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Published: June 22, 2010
Shares of Kroger (NYSE: KR) rose a
smart +4% today as the nation's largest standalone grocer beat
profit estimates by 8% for the quarter ended May 22. Yet once
you dig deeper into the numbers and get a sense of industry
trends, it becomes apparent that shares could move sharply lower
in the weeks and months ahead.
It's easy to look good when little is expected. Analysts were so
bearish about the grocer's rising cost picture that they lowered
their profit forecasts well below management guidance. So
earnings were seemingly robust, but really only not as bad as
feared. More important, earnings were more than 10% below
year-ago results due to a sharp drop in gross margins. And gross
margins are the real story here.
If you've shopped for groceries at a Wal-Mart (NYSE: WMT)
store in the last year, you've probably noticed that produce was
the one category that seemed unusually pricey. Yet as we
noted earlier this week, Wal-Mart is rolling back prices
thanks to a renewed emphasis on securing locally grown produce.
The mega-retailer is actually rolling back on prices on a wide
range of goods, but it thinks the most notable impact for
consumers will be found in the produce aisle.
That's not good news for Kroger, Safeway (NYSE: SWY), and
SUPERVALU (NYSE: SVU). All three of these firms are
struggling with anemic sales, rising labor costs, and an
"in-between"
business model. High-end grocers such as Whole Foods (Nasdaq:
WFMI) are appealing to quality-conscious consumers, while
Wal-Mart is stealing away the value-conscious foot traffic.
At first, Kroger and Safeway sought to emulate the Whole Foods
model by heavily investing in store remodelings. Those efforts
petered out when they realized that they couldn't beat Whole
Foods at its own game. Since then, they've vowed to protect the
other flank by lowering prices to retain customers. That's not
helping much either. Top-line growth stalled even as expenses
rose. In its most recent fiscal year, Kroger posted a 1% sales
gain, but a 60% drop in
operating income. Safeway's sales actually dropped -8%
(excluding the impact of a divested set of stores) last year.
GE's (NYSE: GE)
Jack Welch once
noted that an
industry leader
often has twice the
operating margins of
the number two
player, and the
number two player
has twice the
operating margins of
the number three
player. That led to
his famous quote:
"Lead, or get out of
the way" (a slight
twist on an old
axiom from Thomas
Paine). In this
case, Wal-Mart is
doing exactly what
you'd expect: using
its massive size to
wring out costs to
lower prices to the
point where rivals
feel real pain.
And that's just
what's about to
happen. Wal-Mart's
price rollback
strategy began in
March but really
picked up speed in
recent weeks.
Kroger's
just-announced
results aren't yet a
reflection of the
counter-moves it
will need to make to
keep Wal-Mart from
stealing customers.
But it's only a
matter of time. As
Kroger, Safeway, and
SUPERVALU parry
back, look for
analysts to cut
their profit
forecasts.
For investors, the
impact is unlikely
to be felt on shares
of SUPERVALU, which
already trade at
very low
price-to-earnings
ratio (P/E)
multiples. But
Kroger and Safeway
will likely feel the
pinch as earnings
estimates are
revised downward.
Action to Take
--> If
you are comfortable
shorting stocks,
then this is an
ideal pair trade: Go
long Wal-Mart and
short Kroger.
Thursday's rally for
Kroger shares sets
up a perfect entry
point.
-- David Sterman
Staff Writer
StreetAuthority |
