Pall of economic challenges hangs over retailers as pandemic fallout drifts into new year
Russell Redman | Dec 08, 2021
As the sun sets on 2021, the sight dawning on the horizon for the grocery industry in 2022 looks anything but clear.
A haze of supply chain disruption, rising inflation, labor shortages and pandemic hangover has settled atop shifting consumer behavior and retailer omnichannel transformation to cloud the forecast for the year ahead, panelists in the 26th annual SN Financial Analysts Roundtable said. That represents a stark contrast from a year ago, when the pending arrival of COVID-19 vaccines heralded an exit from the pandemic and a national economic rebound.
“Back in January and February, the general consensus was that we would have been sort of past the pandemic, and food-at-home demand would have significantly moderated from last year. But that really hasn’t happened,” according to Arun Sundaram, senior equity research analyst for food and household products at CFRA Research. “Much of that is due to the Delta variant, which derailed certain things. More people are working from home than expected, which helped boost food demand in general.
“People are kind of on their toes right now, waiting, because we’re stuck in limbo between the ‘new normal’ and the peak pandemic phase,” he added. “And then the supply chain issues have just made things harder.”
His uncertainty was shared by fellow panelists Scott Mushkin, founder and CEO of R5 Capital; Rupesh Parikh, managing director and senior analyst for food, grocery and consumer products at Oppenheimer & Co.; and Robert Moskow, senior analyst for packaged food and food retail at Credit Suisse Equity Research.
“Before we get to 2022, how are we going to end 2021?” asked Mushkin, a longtime roundtable participant. “We’re in this insanely volatile time. But even with the pandemic, I can’t remember the visibility being like this — ‘OK, let’s just get through the holidays, and then we’ll see.’ The only comment I have about 2022 and beyond is we clearly have more volume embedded in the food-at-home channel,” he said. “The leap then is, well, we’ll have more growth from there. I don’t know if that’s an appropriate leap.”
In the 12 months through September, the Consumer Price Index stood at 5.4%, up from 1.4% in September 2020. The overall food index rose 0.9% to 4.6%, with component indices at 4.5% for food at home and 4.7% for food away from home. Between September 2018 and February 2021, the CPI hadn’t exceeded 2.5% and mostly was below 2%.
“Two things have been really surprising,” Parikh said. “One is we’re seeing a lot of inflation this year. Last year, it was very inflationary, and as you lapped it this year, I thought inflation would subside. The exact opposite has happened, because now it’s accelerating again. And the second thing is work from home. I mean, I don’t think any of us would’ve thought work from home would be this prominent this late into 2021.”
Moskow cited inflation as the biggest headwind for the grocery sector. “It hit the vendors first and is now flowing through grocery [retail] — just getting started, I would argue,” he said. “SNAP benefits have been structurally increased, but the dollars are going to be lower than they were a year ago, when there was so much emergency spending. And these pale in comparison to the unemployment benefits that are rolling over. That’s a much bigger chunk. So I’m uncertain as to how strong the consumer is going to be heading into 2022.”
Supply & Demand & Labor
COVID-19’s disruption of the supply chain shined a light on its complexity, from ports to manufacturers and distributors and then to retailers and consumers. High consumer demand and a shortfall of labor — due to COVID infections, pandemic restrictions and workforce displacement, among other factors — have made it harder for manufacturers to receive raw materials, turn out enough product, and package and transport goods to distributors and retailers. That has resulted in backups at ports, inventory shortages at wholesalers and stores, and low-stock or empty shelves for consumers, in turn hampering fulfillment of online orders.
“The supply chain is just nuts,” Mushkin said. “There are categories where it’s very difficult to get product. So that’s one of the big things going into the end of the year. It’s very surprising to be at this juncture, with the challenges we’re seeing out there. I know a lot of press is [focusing on] on the ports and Asia, but the food-at-home channel is just as bad or worse than anything out there,” he explained. “It’s just hard to get product to the shelf.”
