If you thought we’d seen the worst of the pain for grocery stocks, think again. Morgan Stanley warns that disruption is accelerating in the food retailing sector.
Where we were: Supermarkets have always operated with thin margins, but growing competition from big box stores and online startups has intensified competition.
Where we’re headed: Margins could shrink further as more shopping moves online.
Retailers across the spectrum have had to deal with the ongoing shift to online shopping, and food retailers are no exception. Morgan Stanley’s Simeon Gutman writes that Walmart and Kroger are increasing their click-and-collect locations by around 80% this year, to some 3,600 by year end. At the same time, Amazon.com now offers free Whole Foods two-hour delivery for Prime members in nearly 50 locations, and no-frills discounter Aldi will expand grocery delivery nationwide, via Instacart, by Thanksgiving.
Based on retailers’ response to the rise of Walmart in the 2000s in the U.S., and the advent of hard discounters in the U.K. in the 2010s, he says, the cost of investments to remain competitive on prices will cut into gross margins by a cumulative 0.5 percentage point over the next five years.
At the same time, lower-margin online sales are cannibalizing in-store revenues, even as high fixed costs for brick-and-mortar locations remain, he says.
Given the level of investment—and willingness to slash prices—needed in this environment, it looks like a big player’s game, even if they too see margins suffer. Gutman writes that his grocery revenue model indicates the top 20 food retailers hold 83% of the market, up from 79% five years ago.
“Scale should prevail as the larger retailers use their size to maintain price competitiveness while still investing to drive omni-channel growth and maintain in-store service levels,” he writes, noting that market expectations are for stable margins at Kroger and Walmart.
That appears challenging, Gutman says. He reiterated Equal Weight ratings on both companies.
Kroger was down 0.9% to $29.13 in recent trading, while Walmart was up 0.3% to $94.83.