The old rule that you should invest in what you know and use could lead to the conclusion that grocery store stocks are a great long-term holding. Everyone needs to eat, after all, right? Well, not so fast!
The supermarket business model is old, and many businesses in the industry suffer from a lack of real competitive advantages. Add digital disruption to the mix, with e-retailer Amazon.com (AMZN -0.32%) leading the charge and you end up with some serious supermarket investor grief. For some, a rebound might be in order, but it may be time to bail out on others.
Peeking behind the curtain
The grocery business has become a diverse industry. Predating Amazon's foray into the space is that of big-box stores such as Walmart (WMT 0.49%) and wholesale clubs such as Costco (COST 0.11%). That's some serious competition for the traditional supermarket, and the stock performance for three prominent ones -- Kroger (KR -0.69%), SUPERVALU (SVU), and Sprouts Farmers Markets (SFM 0.04%) -- is indicative of that.
Data by YCharts.
Each has taken a different approach to fighting back. Kroger, the largest grocery retailer in the U.S., has taken the diversification approach over the years, operating under different regional grocery store names across the country. It also has fuel, jewelry, pharmacy, and food production operations. The diversified nature of its business has helped stave off disruption, but revenue and profits have begun to slow the past few years.
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Kroger began offering online ordering and pickup services a few years ago, and now it's doubling down on its digital transformation. Through its "Restock Kroger" plan, more emphasis will be placed on digital sales and convenience, competitive pricing, artificial intelligence and robotics, and growing alternative revenue streams such as advertising.
SUPERVALU, on the other hand, has decided to transition to a wholesale-based model instead of a retail one. It has been offloading stores, most notably when it sold its Save-A-Lot chain to private equity firm Onex Corp. at the end of 2016. Other cost savings initiatives around its retail business have been pursued, but its wholesales now make up three-quarters of revenue.
While sales have begun to improve through the change, profitability continues to head in the opposite direction. SUPERVALU's fiscal year-to-date earnings per share were down 77% from last year.
Though its stock performance has left much to be desired, Sprouts Farmers Markets has posted steady business growth since making its public debut a few years ago. The chain operates in the organic grocery segment, much like Amazon's Whole Foods subsidiary does. Shares had a volatile 2017 as investors mulled over the reality of having Amazon become a direct competitor of Sprouts, but seeing business results continue to go in the right direction helped assuage fears.
Sprouts is still a small grocer, with only 300 stores in 15 states at the end of 2017. It thus has a lot of room to build, but it could also have the most to lose as Amazon expands its grocery offerings and better-established chains adapt to the new digital business reality. Despite the odds, revenue and profit grew 15% and 22%, respectively, in 2017.
Momentum is hard to beat
Old supermarket businesses are finally taking digital disruption seriously, but with mixed results. They may survive in some form, but the uncertainty should give investors pause. When competing against a disruptive force that has momentum propelling it forward, having to rethink the business model is an unenviable position to be in. Remember what Walmart did to retail during the last century?
If I were to keep one supermarket stock, it would be Sprouts, since it's been defying the odds and has the trend toward higher-quality food going for it. As for the others, I'd consider long and hard whether they even belong in a long-term portfolio.
