5 Growing Grocers and the 1 to Buy Today

Take everything you ever knew about the grocery business and toss it in the trash along with that funky-smelling milk. Since the dawn of the supermarket supermom, grocery stores have been a part of our daily lives. Those days may soon be disappearing, though, as shoppers become less concerned with experience and more concerned with convenience. From bulk purchases to cheap fuel to online offerings, traditional grocery stores and innovative new competitors are all vying for consumer attention. In this rapidly changing industry, their decisions will ultimately determine whether each company succeeds or fails.

The grandfather of grocers
Founded in 1883, Kroger (NYSE: KR  ) is one of the oldest and largest food retailers around. As the top dog, Kroger has decided to keep doing what it does best: sell food. However, it's also creating a one-stop-shop experience by integrating pharmacies and fuel stations into almost half of its stores. Throw in a reasonably navigable website supporting its rewards program and online coupons, and Kroger seems to be maintaining a healthy balance between traditional and innovative.

That said, Kroger's razor-thin profit margin of 0.7% doesn't give it much wiggle room for high-risk, high-reward business decisions, despite its formidable $90 billion revenue.

Buy bulk
Capitalizing on the "get big" mentality, Costco (Nasdaq: COST  ) has created convenience through quantity, rather than accessibility. Its plunders often exceed the output of a small farm. To further draw in customers, Costco has been adding fuel stations to its stores and is expanding its online food options. However, with only 315 food items currently available on its website, it has a long way to go before customers head to Costco.com instead of to Costco.

Of all the stores I'll mention here, Costco has the steepest multiple. With it you'll get enviable customer loyalty, crazy high sales per square foot, and a company with sterling management. However, with beloved former CEO Jim Sinegal no longer at the helm, it's fair to wonder whether it has the momentum to maintain such historically impressive growth.

Targeting food
Ten years ago, most people would've laughed at the idea of buying boxers and bratwursts at the same store. Now Target (NYSE: TGT  ) is quickly making it possible to buy pants, then food, then bigger pants, then more food, then ... well, you get the idea. In the past year alone, Target opened 20 new food stores and converted 393 more of its locations, almost doubling its exposure and passing the 50% mark on stores selling groceries. With a 4.1% profit margin, it's remaining a solid cash generator even as it pours money into development. You can't purchase food online from Target, but its website prominently displays food coupons to lure you into one of its 1,764 stores nationwide. Bull's-eye.

A fruitful pharmacy
It's hard to imagine an easier place to pull into than one of Walgreen's (NYSE: WAG  ) 7,761 stores. It's just not an intersection if there isn't a Walgreens store on at least one corner.

One of the newer players in the grocery game, Walgreen gives a nod to food sales in its most recent quarterly earnings report, citing food as the main reason for its increase in front-end gross margin percentages. Its website contains a catalog of nearly all its food items, but a large share of them are available for in-store purchasing only.

In the past two years, Walgreen has even put resources behind locations identified as "food deserts" where other grocery retailers have no presence. In addition to creating a niche market, this initiative offers accessible and healthy food to areas historically lacking access to quality nutrition. The few extra social-responsibility brownie points aren't too bad, either.

E-grocer
Amazon.com (Nasdaq: AMZN  ) is the definition of convenient consumerism. Online grocery shopping may seem like something best left to the Jetsons, but remember what people thought about boxers and bratwursts? With nearly 550,000 grocery items, Amazon.com is taking the conventional grocery-store concept by storm. Online shoppers are forking over $79 a year for free shipping to order noodles, a single can of beans ... even a Pez dispenser.

But Amazon's going retro, too, harping back to the days of milkmen with Amazon Fresh's doorstep delivery. Offering greater Seattle more than 1,500 fresh food items, there's no doubt Amazon is sampling consumer sentiment for a grocery revolution.

Normal metrics such as "comparable store sales growth" or "sales per square foot" simply don't compute for Amazon's model, which is one reason to both love and fear this company. If there's a rule breaker here, it's Amazon's storeless approach to grocery shopping.

From here to there
Call me crazy, but I think people are going to buy food no matter how bad the economy is. Historically, "grocery retail" and "volatility" have rarely been used in the same sentence, but that doesn't mean you can just invest passively without a little extra research. Here are some tips to keep you on track:

  • Check same-store sales where applicable.
  • Watch for increased food sales from new players as they vamp up their grocery departments.
  • Watch for shifts in the sales of certain segments from food for grocery store veterans as they expand their offerings to include fuel stations, pharmacies, and the like. Remember that some categories like fuel are often sold as loss leaders to drive sales elsewhere.
  • Valuation matters, so take current stock prices into account. Investors are expecting change, and different companies are priced accordingly.

