Attention Shoppers:  Supermarket Industry Update

The grocery retail sector continues to face consolidation as a result of the changing market environment, with regional and independent chains being the primary target for acquisitions.  Competition from a variety of fronts, including the mass, specialty, and off-price markets, as well as drug stores, and e-tailers, continues to challenge market participants for share of wallet.  Inflation, while not expected to increase dramatically in 2014, is expected to increase in most departments, notably meat, with price increases being passed along to the consumer.  As a result, Hilco has prepared the following considerations for Lenders regarding grocery accounts, specifically, supermarket retailers.

Stores that have higher-than-average exposure to locations in depressed socio-economic areas of the country are at greater risk when there are changes in federal food subsidy programs:

  • Companies operating in states with higher than average unemployment rates should be monitored.  The seasonally adjusted national unemployment average for January 2014 was 6.6%.  States with an average unemployment rate of 8.0% or higher include California, D.C., Illinois, Kentucky, Michigan, Mississippi, Nevada, and Rhode Island. 
  • Stores in these areas most likely will have a greater exposure to customers using Electronic Benefit Transfer (EBT) as a payment method.  Specific to EBT, the maximum monthly allotment for a family of four decreased from $668 to $632, a 5.4% decrease, in November 2013.  Grocers have noted a direct impact on sales to this customer group as a result of the cuts in The Supplemental Nutrition Assistance Program (SNAP).  These customers are simply spending less, which is having a direct impact on store level sales results.  The Lender should ask the Company for a summary of transactions by payment type to gauge this potential risk. 
  • Previously, EBT disbursement took place at a specific time each month.  This placed stress on retailers related to staffing and merchandising for these disbursements.  However, in January 2014, disbursement dates changed; now the disbursement day correlates with the first letter of the recipient’s last name.  This change has had a positive impact on a retailer’s operations, smoothing out overall purchasing activity for this customer class.

Inflationary pressure remained relatively limited in 2013 and per-store inventory increases remained minimal:

  • Lenders should consider USDA reports by commodity type on an ongoing basis.
  • Select USDA food inflation projections for 2014 include the following year-over-year changes:
  • An overall increase of 2.5% to 3.5%;
  • A larger-than-average increase of 3% to 4% in beef and veal; and
  • A decline of 1.5% to 2.5% in cereal and bakery.

The higher-than-average snow totals and a cold weather streak for the winter of 2013/2014 could have an adverse impact on crop mortality rates and spring 2014 crop yield.  At-risk groups could include fruits and vegetables.  Some products have in-store substitutes, while others do not.  The impact could increase prices on products, which would influence sales and gross margin activity for the grocers.

Continued elevated levels of competition continue to challenge supermarkets, specifically, regional chains.  Home delivery services, such as Peapod, along with independent startups, such as Instacart, could change consumer shopping behavior. 

Companies that provide a home delivery service should be monitored, because factors, such as delivery charges, could prevent the consumer from using the service.  Additionally, customers might be reluctant to purchase specific food types, such as produce, from a home delivery service.  

Other companies and channels that should be monitored include the following:

  • Wal-Mart Stores, Inc. (Walmart), including Walmart Supercenters, the world’s largest retailer, receives more than 50% of sales from groceries, which continues to challenge regional grocers.  Walmart has been aggressive in adding Neighborhood Market grocery stores, approximately one quarter of the size of a Wal-Mart supercenter.  The Neighborhood Market stores target new consumers, particularly in urban areas, as well as shoppers who prefer not to navigate a large supercenter.  Walmart plans to open between 270 and 300 small stores in fiscal year 2014, in addition to the 346 currently in operation. 
  • Target and its larger grocery-carrying SuperTarget, is the second largest discount retailer.  The company is growing its grocery business and, while it has a stronghold in the U.S., Target’s entrance into Canada has been less than stellar, partly due to logistical issues that led to product out-of-stocks in the Canadian stores.  
  • Drug stores chains and dollar stores have been expanding product offerings; the product overlap with grocery stores continues to grow. 

The Lender should examine not only regular priced inventory, but also temporary price reduction (TPR) inventory to determine whether the grocer is competitive in the local marketplace for both product classes.  Regional grocers continue to be higher priced compared to big box retailers and discounters, stating that improved customer service and better produce quality and assortment justifies their higher prices.  The Lender should monitor a weighted average market basket of items to understand how the retailer is priced compared to local competition.

The pharmacy department continues to be a loss leader for grocers: 

  • The lack of new blockbuster drugs in the marketplace and pharmaceutical pipeline has led to the continued transition to generic drugs.  These effects have slowed as the drug patent cliff has now been anniversaried.
  • The third-party reimbursement period for grocers has been extended, which has had a negative impact on cash flow for store pharmacies.

Grocers continue to go through SKU rationalization and are trying to align product offering with local markets more effectively.  The industry is turning more toward technology to align product offering with customer demand.  Generally, this is an industry that has been behind the curve in implementing technology for merchandising and advertising.

As a result of these initiatives, store shelf space allotment and SKUs will experience changes as grocers match product offering with consumer demand more efficiently. 

Lenders should monitor continued consolidation in the industry.  Examples include:

  • Regional players that acquire smaller independent retailers in rural areas; and
  • Mergers and acquisitions, such as Safeway Inc. and Albertsons, LLC.  In March 2014, Cerberus Capital Management acquired Safeway Inc.  Together with Albertsons, LLC (also owned by Cerberus), the new consolidated group has more than 2,400 stores.

Grocery store partnerships with fuel service providers give customers discounts off gas purchases based on in-store purchases.  Retailers are challenged to make this a profitable venture.  Often these retailers are aided by vendor support to offset a portion of the cost. 

The grocery landscape continues to evolve and is forcing many traditional grocers that once had a strong position in their local markets to rethink their product and store strategy.  Hilco recommends that the Lender discuss with clients and their appraiser the points highlighted above to identify potential areas of risk. 

For more information contact:

Stephen D'Aquila
Hilco Valuation Services
(781) 471-1251