Grocery & Supermarkets
Date November 2017
Approximate net recovery on cost
- Through September 2017, U.S. grocery store sales increased 2.2% year over year
- The consumer price index for food increased 1.2% in September 2017 over 2016
- While the overall industry is growing, major shifts are happening within the sector
- The acquisition of Whole Foods by Amazon for $13.7 billion closed in August 2017; Amazon immediately slashed prices on key items
- In October, the Food at Home Price Index increased for the fourth consecutive month
Market Disruptions Force Change: Changes in the way consumers eat and shop for food are mixing up the crowded global grocery market. Disruptors include online competitors, the rise of discounters, and changing consumer perceptions of value. Traditional grocery chains now compete for market share with a range of competitors, including warehouse clubs and discounters, convenience stores, drug stores, dollar stores, internet retailers, and the recent expansion of meal-kit delivery companies. Cross-border forays by grocery retailers looking for growth beyond mature home markets continue to reshape the grocery sector.
Sales Shifting Away from Traditional Grocery Stores: In a highly competitive market, retailers are narrowing in on new tactics to grow share and mitigate challenges from new market entrants. Many stores have shifted their assortment towards more fresh and organic produce, whose sales are surging. In May 2017, the Organic Trade Association released a report highlighting new sales of almost 3.7 billion from the previous year. Organic sales in the U.S. totaled approximately $47 billion in 2016; organic food now accounts for 5.3 percent of total food sales in the U.S. Additionally, millennials are more likely than older shoppers to buy produce at a non-traditional venue, according to a report from the Food Marketing Institute (FMI). Supercenters, organic and specialty retailers, and farmers’ markets are among the alternative channels frequented by millennials for fresh fruits and vegetables, which poses another threat to traditional grocery chains’ revenue and margins.
Consumer migration online has grocers racing to increase their online presence, while online retailers including Amazon and China’s Alibaba, are trying out a brick-and-mortar retail format. Fierce competition, particularly at the high and low ends of the market, and the cost advantages of online retailers have sparked supermarket price wars, which benefit consumers but threaten to erase the grocery industry’s already razor-thin profit margins.
After years of tepid growth, online ordering appears to be nearing a point of change. Online grocery sales are rising, particularly in the world’s most advanced e-commerce markets such as South Korea, China, and the U.K. In the U.S., online grocery sales comprise less than 5 percent of total retail grocery sales, but it’s a quickly changing metric. Online sales are expected to grow to over 20 percent (representing more than $100 billion) of the U.S. grocery market by 2025, according to the Food Marketing Institute (FMI) and Nielsen. The e-commerce customer experience is getting better, prices are dropping, and delivery options are expanding. While numerous retailers across the size spectrum have entered the market, including industry leaders Walmart, Kroger, and Safeway, a non-traditional threat looms. One of the biggest players in the grocery e-commerce market is AmazonFresh, Amazon’s on-demand grocery delivery service.
Additionally, smaller store formats, while not a new concept, have picked up steam in recent years with major retailers taking serious steps into this space including Aldi, Sprouts, Ahold’s Bfresh and Whole Foods’ 365. But the success of these smaller formats will depend on higher sale density, so many are focusing on higher margin areas such as prepared foods, produce, meat and bakery and are shrinking the center aisles.
All of the above trends are contributing to the mounting pressures on traditional grocery stores and, in some cases, their closure. Having said that, a liquidation in the grocery space, if managed professionally in terms of product mix management and effective advertising, can be successful without a go-forward retail prospect, and in spite of a competitive market disadvantage.
Amazon Buys Whole Foods: In June 2017, Amazon announced its acquisition of Whole Foods Market Inc. for $13.7 billion. The deal has massive implications for the $800 billion U.S. grocery market. Amazon is now a much bigger player in food and beverages, with access to more than 460 Whole Foods stores and a network of distribution centers in the U.S., Canada, and the U.K. Amazon’s e-commerce, data, and distribution expertise combined with Whole Foods ($16 billion in sales) puts immense pressure on Kroger and Wal-Mart, which are the largest sellers of groceries in the U.S., as well as other brick-and-mortar grocers.
