Taking Stock

Performance is, of course, all relative.

When investors evaluate a company's stock, they compare its performance with that of competitors and overall industry.

Historically, grocery retail stocks have been less volatile than equities in other sectors because regardless of how the economy is doing, people have to eat. But recent changes in the competitive landscape are shaking up traditional assumptions about where and how consumers will purchase food and packaged goods.

Along with high fuel and commodity costs, traditional supermarkets face new entrants to the retail market that have stirred the pot, eroding grocers' market share, margins and valuations.

It's a perfect storm that has been in the making for years. "The past decade has been a trying time for traditional supermarkets," said Robert Greene of Value Line in a Sept. 23, 2010, report. The rise of discounters Walmart, Target, Costco and multiple dollar store banners has lured price-conscious shoppers away from their neighborhood Safeway, Food Lion or Albertsons stores.

Dollar stores' success is spurring development of smaller-format Walmart Express stores and expanded grocery sections in drug stores, such as Walgreen Co. and CVS Caremark, which cater to consumers' desire for convenience. At the same time, Whole Foods Market and other specialty retailers have snatched health-conscious shoppers on the high end.

"We suspect rivals such as these will remain the big threat to profits and shareholder returns over the next several years," Greene said. Throw in a bribery scandal at Walmart, a period of Chapter 11 bankruptcy protection for Great Atlantic & Pacific Tea Co. and a prolonged sales slide at Supervalu, and it's clear that risk comes in many shapes and sizes.

Among companies that analysts find attractive are the best-in-class retailers, such as Costco Wholesale, Dollar Tree and the leader of the traditional class, Kroger. Retail Leader scoured financial research to determine how retail companies were performing and how they could improve.

Supercenters Draw Traffic with Grocery

As giants Walmart and Target have embraced the food arena, the playing field has changed for all grocery retailers. Yet profitability at the mass merchandisers stands to fall as lower-margin food sales take on greater importance, analysts say. While Walmart enjoyed a first-mover advantage in grocery, Target has been effective at drawing traffic by emphasizing quality as well as price in its PFresh food business. "Consumers are not buying more at Target. What's driving their sales is maybe people are shopping a bit more often," Brian Sozzi, chief equities analyst at NBG Productions, told Reuters in May.

Target's grocery offerings helped spur a 5.3 percent hike in same-store sales in the first quarter.

Over time, however, Target is banking on grocery shoppers to buy more throughout the store. Target, which reported a same-store sales increase of 5.3 percent in its first quarter, ended April 28, outpaced Walmart U.S.'s 2.6 percent same-store sales growth. Walmart, the nation's largest grocery retailer, is facing another round of negative publicity stemming from allegations that the company bribed Mexican officials to win building permits there. In the United States, ongoing litigation over Walmart's workplace issues, including allegations of gender discrimination, coupled with frequent community opposition to the company's planned expansions, stand to impact its performance.

While Walmart's low-price strategy lures shoppers, the company faces new competition from alternative discount retailers, including dollar stores and no-frills grocers Aldi and Supervalu's Save-A-Lot, which are expanding.

Market Price
Despite their non-cyclical image, grocery retail stocks have fluctuated substantially during the past year.
Price of one share of company stock
52-week low
52-week high
Fair value* est.
May 11 share price
Costco Wholesale Corp. (COST)
Delhaize Group (DEG)
Dollar General (DG)
Dollar Tree Stores (DLTR)
Family Dollar (FDO)
Kroger (KR)
Safeway (SWY)
Supervalu (SVU)
Target (TGT)
Whole Foods Market (WFM)
Walmart (WMT)
*Fair value estimate provided by Morningstar analysts; "na" denotes estimate not available.
Source: Morningstar

Dollar Stores Deliver Results

Analysts are bearish about Dollar Tree Stores Inc. despite the company's success to date, including a 7 percent increase in comparable-store sales in the fourth quarter of 2011. Dollar Tree, which reported annual revenue of $6.63 billion for fiscal 2011, has expanded to more than 4,000 locations. "However, we don't think current productivity is sustainable, as we believe some consumers may trade up to other retail channels once economic conditions improve," Morningstar analysts said.

