right on those prices."


"It's become a bifurcated shop. You're going to save on the things you consider a commodity."

–Karen Short,

BMO Capital Markets Corp.

Less loyalty among millennials means more retail-hopping to save a buck here and there. "It's become a bifurcated shop. You're going to save on the things you consider a commodity," Short says.

While it's easy for shoppers to compare the price of Coke across locations, stores have more leeway with specialty items that are hard to come by. Trader Joe's proprietary foods helps it stand apart from other stores, Hertel of Willard Bishop says.

Similarly, Whole Foods stocks exclusive products that can command a higher price. "They sell extremely high-quality, relatively non-commoditized products....Within the meat, soups and prepared foods, you can't find lot of those items at comparable stores, they don't make them," Short says.

Whole Foods has cut some of its prices and now is lower on "like-for-like" items than the Fresh Market, Short says. Meantime, the Fresh Market attracts a slightly older customer who likes its European-market feel, Short says. "It's about not being in a crowded store, and it's the experience" that lures customers, she says.

By positioning Mariano's between high-end specialty markets and value-priced supermarkets, Roundy's could open the mass market to a fresh concept. "They've done a remarkable job by setting themselves apart, but making it OK where a mainstream person might feel more comfortable than at Whole Foods," Hertel says.

Many conventional supermarkets are watching Roundy's new foray into fresh with interest, and it's likely some will follow their lead. Fresh markets aren't necessarily competing with each other or even with supermarkets, Hertel says. Instead, they might be stealing sales from neighborhood restaurants or other channels.


"The dollars do come from somewhere, but they don't necessarily come from the guy who is across town and in a different neighborhood and offering a different shopping experience."

–Jim Hertel,

Willard Bishop

"The dollars do come from somewhere," he says, "but they don't necessarily come from the guy who is across town and in a different neighborhood and offering a different shopping experience." That gives the fresh wave plenty of room to grow.

Freelance business journalist Ann Meyer serves as senior editor of Retail Leader magazine. She is also president and CEO of L3C Chicago, L3C, and editor of www.SmallBizChicago.com