Food deflation woes hit Kroger in new 'grocery price war'

Shoppers at a Kroger supermarket in Peoria, Ill.
Daniel Acker | Bloomberg | Getty Images

Supermarkets such as Kroger are facing a pickup in food deflation, which is hurting top-line growth and igniting what Credit Suisse this week termed a "grocery price war."

"One big issue with deflation is with lower prices it breeds more competition because you're trying to win traffic and you're being more promotional doing that," Wells Fargo analyst Zachary Fadem said in an interview.

There have been price wars in the supermarket sector before and history has shown it can decimate margins and profitability as chains attempt to increase market share at all costs.

The current landscape is now beginning to look a lot like 2009, when meaningful deflation resulted in an industry price war and multiple quarters of declining earnings.
Edward Kelly
analyst, Credit Suisse

Food-at-home prices fell in July by 1.6 percent from a year ago, marking the eighth consecutive month of declining food prices, according to the government's Consumer Price Index for food measured by the Bureau of Labor Statistics. Categories showing the most deflation in July were eggs, followed by beef and pork.

"The current landscape is now beginning to look a lot like 2009, when meaningful deflation resulted in an industry price war and multiple quarters of declining earnings," Credit Suisse analyst Edward Kelly said in a note Wednesday. He said the "price war of 2009/2010 carried on for three to four quarters before abating."

Some analysts suggest the last price battle back starting around 2009 was one when Kroger won over customers by adopting more aggressive price promotions to compete with Wal-Mart Stores and others. At the time, its margins and sales took a hit and Kroger was pushing its own private label brands as a value alternative to name brands.

On Friday, analysts will learn more about Kroger's current strategy when the company reports its fiscal second-quarter earnings and holds a conference call with analysts. Kroger declined comment for this story.

In trading Wednesday, Kroger closed down $1.35, or 4 percent, to $31.32 a share — the stock's lowest level since December 2014. Earlier Thursday, the stock sank to a fresh 52-week low of $30.70, before edging higher. Kroger shares are down 25 percent this year. Wednesday's sell-off followed a disappointing announcement from Kroger rival Sprouts Farmers Market.

In a press release Wednesday, Sprouts — a Phoenix-based supermarket chain operating in 13 states — warned about tougher industry conditions and lowered same-store sales guidance for its current third quarter. Specifically, Sprouts cited "significant ongoing deflation" as well as a "stepped-up promotional environment." Shares of the stock sank almost 14 percent Wednesday, and slipped less than 1 percent Thursday morning to trade at $19.52.

As for Kroger, analysts are forecasting the supermarket giant will report mean earnings per share of 45 cents, up 2 percent from a year ago, according to Thomson Reuters. Revenue is forecast to rise 5 percent to $26.79 billion.

In June, Kroger management conceded earnings for the fiscal second quarter ended Aug. 13 would not be easy.

"In thinking about the cadence of our quarterly results compared to our long-term 8 percent to 11 percent guidance, we believe that the second quarter will be the toughest quarter, with slight growth over 2015," Kroger CFO J. Michael Schlotman said during the Cincinnati-based retailer's June 16 first-quarter conference call.

Several analysts suggested there's a chance Kroger could bring down earnings and same-store sales forecasts for the full year. The Street consensus on comparable-sales growth, excluding fuel, is for a 2.6 percent gain in the second quarter, according to Consensus Metrix.

"Given weaker-than-expected comps from several competitors who reported over the past six weeks (Sprouts, Smart & Final Stores, SuperValu, Whole Foods Market, Publix, just to name a few), investor expectations for Kroger have been reset lower," Deutsche Bank analyst Shane Higgins said in a note Thursday.

Higgins added that investors in Kroger stock "were already skittish given Wal-Mart's widely-communicated price investments and the impact they could have on industry-wide sales and margins; Sprout's pre-announcement only fanned these concerns."

According to Credit Suisse's Kelly, the conventional grocery chains are the ones accelerating the promotional activity, although he believes Wal-Mart could roll back prices to increase share and make it an even more challenging environment for food retailers.

Wells Fargo's Fadem agrees Wal-Mart is getting more aggressive but says competition also is heating up from the dollar store players along with European hard-discount grocer Aldi's expansion. Currently, Aldi operates more than 1,500 stores in 33 states, and expects to have more than 2,000 outlets nationwide by the end of 2018.

Indeed, Goldman Sachs conducted a price survey last month in the St. Louis, Missouri, market using 27 identical items found at Aldi, and it concluded those items were "priced 12 percent below the average price" of dollar stores (such as Dollar General and Family Dollar) as well as Wal-Mart.