Following Amazon’s acquisition of Whole Foods and the big drop in supermarket stocks – especially Kroger (KR) – I’ve decided to do a series of re-posts of my analysis of the U.S. supermarket industry.
Today’s re-post is a roughly 1,300 word excerpt from the Village Supermarket (VLGEA) stock report Quan and I wrote back in 2014. This section focuses on whether or not a supermarket can be a durable investment. The full 10,000+ word report on Village – along with 26 other reports of similar depth – are now available at my new site, Focused Compounding.
Some facts have changed since this report was written. For example, Amazon’s companywide sales figure is much, much higher than it was in 2013 (the last year for which we had data when we wrote this report).
And – more relevant to the grocery industry – Amazon Fresh has gone from a $300 a year add-on to Amazon Prime to a $15 a month add-on to Amazon Prime (so 40% cheaper).
Durability (From the 2014 Report on Village Supermarket)
High Volume Supermarkets are Durable Local Market Leaders
Demand for food is stable. Most grocers do not experience meaningful changes in real sales per square foot over time. Changes in real sales numbers almost always reflect changes in local market share. There will be online competition in the grocery business. However, in Village’s home market of New Jersey, direct to your door delivery of groceries has been available for 18 years. Peapod started offering online grocery shopping in 1996. The company was later bought by Royal Ahold. Royal Ahold owns Stop & Shop. Peapod has 4 locations in Somerset, Toms River, Wanaque, and Watchung. These locations offer grocery delivery in Village’s markets. They are direct competition and have been for years. Peapod does not require a $300 annual fee like Amazon Fresh. Instead, Peapod simply adds a delivery charge. Customers also tip the driver. Since the driver normally carries the bags into the customer’s home and puts them on the kitchen counter for the customer – the tip is usually a generous one. Peapod charges $6.95 for orders over $100. The charge for orders under $100 is $9.95. The minimum order size is $60. Customers can also order online and then drive to one of the 4 Stop & Shops mentioned above (Peapod often uses the second floor of a building where the ground level is Stop & Shop’s retail store) and pick up their own order. Pick-up is free. However, a Peapod employee still collects the groceries and brings them to the customer’s car. So, a tip is still expected. Common tips are probably $5 to $10. So, the total cost of a Peapod home delivery order is probably anywhere from $12 to $20 higher than a trip to a Stop & Shop grocery store. Even a pick-up is probably $5 higher than a normal Stop & Shop visit – and the customer still has to drive to a store to make the pick-up.
Wakefern is a large co-op with similar scale to Stop & Shop nationally and more scale than Stop & Shop in New Jersey. Creating a retail website is easier now than it was in 1996. Therefore, it is no surprise that 87 of Shop-Rite’s 480 locations offer online shopping. In fact, online shopping is available from both Shop-Rite and Peapod in certain towns like Somerset.
This is important, because the average supermarket customer in the U.S. does not drive far to visit a location. Kroger uses a 2 to 2.5 mile radius to define its local market. Research on the opening of a new Wal-Mart found that supermarkets further than 3 miles from a new Wal-Mart saw no meaningful impact to their sales. This suggests that Wal-Mart Supercenter’s do not draw grocery customers from more than 3 miles away. So, a 2-3 mile radius is a reasonable definition of a supermarket’s local market. Convenience is the biggest hurdle for online grocery providers to clear. Amazon Fresh requires a $300 annual fee from its customers. Peapod requires a $60 minimum order.
The average grocery store visit results in a checkout of less than $60. At Shop-Rite, the average customer pays $52 at checkout. So, online grocery shopping tends to be more expensive and require larger orders than traditional brick and mortar supermarkets. Furthermore, online selection is usually inferior to the largest traditional supermarkets. For example, Peapod has a narrower selection of items on its website than it does at its retail stores – even though its online business is literally housed in actual supermarkets. This is a logistical problem caused by the difference between running a delivery business, an employee collected pick-up order, and a customer’s self-selected in store order.
Costs tend to be lowest and selection widest when a customer is forced to put their own items in their own cart by going through the store aisles themselves. Another problem with online ordering is the need for scheduling. Online grocery orders require the customer to be home at a specific time. The customer is usually given a window that can be as long as 2-3 hours during which they must be home to answer the door. Meanwhile, in store visits are always at the customer’s options. Traditional supermarkets are often open from roughly 10 a.m. to 8 p.m. seven days a week. Customers can drop into their local store at their convenience – including on the way home from work – and pick-up an order of any size. There is no scheduled time, no delivery fee, no tip, and no minimum order size. The selection is usually as wide as the company can provide.
For example, Village’s largest new store is 77,000 square feet. It includes plenty of fresh foods and prepared foods that are not sold online. So, online competition is not new to the New Jersey grocery market. And groceries are an especially tough business for online retailers to compete in.
One problem for online retailers is that all of their offline competitors have local scale. There is no such thing as a “Mom and Pop” grocery store in the U.S. Unlike hardware stores, pet stores, and book stores – the supermarket business is very locally consolidated. It would take an online retailer a long time to have scale locally. However, it would be possible for online retailers to develop bargaining power with suppliers. This is why Shop-Rite is run as a co-op.
Online retailers will continue to enter the grocery business. It is a huge market. The opportunity for growth is enormous. For example, the U.S. grocery business is probably about $600 billion a year while Amazon’s entire companywide sales are just $75 billion. Amazon could more than double its sales with just a 13% share of the nation’s grocery business. The size of the opportunity in groceries will continue to attract online and non-traditional competitors.
Non-traditional competitors are the biggest threat to Village. In the industry, “non-traditional” refers to both deep discount and high end (especially fresh and/or organic) grocery stores. In New Jersey, the high end is the area of greatest concern. The non-traditional supermarket with the store model best suited for entering New Jersey is The Fresh Market.
Local competitors that segment the market are a risk for existing supermarkets. The one-year customer retention rate in American supermarkets is probably around 70%. About 30% of customers may switch to a local competitor each year. In a Consumer Reports survey, the top reasons giving for switching were: “lower prices” and “better selection”. Shop-Rite generally has the lowest prices and widest selection in its local market. The only exception is in towns with a Wegman’s. Wegman’s has larger stores and wider selection than even the biggest Shop-Rites. As a result, Wegman’s is usually ranked #1 in customer satisfaction.
Supermarkets tend to be durable. However, there is a constant churn of locations at most companies – closing failed stores and relocating stores to better locations – that can be costly. Since a restructuring in the early 1990s, Village has not experienced any store failures. Nor has it relocated a store for any reason other than wanting to increase its size. Over the last 17 years, Village has spent just 1.7% of sales on cap-ex. Meanwhile, Kroger spent 2.7%, Safeway spent 3.0%, and Weis Markets spent 3.2%. Village’s low cap-ex advantage is entirely due to not closing stores. Because Village – as a Shop-Rite operator – has the highest sales per store of any supermarket, it also tends to be able to renew leases. Supermarkets are the “anchor” tenant at strip malls. In the last 17 years, there was only one example – in 2003 – of Village failing to sign a new lease. Village has the most durable portfolio of supermarkets of any publicly traded company. For example, in just the last 12 years, Kroger closed 21% of its starting store base. Village owns 4 stores (with 335,000 square feet of selling space) and leases 24 stores (with 1.3 million square feet of selling space). The initial term of a lease is usually 20-30 years. Many have multiple renewal options after those first 20-30 years.