The grocery store sector is in the middle of a massive change. The problem for investors, grocers, and anyone else who happens to be interested, is that it's not clear what the change looks like. Are big retailers' adding on grocery businesses the new normal? Maybe the change is that we can get groceries online. Or maybe the biggest change is that straightforward grocers can be more profitable by focusing on quality products. No matter what you think, there are some great places for investment, and here are five of the best grocery stocks for 2014.
Setting the bar with Kroger
There are lots of traditional grocery chains out there, but none of them are doing as well with nailing the basics as Kroger (NYSE:KR). The company managed an operating margin of 2.7% for the first nine months this year. That may not seem like a lot for traditional retailers, but consider that Safeway has managed just 1.4%, year to date. Kroger has managed to be a traditional grocery store chain, but with meaningfully better margins. Same-store sales have been rising in low single digits this year, pushing total sales by 3.2% last quarter.
The company is well set for 2014, and the recent addition of the Harris Teeter brand could help it reach new highs. The two companies announced a merger earlier this year, and the addition of the brand gives Kroger a new way to reach into some untapped markets. It also gives Kroger a quick move into some higher growth markets near colleges and upper-middle suburban areas.
If you're looking for a solid grocery chain that's simply doing what grocers have always done, but doing it better, Kroger is a great place to get started in 2014.
Whole Foods breaks the mold
Take the fundamental grocery model one step further and you'll wind up on the doorstep of Whole Foods Market (NASDAQ:WFM). Whole Foods has been growing like kudzu for the past few years. This year, it put up an annual comparable store sales growth of 6.9%, besting most retailers of any stripe. On top of that, it managed to wallop Kroger's operating margin, pulling in a 6.8% margin.
Whole Foods' secret is out there in the open. The company plays on a desire for higher quality, responsibly sourced food. It happily provides its consumer base with free-range everything, charging an excellent premium along the way.
In 2014, Whole Foods is going to keep pushing its broad expansion. That means opening new stores; the company has 94 new locations lined up and ready to go. Of those, about 35 should open up next year, driving an 11% to 13% increase in total sales. 2014 is shaping up to be a good year for Whole Foods and its investors.
Going big with Costco
Maybe you're not interested in appealing to the foodies -- no problem. Costco (NASDAQ:COST) is out there selling huge volumes of stuff for discount prices. The business keeps costs low by running warehouses instead of traditional stores and keeps customers coming back with its membership program.
Food -- not counting booze, candy, and all the other good things that also kill you -- makes up about a third of Costco's total sales. Fresh food currently makes up 13% of Costco's sales while packaged food accounts for 21%. For investors, the business has a number of upsides that these other grocers don't.
First, Costco has a member base. In its last earnings call, management announced that there were 72.5 million cardholders now. That gives the company a dedicated consumer that the other businesses can't boast. Second, Costco sells other stuff, insulating it from all the ups and downs of the market. By selling TVs and jewelry and coffins, Costco gives investors a more stable retail environment.
Finally, Costco's reach is well beyond that of Whole Foods or Kroger. The company operates in Mexico, China, and Australia, among other countries. That global reach again levels out the business, but also gives it growth opportunities that traditional grocers don't have. 2014 is going to see the business expanding further and hopefully pushing its operating margin up, especially in fresh food, which took a hit this year.
Why go out when Amazon brings it to you?
In the list of disruptions to the grocery business that I never thought I'd see, drone delivery of eggs is pretty far up there. Now, Amazon (NASDAQ:AMZN) may never actually use drones for delivery -- and even if it did, eggs might be off the list -- but it's still something to think about. It points to a possibility that Amazon has made real by focusing on giving shoppers what they want, no matter how odd it seems.
Right now, Amazon is trying out fresh food delivery through its AmazonFresh brand. Three cities on the West Coast -- LA, San Francisco, and Seattle -- are serviced by the company and shoppers can receive fresh produce right on their doorstep.
The delivery service, along with the drone research, along with the Sunday delivery that Amazon worked out this year with the USPS, all point to Amazon's next big step -- delivery control. If Amazon can crack delivery on the fresh side, it can start to charge for convenience, taking market share from traditional grocers. While 2014 is unlikely to be the big year for AmazonFresh, it's hard to argue with getting into Amazon sooner rather than later.
Finishing on hope with The Fresh Market
This year wasn't kind to The Fresh Market (UNKNOWN:TFM.DL) or its investors -- the stock is down 17%, year to date. Growth slowed, and the company has had difficulty in its new markets. Stores in California and Texas have been underwhelming, but have taken a huge chunk of cash to get running. So it's fair to wonder why it would be on this list.
Opportunity. Fresh Market is in a position where it's been presented with a fantastic opportunity. Anyone who's been in a store can see right away how the business is different from traditional grocers, but it also stands out from Whole Foods. The company focuses on customer service and ambiance, creating a pleasant shopping environment through low shelves and a high employee-to-shopper ratio.
Fresh Market makes fistfuls of cash from its operation when it does work, and its year-to-date operating margin is 7.4%, beating out every other business on the list. Fresh Market also has an incredible opportunity in front of it with its California and Texas locations. Right now, those businesses are struggling to grow, but if they can, everyone will be a winner. Whole Foods has about a fifth of all its locations in California, signifying the demand for higher-end food there.
Fresh Market's 2014 success is not a given -- none of these businesses' success is a given, but Fresh Market is the least given. The company needs to be better at either multitasking or being selective. One of its big pushes into Texas came about because an opportunity to get a foothold in Houston came up. Fresh Market's existing expansion into California should have kept it from jumping, even though it was a good opportunity. If it can sort out its new markets in 2014, Fresh Market could storm it. If not, it could be another very bad year.
Opportunity at every turn
Whether you're looking for classic grocers or disruptors of all kinds, 2014 looks ready to fulfill your portfolio's need. Investors should also keep an eye on commodity prices, as large swings can have big effects for in-house brands. The real opportunity here is to find a company that has gas in the tank for the long run. While 2014 may be the next year, it's just the first in a long line of next years for smart investors.
John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Fool contributor Andrew Marder has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Costco Wholesale, and Whole Foods Market. The Motley Fool owns shares of Amazon.com, Costco Wholesale, and Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.