Traditional Grocery Stores Can Benefit From Growing E-Commerce

Long thought to be immune from e-commerce and economic downturns, some traditional grocers—defined as those that offer a full line of groceries, meat and produce with at least $2 million in annual sales—have been plagued by shrinking margins, competition, and oversaturation, forcing them to close stores or shut down completely. Over the past several years, A&P, which had nearly 16,000 stores at its peak in 1930, went out of business, as did several regional players such as Fresh & Easy and Marsh Supermarkets.

Retail space devoted to food sales in the United States has hit a record high, while traditional grocers’ share of the market has fallen. According to 2016 data from CoStar Group—the most recent year available—food retail space at traditional grocery stores registered more than 2.5 square feet per person, from less than 1.5 square feet in 1980. But demand hasn’t kept up with store growth. Total U.S. traditional supermarket grocery sales in 2016 fell 5.9 percent from 2015, while industrywide average same-store sales growth has declined since 2012. Falling sales have disproportionately affected traditional supermarkets, as their market share sunk to 44.6 percent in 2016 from 90 percent in 1988, according to Inmar Willard Bishop Analytics.

At the same time, nontraditional grocery outlets’ share of sales shot up to 40 percent in 2016 from 2 percent in 1988, led by supercenters and wholesale clubs such as Walmart (AA-/Negative), Costco (AA-/Stable), Sam’s Club and SuperTarget (A/Negative). On the other end of the spectrum, limited-assortment vendors that operate stores about a third the size of a typical American grocer, such as Aldi, Lidl, Save-A-Lot and Grocery Outlet, are collectively planning to open over 1,000 new stores in the next few years.

While online shopping for groceries continues to lag general merchandise and home and apparel, the number of households buying food online is increasing. In 2016, online grocery had the greatest increase in sales at 24.4 percent, fueled increasingly by millennial consumers and retailers offering the convenience of both delivery and so-called click-and-collect service, where consumers order online and pick up at the store, as per Inmar Willard Bishop Analytics. Further, the number of households in the U.S. that are using online channels to purchase food has increased about four  percentage points since 2014, up to 23 percent in 2017, according to a study by FMI and Neilson, while online penetration in grocery is about 3 percent of the overall market.

Investors and lenders are taking a step back, as the spread in the capitalization rate, or the required return, between different classes of grocery-anchored centers has expanded over the past several years. Lenders appear to be more selective and less tolerant of risk in grocery-anchored properties, as they have shifted to lower-leveraged, lower-balance loans.

A closer look at grocery-anchored loans with exposure to bankrupt tenants provides some context to the risk narrative. Among all A&P, Haggen, and Marsh Supermarkets brands in CMBS, representing more than $1.50 billion in unpaid principal balance, just six loans were liquidated, resulting in $18.3 million in losses. We found that many vacant stores were re-tenanted by other grocers.

Despite rising competition from nontraditional players, oversaturation and the threat of online grocery shopping, it would be a mistake to write off traditional grocers. Such companies could even benefit from the increased acceptance of online sales, as they rethink their approach to convenience and play defense as titan Amazon enters the fray. Given more conservative lending standards and strong demographics of more popular in-fill locations—making them desirable distribution centers—we believe that traditional grocers will prove resilient.

Steve Jellinek is vice president of commercial mortgage-backed securities research for Morningstar Credit Ratings.