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Will Food Inflation Bite Grocery Stocks?

Food prices are perking up.  The November Producer Price Index (PPI) rose 3.1%, the highest jump since January 2012. This data point measures the price that manufacturers pay for anything from mining equipment to a pound of flour.

Increasing food prices are the main culprit.

The food portion of the PPI surged 3.5% according to the data released by the Labor Department. Prices of perishable goods like vegetables, meat, and eggs are on the rise. The Department of Agriculture notes that egg prices in November are at the highest level since 2015 when the avian flu wiped out flocks of chickens.

Volatile weather in Mexico and Florida and the ravaging forest fires in California hit farm crops hard in those geographies. Hurricane Irma decimated the orange crops in Florida, where production is at a 71-year low.

In commodities, supply and demand control prices. Thanks to a healthy economy and a stable job market, demand for food has remained strong. In the face of this solid demand, shrinking supply sends prices skyrocketing.

But I haven’t noticed a change at my grocery store and you likely haven’t either. That’s because grocers are loathing to increase prices.

The Consumer Price Index (CPI) measures the price consumers pay for a basket of goods. Usually, for food products, the price you pay at the store follows commodity prices closely. It’s very easy for a retailer to change the price it charges for meat, vegetables, milk, and eggs. None of these products is tagged individually with a price sticker so an increase or a decrease requires just a change in the checkout menu.

But the CPI has fallen out of step with the PPI. The gap between the prices wholesale grocers pay and the retail price consumers pay is the widest it has been in three years.

 

To gain or even just keep market share, grocery stores have been cutting prices, even in the face of increasing costs. As you can imagine, a widening gap between prices paid and prices charged results in lower profits.

The Kroger Co. (NYSE: KR), one of the nation’s largest grocery chains, is quite vocal with investors about this problem.  Kroger CFO Mike Schlotman recently said,

“Our inflation at cost is still above our inflation at retail. We didn’t pass all of it on.”

Walmart is part of the problem. Its massive move into food retailing has stolen many customers from traditional grocery stores. Target, who expanded into fresh food in 2010, continues to make inroads with increased space for frozen foods, dairy, and meat.

Additional headaches have ensued with the arrival of Aldi and Lidl. These two European discount chains are opening new stores in the U.S. with much lower prices.

Does this mean continued heartburn for Kroger’s stock, which is down 22% this year?

Maybe, maybe not.

Kroger management smartly reset investor expectations this year. In June, it warned investors that it would not promise sales growth for the near term. Later, in October, the company outlined its plan for profitable growth despite slower sales.

It has also started charging suppliers fees if deliveries are not exactly on time. Walmart and other large customers are doing the same. These fees might be enough to offset rising prices of food.

Subscribers to my Profit Catalyst Alert service made 110% on my bearish call on Kroger back in June. Now that expectations seem more reasonable, the stock might be a safe call. I’ll be digging into the delicious numbers to see if I can make a case for a Kroger buy.

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