Labor is “probably the biggest bottleneck,” according to Moskow. “When I try to dig into it with a CPG company, it goes to, ‘Hey, we can’t get our ingredient suppliers to run the production lines enough to get the ingredients we need. We can’t get the distribution company on the other end, once we make the finished product, to have enough labor at their facility to get it off the loading docks and into trucks. And then we can’t find the trucking labor to get it to the stores.’ So it’s omnipresent across the entire supply chain. You can’t really find one specific link in the chain to solve it.”
According to Advantage Sales’ “Outlook October 2021” for the grocery industry, only 34% of grocery manufacturers surveyed expect a more than 90% supply level for the 2021 fourth quarter (38% project 71% to 80% supply), and 51% anticipate exceeding 90% supply in the 2022 first quarter. Retailers aren’t as positive: None of those polled expect a 90%-plus supply level for Q4 — 45% forecast a 71% to 80% level — while 10% think they’ll reach over 90% supply for Q1, with 48% anticipating an 81% to 90% level.
“Going into the holiday season, it’s going to be really tough because of all the things happening at the ports,” noted Sundaram. “You’ve seen transportation issues within the country. The freight rates are extremely high. I think the larger retailers are going to do better than the smaller ones, just because they have more leverage in getting product onto the shelves right now.”
Among manufacturers surveyed by CPG sales and marketing firm Advantage, 93% identified transportation and 90% named manufacturing labor as the primary challenges, followed by raw materials (75%), packaging (63%), distribution (56%), chargebacks (30%), retail labor (27%) and safety protocols (13%).
“Labor has been one of the bigger challenges out there, but also just demand,” Parikh pointed out. “You obviously had strong demand throughout the pandemic, so you’re trying to catch up with that. Then labor issues come in, and demand is still very high. We can’t overlook just how strong demand is out there, given all the stimulus and the shift to at-home food consumption.”
Six in 10 manufacturers and seven in 10 retailers think CPG dollar sales will climb during the holiday buying period, Advantage’s study found. Likewise, 63% of manufacturers and 81% of retailers said price hikes will be the top driver of year-over-year dollar sales growth for 2021. Yet expectations diverge beyond the year-end outlook. While 72% of retailers polled forecast grocery dollar sales growth in the 2021 fourth quarter, 58% expect the uptick to carry into the 2022 first quarter, whereas 62% of manufacturers project both Q4 2021 and Q1 2022 growth.
“Labor and inflation are intertwined. Inflation is running hot right now and could accelerate further from here. So that’s a key watch for next year, how significant inflation is and how that impacts consumer purchasing, trade-down, etc.,” said Parikh. “If the labor situation improves, then maybe you’ll see less inflation, because then you’ll have more product availability. So, in some ways, labor is at the middle of all this, the supply chain challenges and food inflation.”
Food-At-Home Appetite Unsated
Though not near the growth rate early on in the pandemic, food-at-home spending remains elevated, longer than many industry observers — including SN roundtable analysts — expected. COVID vaccines and declined positivity rates have brought waves of consumers back to restaurants, giving that sector a much-needed shot in the arm. But the rebound for food away from home hasn’t halted grocery sales momentum.
“If you look at some of the recent government data, grocery sales were up mid-teens on a two-year basis, and restaurant sales were actually up double digits on a two-year basis as well. It was just pretty surprising. People have gone back to restaurants, and food at home has stayed very resilient,” Parikh observed.
Interestingly, food-at-home sales remain robust after more than price inflation from a year ago. “If you look at groceries, a mid-teens [sales] increase on a two-year basis, half of that could be pricing mix,” according to Parikh. “That suggests you’re going to have a stickier base for the food at home and even food away from home. Both have risen pretty significantly. Going forward, even into next year, I’m not worried about much of a drop-off, because you have a lot of pricing embedded within that grocery retail sales growth rate.”
In its U.S. Grocery Shopper Trends Tracker for the 2021 holiday season, FMI-The Food Industry Association reported average weekly grocery spending of $144 through the first week of October. That compares with $121 in February 2020, before COVID-19 was declared a national emergency, and $161 in March 2020, the highwater mark of consumer stockpiling.
MasterCard SpendingPulse data, presented in FMI’s holiday forecast videoconference, pegged grocery sector year-over-year sales growth at about 11% on a seven-day moving average through Oct. 16, with an increase of roughly 17% on a two-year stack. Restaurant sales were approaching 40% growth, with the gain at about 23% over two years.
