Keith’s TREND/TRADE model suggests more risk than reward. The fundamental story sounds the same.
After listening to Kroger’s conference call yesterday and discussing the finer points with Keith, we’ve come to the conclusion that this is a classic value trap with “hope” pinned solely on inflation (or less deflation). So long as market share continues to shift away to discounters, dollar stores, and warehouse clubs and flexibility with union labor costs is inherently limited, visibility on margin expansion remains unclear to us.
Key points from management’s 2Q recap point to another quarter of headwinds for KR (and likely SWY, SVU) with:
- Deflation having a greater negative impact on sales and margins. Now spreading to areas away from dairy and perishables and into most grocery categories. Perishable deflation deeper than anticipated.
- A pick-up in national brand sales which adversely impacted mix (this is likely due to intense price competition and vendor support which is allowing consumers to trade back into branded goods simply based on lower prices).
- Sharp increase in customers using food stamps.
- Intensified competition on price during the quarter.
Bottom line, it appears that the environment is getting worse here on the margin for the grocers . This is mostly due to the industry pulling the trigger on price at a time when it was originally expected that deflation would reverse. Investors who are long these names are banking on inflation. In my mind, it takes a lot more than that to drive traffic back from the non-traditional competition.