The current economic news in the U.S. isn't good. The negative indicators abound. For example, The sub-prime credit crisis not only has a record number of homeowners getting their houses foreclosed on, but its also having a more profound macroeconomic result, which was witnessed the other day when Bear Sterns, the country's fifth-largest investment bank, nearly had an old-fashion bank run on its funds.
In order to prevent that from happening, banker J.P. Morgan and the U.S. Federal Reserve Bank loaned the company ten's of billions of dollars in a scheme not used in the U.S. since the great depression. J.P. Morgan then stepped in a couple days later, and with the Feds backing acquired Bear Sterns for $2 per-share, a mere fraction of what the investment bank's share price was just a week before.
Further negative economic indicators include record oil, gasoline and energy prices, food price inflation, rising unemployment and a host of other serious economic ills. About 50% of the professional economists in the U.S. recently polled by the Wall Street Journal said they believe the U.S. was already in a recession. Economic forecasters in states like Michigan and California are saying the respective states have probably been in recession since the end of last year.
We don't have to wait until a committee calls an official recession however to know the U.S. economy is in a severe patch. Like billionaire investor and chairman of Berkshire Hathaway said in this piece we wrote a few days ago, "The U.S. economy is essentially in a recession."
For example, food and grocery product inflation jumped by 4% between 2006-2007, the highest increase since 1990, according to the U.S. Department of Agriculture's Economic Research Service. And, of course, we don't have to tell you how much better the U.S. economy was doing in 2006 and early 2007, compared to its current performance. All indications suggest food and grocery inflation will rise at least 4% this year, and likely higher, according to the Economic Research Service's forecasts. As a point of contrast, in the mid -to- late 1990's food and grocery inflation averaged about 1%.
Retail prices on key food and grocery items has increased in the last year by far more than that overall 4% however. Eggs are up 15-20% over 2007 prices. Milk is up about 12%, compared to last year. Additionally, the commodity prices of wheat and corn, which are used in everything from bread and tortillas, to cereals, packaged and prepared foods, and in the case of corn as a major food additive and sweetener.
These soaring commodity prices have pushed the price of items like whole wheat bread up by 15-20% in the last year--and food products containing wheat and corn continues to increase since there's currently no light at the end of the price-increase tunnel in terms of when the commodity prices might stabilize.
For example, Supermarket chain buyers are telling us they've been receiving more frequent price change notices from vendors (in categories and on items across the board) than they can remember receiving in the last 15 -to- 20 years. Food manufacturers and marketers also are telling us not only are they getting significant price increases in the commodities they purchase but that the frequency of those increasing is record setting.
In low food and grocery inflation times (like the 1% 1990's) grocery retailers try to not pass on, or to pass on only a portion of, the price increases they get from their suppliers. However, in times of high food inflation like now, the retailers like to pass on the entire price increases, as the food inflation provides cover, so to speak, for doing so. It's also a must to do so in such bad economic times.
We believe, and are beginning to see evidence, that the current economic downturn in the U.S. economy could have serious negative effects on some upscale food and grocery retailers. In particular, we think the more middle-range upscale grocers like Safeway (Lifestyle format), Kroger (its upscale format), SuperValu (its more upscale banners) and a few others are likely to experience some significant sales downturns beginning in the second quarter of this year.
Our analysis also is that smaller, regional upscale food and grocery retailers (the single and multi-store independent and the smaller, privately-held regional chains) are at serious danger do to the current economic conditions in the U.S. One of the primary dangers to these grocers financial markets' credit crunch.
These independents and regional chains generally don't have a corporate cash-flow to tie them over like the upscale banners of larger supermarket chains do. (for example, gourmet grocer Bristol Farms is owned by SuperValu.) As a result, if sales drop significantly and the grocers need temporary operation funds, the difficulty of obtaining a credit line, or the interest rate cost of doing so, could put them in serious financial and operation straights.
The good news for these independent and regional upscale grocers is that they've been there before, and have survived previous recessions. Those retailers that have survived severe economic downturns in the U.S. have done so because they are in touch with their customers and communities. They also haven't been afraid to innovate and change--including lowering prices temporarily if needed--until better economic times arrive. It's all about increasing value during the down times.
