Grocery space is tough with Walmart doing so well, says Bernstein's Zhihan Ma

Key Concepts

• Inflation: The general increase in prices and fall in the purchasing value of money.
• Market Cap: The total market value of a company's outstanding shares of stock.
• Dollar Stores: Retailers that sell a wide variety of merchandise at low price points, often around $1.
• Grocery Specific Weakness: A downturn or underperformance within the grocery retail sector.
• Macro Tailwinds: Favorable economic conditions that boost a company or sector.
• Trading Down: Consumers shifting from more expensive brands or retailers to cheaper alternatives.
• Discretionary Dollar Stores: Dollar stores that sell items not considered essential.
• Tariff Driven Price Increases: Price hikes resulting from import tariffs.
• Benign Elasticity: A situation where price increases do not significantly reduce demand.
• Sticker Shock: The feeling of surprise or dismay at the high price of something.
• Price Leader: A company that consistently offers the lowest prices in its market.
• Omnichannel Grocery: A retail strategy that integrates online and physical store experiences for grocery shopping.
• Scale: The size or extent of a business, often implying advantages in purchasing power, efficiency, and market reach.
• E-commerce/E-grocery: Online buying and selling of goods, specifically groceries in this context.
• Comp (Comparable Store Sales): A metric that measures sales performance of stores open for at least a year, excluding new stores or those that have undergone significant renovations.
• Sequential Deceleration: A slowdown in growth rate from one period to the next.
• Lapping a Comp: Comparing current period sales growth against the growth achieved in the same period of the previous year.
• Self-Help Story: A company whose performance improvement is driven by internal strategic changes and operational efficiencies.
• Tax Refunds: Money returned to taxpayers by the government when they have overpaid their taxes.

Walmart's Market Cap Surge and Competitive Landscape

Walmart has reached a significant milestone, with its market capitalization surpassing $900 billion for the first time. This achievement highlights its dominant position in the retail sector, particularly in the grocery space. Qihan Ma, Senior Analyst at Bernstein, attributes Walmart's success to its strong performance across both in-store and omnichannel grocery operations. This comprehensive approach, which integrates online and physical shopping experiences, is a key factor in its market leadership.

Challenges for Kroger and the Grocery Sector

The grocery sector, in general, is facing a tough environment, largely due to the "800-pound gorilla" that is Walmart. Kroger, specifically, is not known for being a price leader, which puts it at a disadvantage when consumers are experiencing "sticker shock" due to inflation. Ma notes that Kroger's attempt to merge with Albertson's was aimed at gaining price advantage, but the deal did not go through. This lack of scale presents a structural challenge for Kroger, especially in competing with Walmart's ability to leverage scale for pricing and e-commerce capabilities. The ability to execute e-grocery effectively also requires significant scale, further benefiting Walmart.

Dollar Stores' Resurgence and Macroeconomic Factors

After a challenging period, dollar stores are experiencing a significant turnaround and are once again performing well, reminiscent of their success in the 2010s. This resurgence is attributed to several "macro tailwinds."

• Trading Down: Middle to high-income consumers are increasingly "trading down" to dollar stores for both essential and discretionary purchases. This behavior is driven by inflationary pressures and a desire for value.
• Benign Elasticity: Unlike some other sectors, dollar stores have benefited from "benign elasticity," meaning that tariff-driven price increases have not led to a substantial drop in demand. This allows them to pass on some cost increases without significantly impacting sales volume.

Company-Specific Dynamics within Dollar Stores

While macro tailwinds are a significant driver, company-specific strategies and turnarounds are also playing a crucial role.

• Dollar General (DG): Ma views Dollar General as more of a "self-help story," suggesting that its performance is driven by internal improvements and strategic changes.
• Dollar Tree: Dollar Tree's situation is different, particularly after divesting from Family Dollar. The focus is now on the performance of the Dollar Tree banner itself, free from the "Family Dollar noise." Dollar Tree may have benefited more directly from the macro tailwinds.

Despite the positive momentum, dollar store stocks are not yet at their all-time high levels. For instance, DG's stock, though bouncing back from a trough, is still down significantly from its peak.

Five Below's Performance and Future Outlook

Five Below's stock performance is described as "interesting." Despite reporting a strong 14% comparable store sales (comp) growth in Q3, its stock saw only a modest increase. This is attributed to the fact that the strong comp was largely anticipated and already "well expected" by the market.

• Focus on Q4 and Next Year: The market's attention has shifted to Q4 guidance and the outlook for the next year. Five Below guided for a "sequential deceleration" in Q4, raising questions about whether this is a conservative estimate or an indication of actual slowing growth.
• Lapping Difficult Comparisons: A key challenge for Five Below in the upcoming year will be "lapping" its strong comps from the previous year, especially after achieving nearly double-digit comps for the first three quarters of the current year.
• One-Off Positives: The company has benefited from several "one-off helps" during the year, including price hikes and the "Boo Boo craze" (the specifics of which are not detailed). The question remains whether Five Below can repeat these positive drivers or sustain its growth as these factors dissipate.
• Sustainability of Trade-Down Benefit: The benefit derived from middle to high-income consumers trading down to dollar stores is also being questioned for its sustainability into the next year. The potential impact of incremental tax refunds early next year on consumer spending habits is a key factor to watch.

Conclusion

The retail landscape is currently shaped by inflationary pressures, leading to shifts in consumer behavior. Walmart's market dominance is evident, while Kroger faces structural challenges in the grocery sector. Dollar stores are experiencing a revival driven by consumers trading down, with both macro tailwinds and company-specific strategies contributing to their success. Five Below, despite strong recent performance, faces the challenge of maintaining growth momentum and lapping difficult year-over-year comparisons in the coming year. The sustainability of consumer trade-down behavior and the impact of economic factors like tax refunds will be critical in determining future retail performance.