“In the midst of the pandemic, food at home was around 70% of food spending, and food away from home was around 30%,” Sundaram said. “And then fast-forward to today, food at home is around 51%, and food away from home is around 49%. But both channels are growing by double digits. That doesn’t mean people are just eating a lot more, so it must mean that prices are going up to cause these growth rates.”
Pressure on Promotions
To offset rising costs, 89% of manufacturers in the Advantage Sales survey said they aim to raise list prices, and 92% have already taken or plan first, second and third increases. Most of the price elevations are under double digits, with 55% of companies polled hoisting prices 6% to 10% and 34% enacting 1% to 5% hikes across first, second and third increases. Unsurprisingly, the higher prices are trickling down to consumers. Three-quarters of manufacturers reported that 50% to 100% of their raised prices show up at the shelf across rounds of increases.
Shoppers, meanwhile, can expect less help in terms of deals and discounts. Fifty-five percent of manufacturers in Advantage’s study plan to scale back trade spending. Over the next six months, 52% aim to reduce trade promotions “a little” and 17% expect to do so “a lot” versus the pre-pandemic period.
“It’s prudent to hold back on promotions right now, because we have tight inventory and extremely high demand,” explained Sundaram. “Also, the competitive environment hasn’t been as intense as it used to be, given the naturally high demand. So right now I think promotional activity will stay low for a while. But once things go back to the new normal and competition heats up again, you’ll start to see more grocers fighting for market share and promotional activity will come back more.”
Manufacturers polled by Advantage named supply constraints (57%) and cost increases (49%) as key reasons for reducing trade promos. Another 37% said they’re trying to “be more surgical” with promotions because of inflation.
“What I heard from one leading manufacturer is that it’s not going to be the number of promotions that they pull back on, but the depth of those promotions. That’s the lever that they’ll pull,” Moskow said. “You’ll still see a lot of end-aisle displays and banners and price reductions, but they’re not going to be as attractive as they otherwise would’ve been.”
Even as inflation boosts grocery sales numbers, it could come back to haunt retailers if prices keep climbing. FMI’s tracker found that 53% of food shoppers are worried about rising prices. Of consumers polled in the 2021 Deloitte Holiday Retail Survey, seven in 10 said they expect higher prices this season, and half of shoppers who plan to spend less this holiday season cite higher food prices as a reason.
“My bet would be that inflation sticks. And if inflation sticks, what will that mean over the next year?” Mushkin noted. “Will it mean trade-down to Dollar General or Walmart? You know, chicken becomes pasta, and the T-bones become ground beef. It’s typical behavior we’ve seen. In that environment, depending on how aggressive it gets, you could get more margin compression than you would desire. Unless it’s offset by so many people flooding in from the food-away-from-home channel, or other things keeping volumes up, you’d be on high alert for that type of stuff, depending on how things break in 2022.”
The E-Commerce Question
In 2020, the pandemic-triggered boom in online grocery shopping led food retailers of all sizes to quickly boost their e-commerce investment. Although e-grocery sales growth peaked in the early part of the crisis, the market remains elevated. Now the question facing grocery chains is, how much e-commerce capacity is needed?
The big story on that front is The Kroger Co., which Mushkin said is “charting its own path” in e-commerce. The company has launched an Ocado-automated customer fulfillment center (CFC) in Florida to fill online orders and plans to open another in the Northeast — two markets where the supermarket giant lacks stores. Kroger also aims to build two more CFCs in Florida and two in Southern California, as well as various “spoke” facilities and micro-fulfillment sites, adding to eight other CFCs in the works. The first CFC, in Monroe, Ohio, went live in April.
“What model will work? We heard from Kroger that they’re going to be opening Ocado facilities in the Northeast and South Florida. That they’re going to do micro-fulfillment. How will it work?” Mushkin said. “The challenge is balancing that asset deployment with profits, and then are you just taking from Peter to give to Paul? It’s going to be really interesting over the next couple of years to see if we get omnichannel wars breaking out as Kroger drops facilities in the Mid-Atlantic or Florida. How will people react? I think it’s a huge risk in the industry over the next couple of years. That’s a big concern I have on omnichannel.”
