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In a nutshell, rising gas prices hurt. Maybe some people were shocked to notice signs of oil demand destruction last week as American consumers reduced their driving, but it's only common sense that at a certain point, folks won't (or, sadly, can't) fuel up as often when gas prices exceed $4 a gallon.
As for the popular sentiment that inflation's mild, it's only mild if you don't need food or gas, or you're swimming in so much money that you simply don't notice. For normal, average Americans, inflation has been very, very real.
Consider some recent consumer price data released by the Bureau of Labor Statistics. As of March, consumers were shelling out 17.9% more for butter, 4.2% more for eggs, 23.7% more for tomatoes, and 10% more for ice cream than they were just a year ago. These examples of the rising prices for common grocery list items tell the tale.
With these factors in mind, investors should be wary if they're thinking of picking up some grocery stocks. With consumers' pocketbooks pinched by high prices, shopping carts will likely become lighter as demand is curtailed.
Some grocers will experience outright customer defection to cheaper rivals. However, I've picked one grocer I still believe can win, even in this unappetizing environment.
Time to buck convention
Conventional grocers face a difficult competitive environment even in good times. In tough times like these, it's going to be even harder to increase operational performance.
For example, Safeway (NYSE: SWY ) recently reported a 73.9% quarterly profit drop. Although that precipitous drop is mostly related to charges from its debt repayment plans, future headwinds could make things a little unsafe for Safeway.
Just like the average consumer, Safeway's contending with high gas prices because it sells gas at some of its stores; last quarter, this hurt its profit margins. Although the grocer's revenue increased 5%, the battle for sales isn't over: Safeway is one of the grocers that must compete on price to bring customer traffic through the door.
Meanwhile, Wal-Mart (NYSE: WMT ) is a massive threat in the grocery business; its own slowing U.S. sales have resulted in renewed focus on its low price competitive advantage to try to convince struggling shoppers to use its stores for their grocery needs.
That spells trouble for rivals such as Safeway and Kroger (NYSE: KR ) . The need to pass higher costs onto consumers while identifying prices that won't drive shoppers into the waiting arms of Wal-Mart is going to be a tricky endeavor.
Here's one you can take to the checkout
It may sound like a good time to shun all grocers, but think again. One grocery standout shows remarkable resilience.
Some investors shunned Whole Foods Market (Nasdaq: WFM ) prior to its quarterly earnings results (news of rising costs and increasing bearishness pressured many grocers' stocks last week), but the organic grocer delivered an admirable quarter. Second-quarter net income increased 33%, to $89.9 million, or $0.51 per share. Revenue surged 11.6%, to $2.4 billion, and same-store sales increased 7.8%.
There are lots of reasons to prefer shares of Whole Foods over those of conventional grocery stocks. A big one is its core clientele: They tend to be affluent, and therefore they're probably more resilient to the rising cost of living. On the other end of the spectrum, Wal-Mart has described its core customers as struggling more than ever lately; CEO Mike Duke recently described them as running out of money faster than they did a year ago, and rising gas prices are the culprit.
Meanwhile, Whole Foods' heavy emphasis on healthy eating habits (and educating consumers on healthy eating) should help ensure loyalty among many of its shoppers. Whole Foods' focus on a meaningful grocery shopping experience gives the impression that shopping there for healthy, high-quality foods is worthwhile. This should continue to give it an edge, even in a more difficult pricing environment.
Does Whole Foods have a whole moat?
Not surprisingly, Whole Foods looks like one of the priciest grocery stocks out there. It trades at 36 times earnings; compare that to Safeway (P/E: 18), Kroger (P/E: 14), or Wal-Mart (P/E: 12).
However, if Whole Foods does have the competitive advantages I believe it possesses, this multiple may not be turn out to be so outrageous when future growth comes to pass.
On the other hand, the grim realities eating away at consumers' budgets are certainly out there. If Whole Foods can't give its clients a good reason not to trade down to retailers boasting lower prices, this could be a dangerous time to buy up shares.
What do you think about grocery stocks in the current environment? Do you agree that Whole Foods is a good stock idea, or do you think more conventional grocery stocks are better investments right now? Share your thoughts in the comments box below.