Of all the companies I've mentioned here, Target is the one company I'd keep in my cart no matter how long the line is. Kroger isn't innovating fast enough in my opinion, Costco's growth is priced into its uber-analyzed stock, Walgreen's grocery offerings are limited by its store size, and Amazon's stock is a bit too expensive for me to trust.

Over the past three years, Target has proved its complementary clothing-plus-food model by consistently increasing overall sales and sales from food. Stellar management has also proved that Target can stand up to industry giants such as Wal-Mart, all the while maintaining an admirable 4.15% net profit margin. With a reasonable P/E ratio and a 2.48% dividend yield for you to snack on while it grows, Target seems to be aiming for expansion without sacrificing shareholder happiness.

American companies aren't the only ones cashing in on this massive shift in the grocery business. Picked as The Motley Fool's Top Stock for 2012, this "Costco of Latin America" has the potential to make you mega bucks in the next few years. Check out this limited-time free report now!

Fool contributor Justin Loiseau owns none of these stocks, but he regularly loads up on 12-packs of Ghirardelli Brownie Mix at Costco. You can follow him on Twitter, @TMFJLo, and on Motley Fool CAPS, @TMFJLo.

The Motley Fool owns shares of Costco Wholesale and Amazon.com. Motley Fool newsletter services have recommended buying shares of Costco Wholesale and Amazon.com and creating a diagonal call position in Wal-Mart. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (4) | Recommend This Article (6)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 04, 2012, at 5:08 PM, DAG1996MF wrote:

    Sorry, but it's laughable to suggest that a retailer that barely has a grocery business to speak of is somehow the best grocery business. It's quite a stretch to suggest that Target will not only dethrone the formidable retailer that it actually competes with (Walmart), but will somehow do what Walmart has not been able to do in all the years it has been trying to take over the grocery business -- stop Kroger from thriving in the face of their competition. It's a bit curious that there aren't even any other grocers mentioned in an article supposedly about the grocery business. Perhaps a dose of reality is in order -- Kroger is the only grocery retailer that's not getting it's lunch eaten by Walmart (not Target) and is actually benefiting from the battering other grocers have taken. Kroger also owns convenience stores, gas stations and jewelry stores, in addition to grocery stores, and is using that diversity to open a chain of EV charging stations. Target is a fine company, but the idea that Target is the best buy specifically in the grocery space is ridiculous.

    http://dfw.cbslocal.com/2012/06/18/kroger-installing-electri...

  • Report this Comment On July 05, 2012, at 11:58 AM, TMFJLo wrote:

    @djohn1969

    Thanks for your comment. Kroger does benefit from diversification, but with 84% of its sales linked directly to food, it's reliant on a sector that is being increasingly encroached upon by new competitors with healthy diversification and an appetite for innovation.

    Target has steadily increased groceries sales from 16% in 2009 to 19% in 2011 and will continue to expand its food options in the years to come.

    The grocery sector is changing fast, so no one knows for sure who will come out ahead, but healthy debate will make us more informed investors!

  • Report this Comment On July 05, 2012, at 4:32 PM, DAG1996MF wrote:

    Fair points, but we can't have it both ways...

    "I think people are going to buy food no matter how bad the economy is." seems to imply that food is a strong sector and it is, therefore, good for a company to have most of its revenues linked directly to food. So, it doesn't make sense to then say that a company that gets a mere 19% of revenues in that sector is the best option compared to a company that gets 84% of its revenues from that sector. I get it -- the food business is good for Target, but not for Kroger and diversification is good for Target, but not for Kroger. You've made your position clear so I don't expect you to agree... I'm just sayin'.

  • Report this Comment On July 18, 2012, at 6:48 AM, TMFPennyWise wrote:

    Yes, it's been interesting watching the grocery business evolve in the past few years. Living in Cincy, the home of Kroger, we have a huge prototype fancy Kroger (it offers a big wine and beer selection) in our neighborhood and they are buying additional land next door to install more gas pumps (they already have about 10 there). I think the company derives a lot of their profit from their gasoline sales these days. And wine and beer. Not to mention their jewelry. I go there for their organic produce and dry aged beef.

    Down the street we have a Target where more and more often I find myself going in to buy kid's clothes and walking out with groceries for dinner. And I notice the grocery selection is growing.

    And then there's Costco where we shop once a month, always buying more 'stuff' than we anticipated. And of course Whole Foods, where it never ceases to amaze me how crowded and expensive that store is even in tough economic times. And of course Aldi's at the other end of the spectrum.

    So a wide range of options is available for food stuffs and I expect to see more tweaking of the product lines to increase margins and to serve modern families better. It will be interesting to watch.

    (Now, if I were buying stock and not groceries, I'd probably buy Fresh Market though.)

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