Competitor Family Dollar Stores had $8.55 billion in 2011 revenue, up from $7.87 billion the prior year, but it could face a rush of new competition due to the low barriers to entry in the dollar-store space, analysts said. Dollar General reported revenue of $14.80 billion in fiscal 2011, up from $13.04 billion the prior year, with consumables generating 70 percent of its total revenue.

Costco Scores High Among Warehouse Clubs

Among other discounters, Costco Wholesale Corp. receives high scores from most analysts, who expect the warehouse club will continue to sneak market share from competitors. Costco generates about $135 million in sales per club, compared with $78 million at Sam's Club, according to Morningstar analyst Peter Wahlstrom. The company generated net income of $1.46 billion on annual sales of $88.91 billion in 2011, up from profits of $1.30 billion on sales of $77.95 billion in 2010. "Superior merchandising acumen, unrivaled supply-chain efficiencies, and tremendous power over its suppliers provide Costco with consistently positive economic returns," Wahlstrom said in a May 3 report.

Supermarket Winners and Losers

Among traditional supermarkets, analysts are most bullish about Kroger, which generates returns above its cost of capital and has posted same-store sales gains for 29 consecutive quarters. "Kroger has been having multiple terrific years. Among the traditional grocers, they are the best in class," says Joe Feldman, an analyst at Telsey Advisory Group in New York. The company's 4.9 percent same-store sales increase in the fourth quarter outpaced competitors Safeway and Supervalu. Feldman attributes the company's success to a strong management team and good use of customer data through a strategic partnership with dunnhumbyUSA that has allowed the retailer to cater its product assortment to local markets.

Kroger reported annual revenue of $90.37 billion in fiscal 2011, up from $82.19 billion the prior year, while net income fell to $602 million in 2011 from $1.12 billion in 2010.

In contrast, Morningstar analysts give Supervalu a high uncertainty rating because the company has been losing market share to competitors as sales fall. It posted a net loss of $1.04 billion in 2011, an improvement from a $1.51 billion loss in 2010, while sales fell to $36.10 billion in 2011, down from $37.53 billion the prior year. "We continue to view Supervalu as the weakest competitor in food retailing, and as a result the highest-risk stock in the space," Morningstar analyst Michael Keara says.

Whole Foods Market has opened 13 new stores so far this year.

Brussels, Belgium-based Delhaize Group SA, which owns the Food Lion banner in the United States, also has lost market share to competitors, spurring Morningstar to slash in half its fair value estimate. The company, which recently announced major price adjustments at U.S. stores to drive traffic, saw comparable-store sales climb 0.7 percent in 2011 after falling 2 percent in 2010 and 0.4 percent in 2009, Morningstar said. The company reported total revenue of $21.19 billion in 2011, up from $20.85 billion the prior year, while net income fell to $475 million in 2011 from $574 million in 2010.

Safeway, which has invested $4.5 billion in store remodels and other upgrades to avoid competing on price alone, is working on finding the right product assortment, Feldman says. Safeway reported annual revenue of $43.63 billion in 2011, up from $41.05 billion in 2010, while net income fell to $517 million from $590 million.

"They're doing some innovative things in terms of online tools to leverage loyalty and eliminate coupon-clipping," Feldman says, through the "Just for U" program. Yet as Safeway strives to find points of differentiation, he says, "they're getting picked on from different angles," including Walmart, dollar stores and natural foods markets.

Whole Foods Makes a Comeback

Among specialty players, Whole Foods Market stands out for its commitment to high-quality natural foods. "The strength of their brand gives them some very high credibility," Feldman says.

Morningstar analysts raised their fair value estimate to $70 from $31 based on expectations that Whole Foods will achieve operating margins of 5.9 percent this year on revenue growth of more than 14 percent. The company's comparable store sales have been increasing and hit 9 percent in the quarter ended April 8, and the retailer has opened 13 new stores this year.

Whole Foods struggled during the recession after an aggressive growth strategy that included the acquisition of Wild Oats in 2007, shortly before the economy turned south. With a capital infusion from private equity firm Leonard Green and a new strategy of more reasonable pricing, the company achieved comparable-store sales gains of 8.5 percent in 2011, which boosted total revenue to $10.11 billion from $9.0 billion the prior year. Net income rose to $343 million, up from $246 million in fiscal 2010 and $147 million in 2009. With the category growing in the high single digits, Feldman says, "it positions a company like Whole Foods quite well."

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