In light of one of our more important narratives this year--food inflation and its impact on consumer behavior--and this week’s stable CPI, we took a fresh look at how grocery traffic has trended this past quarter. As shown below, the significant shift to value formats from premium small-format specialty and conventional grocers continues–thus, building upon the initial gains during 2022, and that continuation comes despite the flattening in grocery prices.
Within premium small-format specialty, Sprouts has continued its improved trend which we reported upon when it released its Q1 2023 results in May (Sprouts: Stronger Private Brand Offering Yielding Improved Traffic Trend). In contrast, The Fresh Market has weakened. Looking at visitors per location and frequency, the figure below shows that--on the surface--Sprouts has made further progress in arresting the rate of decline in shoppers and shopper frequency. In contrast, The Fresh Market is losing an alarming number of shoppers. However, when we peel the onion one layer deeper, we see that Sprouts’ gains are a bit more “nuanced.”
Sprouts’ gains are being driven by the infrequent shopper (less than 4 visits per quarter) which may be those teased by hot promotions and by delivery gig workers (more than 19 visits per quarter). Looking at the shoppers in-between (4-19 visits) we see the two brands down similarly, negative high-single-digits. In contrast, the visitation market share gainers--including Aldi’s, Trader Joe’s, and Grocery Outlet--are up a respective +3%, +10%. +17% year-over-year. (Yes, Grocery Outlet posted +17% growth in visitors per location, which is massive; moreover, overall cross-shop with Albertsons is up +34% suggesting large inroads by Grocery Outlet into Albertson’s households, see also the below comments from Pepsi.) As to Sprouts’ third-party delivery business, we are suspicious of those gains and question the durability of that business which has grown to an outsized level of 12% of total sales – a level far above competitors and the industry penetration of just over 3%. This suspicion is also fueled by the declines of third-party shoppers at The Fresh Market and Aldi’s (-12%).
The flattening of food-at-home prices raises the important question of what reverses the channel shift given that the job market and economic growth have continued to be extremely healthy and stronger than expected. The answer, in our view, is strong private brand product--new SKUs, more supply, enhanced quality, and disruptive prices/value. As private brands take meaningful share-of-stomach, national brands will respond by lowering their prices and increasing their promotion. Those actions should result in a leveling out in the channel shift. National brands are just starting to respond, but it’s very early and there has yet to be any leveling in channel shift and in national brands’ margin rates. On the flip side and to a “worsening,” should the job market and economy become suddenly much weaker than expected, the channel shift will quickly intensify and losing grocers will become challenged given the industry’s relatively low level of profitability.
In terms of those brands, this week we also heard from Pepsi and Conagra. Pepsi’s Frito Lay business produced +14% revenue and profit growth, driven by pricing increases as volume growth was flat. This puts the business on pace for +$800M in profit growth for the year. Pre-pandemic this business grew profits by around +$240M. Going from $240M to $800M is an astounding change, but we don’t believe that consumption has structurally changed to such an astounding level. In describing the consumer, CEO Ramon Laguarta stated, “Obviously, we've been able to raise prices and consumers stay within our brands. Now we're seeing consumers making some adjustments. We're seeing consumers shopping in more stores than before. They're looking for better deals. They're starting to look for optimization. They're going to channels that have better perceived value. They are buying more in dollar stores or they buy more in mass or in clubs. Every segment of the consumer is making adjustment.” Management also shared that they are seeing consumers shopping more stores to optimize the basket--if during COVID consumers shopped two stores, now in some cases they are shopping seven stores, and also reducing the size of the basket due to fewer items per basket.
On Conagra’s Q2 2023 update CEO Sean Connolly shared, “One behavior shift we've heard about from consumers is just buying fewer items overall, more of a hunkering down than a trading down. There are several potential reasons as to why, including this summer being more travel intensive than last year. Overall, we view this dynamic as likely temporary behavior shift for consumers to stretch their budgets, but we have captured it as a near-term headwind in our outlook. Moving to the second headwind. While very limited, we have seen a few single-ingredient brands become deflationary, and we will make appropriate price adjustments to reflect that." We don’t believe that consumers are buying a material amount of calories. We suspect that Connolly is somewhat blinded to the shift to value grocers like Trader Joes, Aldi, and Grocery Outlet where Conagra’s products are not sold. Lastly, we aren’t the only one’s writing the grocery inflation story, the WSJ had a long article last week.