The Supply Side: Grocery consolidation likely to continue in challenging market

Food retail and food suppliers were active in mergers and acquisitions last year, and the trend is expected to continue, said David Schoeder, principal with The Food Partners in suburban Washington, D.C., an investment banker to the food industry.

“Amazon and Walmart are like two elephants wrestling, and all the other retailers in the U.S. are the grass,” Schoeder said in a recent webinar with the Food Institute.

Schoeder described a fragmented and struggling grocery retail landscape, something even titans like Walmart and Amazon have figured out. Schoeder said Amazon’s bold acquisition of Whole Foods created trepidation early on, but grocery remains tough for Amazon at scale.

“Kroger is making the necessary investments to stay relevant,” Schoeder said. “In May 2019, Kroger partnered with Ocado to build 20 fulfillment centers in the U.S., which will materially expand the retailer’s geographic market as well as improve efficiency and grow online without additional brick-and-mortar investments.”

Ocado was the first grocery retailer to create a sustainable model for home delivery in the United Kingdom. Ocado had 2018 revenue of $1.9 billion, and gross earnings were 5.6% of sales, according to Schoeder. He said partnership will help Kroger reach the majority of households in the U.S. with online grocery orders. Schoeder said the technology investment is not a major threat to Walmart, but it will be interesting to see where Kroger is in three to five years with the plan.

He said some retailers are starting to draw lines in the sand with respect to money they are losing on home delivery of groceries. Trader Joe’s announced in January it was suspending home delivery in the New York borough of Manhattan.

“Instead of passing along unsustainable cost increases to our customers, removing delivery will allow us to continue to offer outstanding value,” Trader Joe’s noted on its website.

Schoeder said there are a number of players focusing on “the last mile” and losing money on every incremental dollar of business. He said the question will be whether the players can generate sufficient volume in a market to create a profitable business model.

“Consumer tastes and preferences continue to shift rapidly for what, when and where they buy food. Food retailers can be separated into two categories: those who are relevant and growing momentum and those still operating as conventional stores,” he said.

FOOD CONSOLIDATION
Schoeder expects to see more grocery industry consolidation. In 2018, U.S. retail grocery store count declined by 2.5%. He expects the trend will continue at the same level or faster in the next five years. Food Partners reports the number of supermarket bankruptcies has remained steady over the past couple of years, but it ticked higher in 2018. Since 2010, five companies with more than 100 stores have filed for bankruptcy — A&P, Fresh & Easy, Haggen, Southeastern Grocers and Tops.

The Food Institute reports food retailers comprised 17% of the merger and acquisitions in a given year. Notable deals of the recent year include United Natural Foods acquiring SuperValu, Lidl making a deal for Best Markets, Walmart’s majority stake in Flipkart and Spartan Nash’s deal for Martins.

This is second only to food manufacturers who continue to lead the industry in merger and acquisitions at 30%. Recent activity included deals like ConAgra’s acquisition of Pinnacle Brands, Ferrero buying Nestle’s U.S. confections, General Mills and Smuckers each investing heavily in the pet category, or Tyson Foods’ long list of acquisitions like Keystone Foods and investments in Beyond Meat and other alternative meat ventures.

Karen Martin, an analyst with BMO Capital Markets, said during the webinar even with active consolidation in food retail, the U.S. still has six times the retail space per capita of other large countries. Martin said food retailers will continue to shutter stores in non-performing markets so they have the funds to invest in online commerce, which is considered “table stakes” in 2019.

“People like to blame Amazon for disrupting grocery and retail in general, but there was going to be pain regardless of Amazon given the excess capacity,” Martin said in her prepared remarks.

DEMOGRAPHIC SHIFT
Martin said the shifting demographics are also impacting the food industry. The era of Baby Boomers being the largest spenders in the U.S. has ended. In 2015, Baby Boomers totaled 79.3 million consumers, which is expected to tumble to 55.9 million by 2035. Millennials numbered 66.9 million in 2015 and that demographic is expected to grow to 71.4 million by 2035. Generation X is also poised to lose ground in the next two decades as 61.3 million of that group in 2015 will decline to 58.7 million by 2035.

Martin said the ethnicity demographic shift from 2014 to 2019 has been just as stark with non-Hispanic whites losing 9.7% of their total buying power. Hispanics saw buying power rise 32.1%, African-American buying power rose by 23.4% and Asian-Americans saw a 29.2% increase in total buying power.

Martin also projects by 2050, non-Hispanic whites will be roughly 47% of the U.S. population, down from 85% in 1960. Hispanics will comprise 29% of the total U.S. population, rising from 4% in 1960 and 18% in 2017. African-Americans are expected to increase to 13% of the population, up from 11% in 1960. Asian-Americans are expected to comprise 9% of the U.S. population by 2050. That’s up from 6% in 2017 and 1% in 1960, according to the U.S. Census Bureau.

With these major shifts, Martin expects retailers and food suppliers to continue catering to changing demographics that won’t compromise on quality, but is continually looking for value. Digital integration is also a must as the new demographics prefer online grocery and online commerce more than other older generations. Martin said grocery retail is likely to get smaller over the next decade as more consumer brands will begin to sell direct to consumer through digital commerce.

She said “Walmart is killing it” and doing a great job out in the grocery marketplace.

When asked if Walmart or Amazon had the toughest road in grocery in the next five years, Martin said Walmart is “competing and adjusting well.”

“I am betting on the player [Walmart] who has been there [in grocery] longer,” she said.

Schoeder said Walmart and Amazon are both giants and will likely continue their successes in the markets they serve.

“I don’t think one will knock out the other, but others will fall out of the race,” he said.

Editor’s note: The Supply Side section of Talk Business & Politics focuses on the companies, organizations, issues and individuals engaged in providing products and services to retailers. The Supply Side is managed by Talk Business & Politics and sponsored by Propak Logistics.