When the acquisition closed in August 2017, Amazon immediately slashed prices at the chain by as much as 43 percent on key items, a signal it intends to compete hard for value-conscious consumers. For products advertising Amazon-related price cuts, west coast chain Ralphs is now 4 percent more expensive than Whole Foods, while it used to be 20 percent cheaper. For those items, Sprouts is now 2 percent more expensive than Whole Foods, where it used to be 24 percent cheaper.
Amazon also announced it planned to turn Amazon Prime accounts into the loyalty program for Whole Foods. This is significant because Whole Foods shoppers are more likely than U.S. consumers overall to be regular Amazon shoppers. Furthermore, they are more likely to already subscribe to an Amazon Prime membership. This could be a crucially important avenue for Whole Foods to improve its lagging same-store sales. The retailer has been cautiously experimenting with loyalty programs for years, conducting small-scale pilots but never launching a nationwide program. This would allow it to quickly give more than half of its shoppers a good reason to come to its stores more frequently; and convince some Prime members who don’t shop at Whole Foods to give the store a try. It remains to be seen whether this leverage allows Whole Foods reaches new customers rather than simply ceding market share to Amazon.
Seasonality, Perishability, and Margins are Key Considerations: When closing a grocery store, there are several unique considerations to selling the inventory. Consistent with the majority of retailers, grocery stores, and supermarkets typically carry a selection of low-turning inventory in order to provide customers with a range of products. When faced with a bankruptcy filing and subsequent liquidation, this product often has low sell through rates due to seasonality or lack of demand. Perishability is also a major factor in dispositions. Inventory that is at (or near) its expiration or “use by” date may require additional discounting to sell through quickly. Produce, a higher margin product, typically has heavy shrink due to the need to dispose of non-selling fresh items. Maximizing recovery rates can also be challenged by sale term duration. Going-out-of-business (“GOB”) sales in the grocery sector are short, typically lasting a maximum of six weeks and often less. Seasonality can also be a major driver in periods immediately preceding holidays such as Thanksgiving, Christmas, and Easter which drive higher volume during the normal course of business.
Grocery stores operate with extremely low margins and depend on volume to generate profits. In some cases, grocery stores net less than a penny per dollar of retail sales. Competition limits a company’s ability to raise prices. Although gross recoveries on retail (by category or in the aggregate) may be higher than average, the blended gross recovery on cost typically does not exceed 100% due to the lower margin nature of the sector.
Category Demand Drives Range of Recovery Rates: Specific categories for grocery retailers can drive significantly higher or lower gross recovery rates depending upon customer demand and level of inventory availability. The highest recovering categories include high turning categories such as meat, deli/prepared foods, dairy, bakery, and produce. These categories typically sell through very quickly in a disposition event. Managing the discounts on slower selling categories once the major perishable categories are sold through is critical to maintaining customer interest in “re-shopping” the sale beyond the opening days. High turning dry grocery sub-categories such as branded staples including crackers, cookies, and pasta, along with infant formula and popular branded health and beauty products typically require less discounting to sell through regardless of season. Conversely, grocery sub-categories including spices and kitchenware are typically in lower demand and require additional discounting to sell through in an accelerated time frame.
The delta between high and low recovering categories in the grocery segment can be significant on a retail basis. Even within stronger recovering categories such as health and beauty, there is potential for a lower recovery on items with depth in the inventory, including vitamins, and less popular first aid and beauty products. Supermarkets may also include gas stations or stock cigarettes and alcohol, all of which are very high recovery categories. However, it is important for lenders to be aware what (if any) additional licensing or permitting may need to be in place in order to sell these highly controlled and restricted commodities in a bankruptcy scenario.
Managing discounts on high and low recovering inventory in tandem with seasonal demand and on-hand inventory levels is critical to a successful GOB event. Understanding and predicting gross recovery rates by category, brand, region, and season comes with experience. Gordon Brothers applies the firm’s extensive real-world grocery and supermarket disposition involvement to each appraisal analysis, which assists asset-based lenders in offsetting risks associated with low-turning inventory.