This Week, Industry Snapshot Looks at
Supermarkets

Albertson's, Inc. American Stores Company Hannaford Bros. Co. The Kroger Co. Royal Ahold nv Safeway Inc. Subscribers Online Discuss Industry Snapshot

ALEXANDRIA, VA (September 12, 1997) -- The following is anabbreviated version of the Motley Fool's "Industry Snapshot," an educational subscription product available for delivery via e-mail or fax. We feel that it is the best tool available for learning how to invest in stocks.

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Every week we will offer up a taste of what is available to Industry Snapshot subscribers by providing a short summation of the industry and the companies that appear in the most curent issue.

This Week's Industry Snapshot

One of the most glorious manifestations of capitalism as a system has to be the supermarket. A tribute to this unpolished gem is the fact that consumers take it entirely for granted. All the complex distribution arrangements that bring the dizzying array of foodstuffs virtually to our doorstep operate transparent to the consumer. Similarly, personnel who stock the stores labor into the wee hours of the morning, like capitalist elves, so that magically when we arrive at the supermarket, the shelves are chock full, brimming with 69 types of mustard and unpronounceable exotic fruit. It's just this type of system that brought East Germans to their knees upon entering West German grocery stores, sobbing all over the abundant offerings.

Unfortunately, investors do not have a similar tearful regard for this sector. Generally, investors place supermarkets in a basket with other retailers. Hence they are commonly overlooked, for their growth prospects pale in comparison with other specialty retail formats. However, shrewd investors realize that supermarkets are in reality a consumer staple, like the food manufacturers that supply them. In the heady market environment of the last six years, where returns have averaged 17% (with a standard deviation of about 10%), the stability and longevity of the supermarket is easy to overlook (that is, average long-term growth in the neighborhood of 12%).

Eventually when the focus on growth subsides (as actual growth slows) a premium will again be paid for a lack of volatility, as well as earnings consistency, two obvious characteristics of the supermarket industry. It is this rationale that has historically affixed the label of "defensive stock" to these issues, and is also the reason for their run-up at the beginning of the year as investors rotated into more "defensive" names in anticipation of a lackluster market.

Food Fight

Ultimately there have been no revolutions with regard to the delivery of food. Consumers still shop for groceries in very much the same fashion as they did 50 years ago. Supermarkets are unique when considered within the framework of retail in that they can simultaneously meet the needs of multiple consumers -- within the same market they appeal to shoppers that have concerns that center around price, time, and quality all at the same time.

The core growth of the supermarket industry is closely linked with population and inflation. Food price inflation has been historically linked to increased profitability at the retail level. Big surprise -- when prices are raised, margins expand. However, price inflation invariably comes about not as a result of sudden pricing power, but as input costs expand (i.e. labor and food costs). Sidestepping the perennially debated question of the causal factors that result in inflation, there has been a correlation between food price inflation and an increase in food retailer's profitability. It is this dynamic that led to a kind of complacency in the industry throughout the 1970s and 1980s, which in turn led to a business as usual attitude. The industry experienced strong cash flows during the period without having to change anything with respect to is business models.

The advent of low cost structure competition from stores like Wal Mart, which entered the food fight in the late 1980s, was a wake up call for lackadaisical supermarkets. The efficiency revolution hit the industry as retailers attempted to take costs out of the supply chain. Computer-based training, labor scheduling, and tighter inventory management all contributed to the belt tightening that was required for the industry to survive. Notoriously slow with regard to change, many of the improvements are just now beginning to be felt. Meredith Adler, a supermarket analyst with Lehman Brothers, recently commented, "The industry is less than 40% done with this efficiency enhancing process, there is lots of opportunity left." For the savvy investor, now might be an excellent time to capitalize on the dramatic changes occurring in the industry.

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