A Mercatus/Incisiv study released in October predicts e-grocery to account for 9.5% of total U.S. grocery sales of $1.097 trillion this year, up from 8.1% of $1.137 trillion in 2020. From there, online’s share is projected to expand to 11.1% of grocery sales in 2022 and to 20.5% in 2026. Pre-COVID, online grocery sales were expected to reach 5.4% of the total market in 2021, up from 4.3% in 2020, and then climb to 6.8% in 2022 and to 14.5% in 2026, the study said.
“My thinking on Kroger’s strategy has evolved. I’m becoming more comfortable with the approach they’ve taken rolling out CFCs, especially after they said they’re now going to open micro-fulfillment centers as well,” Moskow said. “A year ago, the concern in the investment community was that Kroger is going to have 20 white elephants out there, enormous facilities that aren’t flexible enough to handle same-day or 30-minute execution. What I liked is that their relationship with Ocado can still provide automation for immediate delivery needs. Secondly, a year into this, I think all these grocers have recognized they can charge a premium for these [online grocery] services.”
He added, “If I were a long-term investor, I would take a look at Kroger and give them some credit for having a bolder vision for how to outpunch all of their less-capitalized competitors in a highly automated field.”
Walmart already has been adding automation on a large scale to meet surging online grocery demand, and more recently the retail behemoth — and rival Target — has sharpened its focus on micro-fulfillment. Chains also are responding to massive automation investment by Amazon, which Mushkin noted is funneling tens of billions of dollars into “building out an enormous distribution capability.”
Other large grocery retailers piloting automated micro-fulfillment facilities include Albertsons, Ahold Delhaize USA (Stop & Shop), Meijer, H-E-B and Wakefern (ShopRite), as well as smaller chains like Big Y Foods and specialty operators such as Sedano’s Supermarkets and H Mart. Instacart, too, has jumped into the arena by partnering with micro-fulfillment specialist Fabric to offer an automated solution to retailers using its delivery and pickup services.
“Everyone has been forced to add capacity on the e-commerce front. During the pandemic you learned that you need to have all of the offerings, delivery, store pickup and ship from various facilities as well. And then we’ve seen DoorDash, Uber Eats and more third-party delivery. It’s a reflection of the significant increase in demand,” according to Parikh. “Retailers have been forced to catch up, and now they’re trying to optimize their investments. That’s where you’re seeing a big focus, adding all this automation to bring costs down and make it a more sustainable model over time.”
Grocery customers have continued the online shopping habits spurred by the pandemic. FMI’s report said 61% do their grocery shopping online at least occasionally, up from around 53% in late spring and 49% in March 2020. Fourteen percent of those surveyed report shopping online “almost every time” for their groceries, versus about 7% at the pandemic’s onset.
“Grocery retailers learned it’s not all about price. Consumers are willing to pay that premium for pickup and delivery if they can get high-quality products and get it in a more narrow time window,” said Sundaram. “They also want to make sure that the products they choose online are what actually shows up. There are a lot of these out-of-stock issues. Then there are quality issues where you don’t know if someone is picking out the best product for you. To improve that perception, you need to have a stronger fresh offering in your grocery store. That way, the consumer has confidence that someone picking out a vegetable or a piece of meat at the store is selecting a high-quality one.”
Through early October, online purchases accounted for 22% of shoppers’ weekly grocery spend, less than the 28% share in March/April 2020 but well over the 15% share in February 2020 and 11% share in 2019, FMI reported. Mass merchants have been the main e-grocery beneficiaries, with 40% of consumers saying they shop online at those retailers, compared with 25% for supermarkets and 26% for club retailers.
“Now all these investments are going to come on, and we’ll see what the market does next,” Parikh said. “The risk is that e-commerce may not grow that much next year. This year, it’s taking a step back within grocery. Next year, you have all this capacity coming on board, and what if the demand is not there? Then it just becomes overly competitive. Over time, you could see wars between the different players. So that’s probably something else to watch for next year.”
Russell Redman | Dec 08, 2021
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