There is a new research report out authored by analysts at JP Morgan entitled Supermarket Industry Review and Outlook: Is There Room for Two More Giants? It is unusually insightful and brings to the fore crucial points that are often overlooked.
First, it points out that consolidation may be advanced in supermarket retailing but that hasn’t stopped two deep-pocketed giants from entering the market:
Just when the supermarket industry seemed to be settling down, two powerful outsiders are coming to shake things up once more. The likely result: the bitter competition that has marked food retailing since Wal-Mart forced its way onto the stage in the mid 1990s will likely not be abating soon.
These new contenders come with deep pockets and a thorough understanding of the US market. One is Tesco plc, Britain’s leading grocer and one of the very few food retailers anywhere with a record of strong international performance. The other is Target Stores, the old-line department-store company that has transformed itself into America’s most profitable discount retailer and is now pushing hard to build its presence in food retailing.
Alone, we think either one of these companies has the muscle to occupy a meaningful position in the grocery market. Together, they should start to take market share just when the traditional supermarket retailers thought they had mastered the techniques of competing against Wal-Mart.
In our piece The End Of Supermarkets? we explained why the new Tesco concept merited so much attention:
…the underlying point is that we are really talking about the end of the supermarket.
We have already reached the place where it is widely accepted that supermarkets need to emphasize perishables and prepared foods because it is the only way to make a little money as the competition on selling packaged goods from warehouse clubs and supercenters is simply too fierce.
But if Tesco is right and some new concept of small stores is the way to sell perishables and prepared foods, well there is then nothing left.
The supermarket will be finished.
In a sense, the JP Morgan analysts are pointing out the same thing, but adding the impact of a Target newly dedicated to food.
Just as most large and successful supermarket chains seemed to have reached a stasis with Wal-Mart, in which they — a la Safeway’s Lifestyle stores — go a little upscale and emphasize organics and fresh foods, two behemoths start roll-outs that will undercut that positioning.
How will a supermarket compete that has a Wal-Mart Supercenter nearby serving the paycheck-to-paycheck crowd, a Target supercenter attracting a more upscale clientele, 10 Tesco’s Fresh & Easy Neighborhood Market stores stealing the “top-off” shoppers with their convenient neighborhood locations and generous assortment of perishables and prepared foods? Add in some specialty operations such as a Whole Foods, a Costco and a Trader Joe’s and one sees the battle supermarkets will have to come up with a reasonable positioning.
Second, the JP Morgan report reminds us that Tesco must be viewed as a long term strategic competitor and not evaluated solely on its Fresh & Easy concept:
Tesco is a multi-format operator. As it learns more about the US market, we would not be surprised if it looks to add larger supermarket formats, or even hypermarkets. This flexibility has worked well in other markets and lets Tesco avoid a “one size fits all” mentality.
Third, if successful, Tesco will probably drive some competitors out of certain markets:
Based on its initial choice of markets, Kroger, Safeway, SuperValu, Stater Bros., and the privately held Basha’s chain all are exposed to market-share loss from Tesco’s entry. All of these markets already have more large competitors than the average US metropolitan area. If Tesco succeeds in gaining significant share in any market over the next few years, we would anticipate that another retailer would be forced to exit due to the competitive pressure.
Fourth, Target is now becoming a real player in food retailing in certain local markets:
Target is finally beginning to command noteworthy shares of local food retail markets. We consider local market share a vital element of success in broadline food retailing, as critical economies of scale in distribution and advertising can be obtained only with high store density. In previous years, Target’s local market shares have been quite small. In 2006, however, Target took 8% of supermarket sales in its home market, Minneapolis-St. Paul, and had shares in the 5% range in Denver, Omaha, and Cedar Rapids. It also held a 4% share in the large Dallas-Fort Worth market. While these positions are small in comparison with
Wal-Mart, they are enough to affect the competitive balance and weaken the pricing power of established supermarket operators.
