Grocery & Supermarkets
Date August 2016
Approximate net recovery on cost
Food at home price index
- Retail sales at grocery stores rose to $52,481 million in August. Year-to-date, sales have averaged 1.7 percent above last year
- While the overall industry is growing, major shifts are happening within the sector. Trends including growth in fresh and organics, increasing shift to smaller stores, increased online ordering, and growing home delivery sales are among the factors leading to diminished sales at traditional grocery stores at some chains
- At the same time, food deflation is pinching already thin margins. The Wall Street Journal observed that in 2016 the U.S. may record the longest stretch of falling food prices in more than 50 years
Sales shifting away from traditional grocery stores: In a highly competitive market, retailers are honing in on new tactics to grow share and thwart challenges from new market entrants. Many stores have shifted their assortment towards more fresh and organic produce, whose sales are surging. In July, the Organic Trade Association and Nielsen released a report highlighting a 16.4 percent growth from one year ago.
Smaller store formats, while not a new concept, have picked up steam in recent years. Major retailers taking serious steps into this space including Aldi, Sprouts, Ahold’s Bfresh, and Whole Foods’ 365. Success of these smaller formats will depend on higher sale density; many stores are focusing on higher margin areas, such as prepared foods, produce, meat, and bakery, and are shrinking the center aisles.
After years of tepid growth, online ordering appears to be nearing an inflection point. The ecommerce experience is getting better, prices are dropping, and delivery options are expanding. According to a survey released earlier this year by grocery retail consultant Brick Meets Click, 41 percent of consumers have purchased groceries online at some point in time, and during the fourth quarter of 2015, 21 percent of surveyed consumers had bought groceries online during the preceding 30 days. While numerous large and small retailers have entered the market including giants Walmart, Kroger, and Safeway, a non-traditional threat looms. One of the largest players in the grocery ecommerce market is AmazonFresh, Amazon’s on-demand grocery delivery service. Research firm Cowen & Co. estimated its market share at around 22 percent of all food and beverages sold online domestically in 2015. Although this still remains a small slice of the nearly $800 billion market, Amazon has the potential to severely disrupt the industry with its powerful logistics engine and customer database.
All of the above trends are contributing to the mounting pressures on traditional grocery stores and, in some cases, leading to their closure.
Seasonality, perishability, and margins are key considerations: When closing a grocery store and selling the inventory, there are several unique considerations to take into account. 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 significant 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. Per Creditntell, the average gross margin for the top U.S. grocery retailers was 25.8 percent for the 12-month period ended December 2015, which represented a slight increase from 25.3 percent for 2014. Although gross recoveries on retail (by category or in aggregate) may be higher than average, the blended gross recovery on cost typically does not exceed 100.0 percent 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 timeframe.
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 products and beauty treatments. 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 its 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.