Stifel initiated coverage of three grocery stores — Kroger Co, The Fresh Market Inc., and Sprouts Farmers Market Inc.—with Friday notes that rate the shares at buy or hold based on quality goods, smaller stores, and strategic pricing, all big trends in the grocery space.

Stifel analysts describe the grocery landscape as a “barbell,” with large format grocers, like warehouse clubs, on one end, and high-end, smaller shops on the other. In the middle are traditional stores that are largely being “squeezed.”

Sprouts stores, for instance, occupy about 27,000 square feet, while traditional grocery stores are in the 45,000-square-feet range.

Among those on the large end of the barbell are Wal-Mart Stores Inc. which recently announced that it was closing all 102 of its smallest Walmart Express locations to focus on its Supercenters and Neighborhood Markets. Supercenters average about 178,000 square feet and Neighborhood Markets average between 38,000 and 40,000 square feet.

Kroger is “taking share from both sides of the retail barbell,” Stifel analysts wrote. Stifel initiated Kroger with a buy rating and a target price of $45. Shares closed Friday at $22.78.

Kroger has reported 48 consecutive quarters of positive same-store sales. Same-store sales were up 5.4% in the most recent quarter, and earnings were 44 cents, exceeding Street estimates of 39 cents.

Analysts attribute Kroger’s results to three attributes: data analytics, furnished by its subsidiary 84.51°, which, for example, helps the company with pricing; an assortment that includes organic and natural foods sold under an in-house brand called Simple Truth, which raked in $1.2 billion in sales, or 1.1% of total revenue, in fiscal 2014; and what Stifel calls “its prioritization of store quality” that includes higher wages (an average of $14 per hour) and regular store remodels. The company has been modest in its square footage growth, instead opting for acquisitions, like the recent purchase of Milwaukee-based chain, Roundy’s.

“Kroger has positioned itself at the economic center of an industry in transition, boxing out weaker middle-market competitors to capture share of consumers increasingly seeking local convenience and high quality products and service,” the bank wrote.
Kroger’s shares closed Friday up 5.2% and are up about 6% for the past 12 months. The S&P 500 is down 11.4% for the past year.

Stifel initiated Sprouts Farmers Market Inc. a regional healthy market stocked with items like gluten-free foods, with a buy rating and a $27 price target. The stock closed up 5.7% at $23.34.

Sprouts plans to grow to 418 stores from 216 in five years, with the goal of reaching 1,200 stores in 13 years. (Stifel analysts are e4xpected it to take 18 years.)

Sprouts sells produce priced about 25% lower than traditional grocery stores while offering customer service from “knowledgeable employees,” Stifel wrote in a separate note. The small size of its stories is also suited to the quick shopping trips that consumers prefer, and is better for older customers.

“The combination of assortment, prices, and service is winning customers who make Sprouts their primary grocery store, not just another specialty shop,” the note said.

Sprouts shares have fallen about 38% in the past 12 months.

Pricing is an advantage against rival Whole Foods Market Inc. which hasn’t been able to shake its “Whole Paycheck” reputation.

Whole Foods is chasing the trends with its new 365 by Whole Foods stores, the first of which is coming in 2016. The company is planning to open 10 by 2017 in places like California, where Sprouts has a high volume of stores.

Stifel initiated Fresh Market Inc. with a hold rating, emphasizing the “great potential for a concept trying to present itself as a smaller, cheaper alternative to Whole Foods.” However, the grocer made a misstep in its failed efforts to expand in California. The company opened its first store there in fiscal 2012 and announced it was leaving the state in March 2015.

Fresh Market, which has 180 stores that average 21,000 square feet, is also occupying a space that is becoming more crowded, focused on natural and organic produce. Differentiation and strategic pricing is increasingly important.
One thing working in its favor is a broader definition of quality, which includes sweets and comfort foods.

“Indeed, customers don’t view Fresh Market as a ‘health food store’, but instead as a ‘special’ food store for special occasions,” Stifel analysts wrote.

Fresh Market shares closed up 0.4%, but are down 39% for the past 12 months.

Source: MarketWatch