Those upscale retailers at the very top-end and those with a solid niche, will fair much better, we believe. For example, our analysis is that Whole Foods Market should only feel partial effects from the recessionary economy, as it's niche is strong enough we believe to avoid serious sales losses. However, we predict the supernatural grocer will have to get more aggressive on its pricing in order to keep its same-store sales from eroding throughout the rest of this year.
There currently are signs that shoppers are beginning to trade down and search out bargains as their wallets and purses (and available credit) grow emptier because of soaring gasoline costs, the credit crunch, escalating food costs and other negative economic factors. Even worse, their confidence in the economy is very low.
Discount warehouse food store chains like Costco Wholesale, BJ's Wholesale Club and Wal-Mart's Sam's Club, have all recently posted strong same-store sales gains in the last couple months. Further, Wal-Mart just reported solid sales overall and at its Supercenters, which sell food and grocery products at a discount. In fact, Wall Street investment houses last week gave strong buy recommendations for Wal-Mart stock, primarily on the strength of its increased food and grocery sales.
Costco, BJ's, and to a lessor extinct Sam's Club, sell extensive selections of specialty, gourmet and natural-organic foods at prices generally lower than upscale supermarkets. With shoppers visiting these club format stores more frequently because of the bad economic times, many likely will make many of their upscale-oriented purchases while in the club stores, which is going to hurt the upscale grocers sales and margins, especially because these are higher-margin categories.
Dollar Stores like Dollar Tree, Family Dollar, Dollar General and others also are thriving in the current economy, as consumers--including upper middle-class shoppers--search out bargains. These stores carry fairly large grocery product selections, most for a dollar each as advertised
Another sign consumers are searching out lower priced food and grocery stores is the fact that salvage grocers, those grocery retailers who buy overstock, discontinued and slightly blemished products, are reporting increased sales, and saying they're doing dramatically more business than they've done in the last 10 years or so. The salvage grocers also are saying they're seeing lots of new faces (shoppers) in their stores.
Upscale food and grocery retailers that sell basic grocery items as well as more upscale offerings like prepared foods, specialty and gourmet foods, natural and organic products, and other higher-end goods, will need to get more competitive on their everyday pricing strategies in order to stave off the combination of a poor economy and cash and credit-strapped consumers.
People have to eat, and not all consumers are in a position to buy in bulk at stores like Costco, Sam's Club or BJ's Wholesale Club. They either don't need the quantities the stores sell, can't afford to spend a considerable sum of money on any one shopping trip, or just don't like shopping the huge, big box stores. Many of these consumers also would prefer to shop at a more upscale supermarket than visit a combination of stores--a salvage grocery for their hot buys, a warehouse club for loading up, and the upscale supermarket for the specialty, organic and prepared foods items.
However, that's what many consumers are starting to do. It's the economy, stupid, as that old political saying goes. We think upscale retailers can retain many of these shoppers by tightening up operations, buying better, lowering margins a bit for the rest of the year, and offering far better in-store and newspaper promotions than most currently do. The key is to not become a tertiary retail venue for shoppers, who only come shop the upscale store after they've been to a warehouse club and discount store like Wal-Mart.
Many upscale supermarkets have been spoiled by the good economy, allowing the stores to serve primarily as primary grocery shopping venues, and to a lessor degree as secondary stores. The current state of the U.S. economy is changing that. However, upscale grocers can weather this economic storm, even is they see a significant shift in some shoppers from primary to secondary, if they focus on providing value in both basic grocery items and in more upscale offerings like specialty, natural and organic, and prepared foods.
Our analysis suggest there will be some shakeout in the upscale grocery retailing sector. Some upscale grocers will put off building new stores they already have on the planning docket. Others will even close some stores. A few--those who fail to adapt and provide better value during the economic downturn or recession--might even fail completely.
Failing completely, and even closing stores, doesn't have to be an option though. The key is to add value. Buy better, promote more, take a little margin hit, and get ready for a better day--and better economy, which will come, perhaps as early as mid 2009.
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