Supermarkets Face Supersize Rivals


By Joseph Agnese U.S. consumers appear to believe that bigger is better when it comes to where they do their grocery shopping. Supercenters -- those huge retail outlets (more than 150,000 square feet, on average) that house a mass merchandiser and combination food and drugstore in a single unit and devote as much as 40% of their shelf space to grocery items -- continue to enjoy strong sales growth. But that doesn't mean investors should write off the operators of traditional supermarkets just yet.

To be sure, the supercenters have made impressive inroads into the grocery business. Sales of supermarket items at supercenters totaled $85.3 billion in 2004. These behemoths now hold a 13% market share of the grocery industry. Although their profit margins on grocery items are not high, supercenters generate heavy store traffic by virtue of their size, resulting in greater sales of higher-margin general merchandise.

800-POUND GORILLA. Wal-Mart Stores (WMT

; S&P investment rank 5 STARS, strong buy; recent price, $50) is the major player in this arena, accounting for a majority of supercenter industry sales, followed by Target (TGT

; 3 STARS, hold; $58) and the Kmart unit of Sears Holdings (SHLD

; 3 STARS; $158).

Bentonville (Ark.)-based Wal-Mart has spread its dominance to food aisles as well. With grocery sales estimated at about $80 billion from its Wal-Mart Supercenter and Wal-Mart Neighborhood Market formats in 2004, it's the largest seller of supermarket goods in the U.S. Trailing Wal-Mart in this category: traditional supermarket operators Kroger (KR

; $19), with $56.4 billion in sales; Albertson's (ABS

; $21), with $39.9 billion; and Safeway (SWY

; $24), with $35.8 billion.

Clearly, Wal-Mart constitutes the biggest threat to the traditional chain food- and drug-retailers. In 2005, supermarket merchandise is expected to generate about 60% of Wal-Mart supercenter sales. And the 800-pound gorilla is getting larger: Wal-Mart operated 1,808 supercenters and 89 neighborhood markets in the U.S. as of May 31, 2005, and plans to add 240 to 250 supercenters (including about 160 relocations or expansions of existing discount stores), as well as 25 to 30 neighborhood markets by January, 2006. Wal-Mart also operated 554 Sam's Club warehouse stores in the U.S. and plans to open 30 to 40 more by January, 2006.

HOLDING THEIR OWN. In total, Wal-Mart intends to add approximately 55 million square feet of new retail space in its fiscal year ending January, 2006, which would represent a more than 8% increase in square footage for the company.

How are the old-line supermarket operators bearing up in the face of the supercenter onslaught? Despite the intensifying competition, the retail-food environment looks to be stabilizing. Industry operators' first reaction to increased competition from low-priced supercenters was to cut costs while aggressively lowering prices.

But these efforts -- which included renegotiating union contracts, implementing cost-saving initiatives, and investing heavily in promotions and advertising -- are only a first step. These retailers have come to realize that in order to succeed, they will need to put more effort into diversifying offerings to better meet their customers' needs. So they're expanding their selections of perishable offerings,ethnic foods,and gourmet foods.

RIGHT MOVES. They're also adding "dollar-store" items.And tomake theshopping experience more enjoyable and tofurther differentiate themselves from supercenters, traditional food retailersare alsoimproving lighting and product displays, widening aisles, and adding express checkout lanes.

While it's too early to tell who will succeed in this fray, we believe food retailers are taking a step in the right direction in avoiding head-to-head confrontation with low-priced supercenters. Our top picks among the traditional supermarket operators are Safeway and Kroger, each of which is ranked 4 STARS (buy). Albertson's is ranked 3 STARS (hold).

Glossary

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Above Average

D

In Reorganization

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Average

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Not Ranked

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Below Average

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Required Disclosures

In the U.S.

As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 30.8% of issuers with buy recommendations, 56.7% with hold recommendations, and 12.5% with sell recommendations.

In Europe

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In Asia

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Globally

As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 31.0% of issuers with buy recommendations, 55.2% with hold recommendations, and 13.8% with sell recommendations.

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2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.

1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.

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Readers should note that opinions derived from technical analysis might differ from those of Standard & Poor's fundamental recommendations. Analyst Agnese follows the stocks of food retailers for Standard & Poor's Equity Research Services


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