You may have noticed your weekly grocery bill total slowly creeping up last year. According to analysts, you can expect to see more of the same in 2012. Due to factors like bad crops and increased fuel prices, food costs rose 6% last year and are expected to rise at least another 2% in 2012.
But your wallet won't be suffering alone. Grocers' profits are doomed to take a hit, too. In fact, I only see hope for one grocer to come out on top this year.
The grocers' game
Grocers are constantly engaged in a price war. They drop prices lower and lower to attract shoppers, which leaves them with very little profit left over. Net margins (net profit/total sales) measure how much of grocers' total sales trickle down to their bottom lines. The table below shows the net margins of some of the top grocers in the industry:
Whole Foods Market (NAS: WFM)
Kroger (NYS: KR)
Safeway (NYS: SWY)
SUPERVALU (NYS: SVU)
Source: Yahoo! Finance.
As the cost of food continues to increase, it will be difficult for grocers to absorb the difference. In 2012, they will be forced either to pass the price increases on to consumers or let the increases eat away at the already minuscule margins above.
It's a balancing act, and the increasing popularity of coupons makes it pretty obvious that consumers aren't yet pleased. Somebody has to come out on top, though, so what should investors be looking for?
Refer back to the net margins table, if you will. You'll see that Whole Foods is on top, and really, that's no surprise. We all know shoppers are willing to pay a little more there. But why?
Most other grocery stores now carry organic products. Some even have entire aisles or sections of the store sectioned off for these products and other specialty foods like vegan and gluten-free items. But plenty of people are still willing to pay a little more at Whole Foods because of what the brand represents -- a healthy (and possibly a bit affluent) lifestyle.
And with a 3.4% net margin, Whole Foods is in the best position to absorb some of the rising costs without passing them on to consumers. So while Safeway, Kroger, and SUPERVALU are forced to raise prices in their stores or risk losing money quickly, Whole Foods has the option to sit tight.
As one Boston journalist discovered last year, Whole Foods is actually only marginally more expensive than your average grocery store. This means prices could potentially even out, eliminating the one reservation shoppers had about shopping at Whole Foods.
Any hope for the other guys?
Whole Foods is not geographically accessible for all Americans. In markets where Whole Foods doesn't exist, grocers will need to find ways to make their own generic brands stand out from the others to give shoppers a reason to choose them. Focusing too much on providing customers with the lowest price possible could end up being a fatal decision for these companies.
Safeway and Kroger both offer gasoline at a few locations, providing discounts to their rewards members. That's one way to set their brands apart, especially with the cost of oil expected to continue rising. However, if all grocers started doing this, it would simply become another price war. It doesn't actually contribute to the brands' power. Perhaps recognizing this, SUPERVALU actually sold off the bulk of its grocery-store gas stations late last year.
Another threat brought in by food cost increases is the perception that eating at restaurants is more affordable than it used to be. As I mentioned earlier, restaurants are able to absorb a lot of the rising costs with liquor sales. As a result, menu prices haven't increased at the same rate as price tags at grocery stores, and that's very appealing to budget-conscious consumers. It's definitely something to watch in the upcoming year.
I'm definitely putting my faith in Whole Foods for 2012. If you're not sold, though, our top analysts have found another company they think will come out on top this year. "The Motley Fool's Top Stock for 2012" is a free report that discusses this international retail company in detail. Click here to read the report now!
At the time thisarticle was published Fool contributor Amanda Buchanan holds no position in any company mentioned. Click here to see her holdings. The Motley Fool owns shares of SUPERVALU and Whole Foods Market. Motley Fool newsletter services have recommended buying shares of Whole Foods Market and buying calls in SUPERVALU. 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.
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