Although Target is weaker than this in perishables (the JP Morgan numbers include substantial food sales through its conventional Target stores which sell few perishables as compared to its SuperTarget stores), Target is building the infrastructure for substantial growth in perishables, as we mentioned in our piece Target Builds First Food Distribution Center.
Fifth, Target’s expansion, JP Morgan explains, is a problem for conventional supermarkets:
…we anticipate that Target will continue to increase its shares in local markets in a cautious, steady way. Unlike Wal-Mart, it will likely not trail independent grocers’ bankruptcies in its wake. But we believe its expansion will almost inevitably erode the market shares of incumbent supermarkets, and may increasingly constrain their pricing power.
Sixth, despite the popular perception that Wal-Mart is in trouble, its operations continue to garner more and more of the food industry:
Wal-Mart extended its domination of the US food retail market last year. Wal-Mart’s supercenters now account for more than 50% of supermarket sales (excluding warehouse-club sales) in seven of the 100 most populous markets, and for at least 40% of supermarket sales in 20 of the top 100 markets. Wal-Mart SuperCenters lost share in only one market last year.
Seventh, JP Morgan believes that Wal-Mart’s gains in market share seem highly likely to continue:
In 2007 the company plans to open 265-270 supercenters, most of them conversions of or replacements for traditional discount stores. This is all but certain to bring substantial further gains in sales and market share.
Eighth, although Kroger posted strong sales in 2006, it is not opening enough new stores to increase market share:
Kroger fared poorly in the market-share wars last year, losing share in 26 of the 36 major metropolitan areas in which it holds at least 10% of the market. This share loss appears to be due to Kroger’s extreme caution about opening new stores. The company’s store count fell by 39, and square footage remained unchanged.
Ninth, Safeway is also seeing total store count drop and has not been able to capitalize on opportunities to increase market share:
Safeway’s store count declined in 2006, for the second consecutive year, due principally to store closures in its troubled Texas markets… It gained only 1 share point in San Francisco, despite the closures of 36 stores by Albertson’s LLC and 10 stores by Kroger.
Tenth, JP Morgan’s report emphasizes that while supermarkets reshuffle assets and, in some cases, such as Supervalu, this may really benefit individual companies, the supermarket industry as a whole is changing in ways that will be further evidenced by Tesco’s new offer and a Target focused on food:
Wal-Mart Stores strengthened its position as the largest US food retailer in 2006. JPMorgan estimates that Wal-Mart sold $106 billion of supermarket items through its supercenter division and another $25 billion at its Sam’s Club warehouse stores. The total of $131 billion gives Wal-Mart nearly twice the sales of supermarket items of Kroger, the largest traditional supermarket operator. Costco advanced one place in our ranking due to the break-up of Albertson’s Inc., and Target Stores has emerged as an industry leader due to its increased emphasis on food sales — and to its willingness to disclose sales in the relevant categories. Thus, four of the top 10 food retailers are not traditional supermarket operators.
This point is crucial, we made the ame point fourteen years ago in our piece “Death By A Thousand Cuts,” which ran in PRODUCE BUSINESS, the Pundit’s sister publication is crucial. We don’t know what market share Tesco needs to make a good return on its investment or how much fresh foods Target needs to sell to justify building new distribution centers, but only a small market share is necessary to affect the competitive balance, to constrain the pricing decisions of competitors and to force a weak competitor out of a market.
Contributors to this excellent report are the following:
Marc Levinson, Economic Research, Carla Casella, CFA, North America High Grade Credit Research, Virginia Chambless, CFA, US Equity Food & Drug Retail Research, Stephen C. Chick, CFA, US Equity Broadlines Retail Research, Charles Grom, CFA, CPA, European Equity Retail Research, Jaime Vazquez and Alastair Johnston, European Credit Retail Research, Katie Ruci, J.P. Morgan Securities Inc.
The report includes specific credit opinions and much else of great value. We appreciate JP Morgan’s willingness to allow us to share their insights with the broader industry.