Big grocers’ loss is your gain – for now

Dillons and other grocery chains have felt a real financial squeeze from falling egg, dairy, meat and grain prices.
Dillons and other grocery chains have felt a real financial squeeze from falling egg, dairy, meat and grain prices. The Wichita Eagle

The low price of eggs is a nice surprise at the grocery store these days – but is it too much of a good thing?

Prices for eggs – as well as for cheese and other dairy products, meat, grains, gasoline and diesel fuel – are all down from a year ago.

And it’s giving grocers indigestion.

Kroger, parent of Dillon Stores, and Wal-Mart – the nation’s two largest grocers – both reported in recent conference calls an overall fall in food prices, which has cut sales growth, profit growth and their stock prices in recent quarters.

Corporate officials and analysts in the industry have dubbed it “food deflation.” It’s caused by a low ebb in the cycles of a series of food commodities sold on grocery store shelves. The price drop has caused trouble for food producers, manufacturers and, now, grocers.

The big winners are consumers.

The price drop is a big factor in holding down inflation and allowing people to survive on their wages, which had been fairly stagnant until recently.

According to the U.S. Department of Agriculture, the price of food bought to eat at home was down 1.6 percent from a year ago, even while the price of food bought at restaurants was up 2.6 percent.

So what does that mean for the big grocery chains when prices are falling? It’s a challenge to their financial models, which assume price inflation, allowing them to show increased store sales and more flexibility in pricing.

Kroger CEO Rodney McMullen told analysts in a recent conference call that the chain’s grocery prices overall were down 1.5 percent for the quarter compared to a year ago. Wal-Mart, in its most recent quarterly filing, showed that food prices were down 1 percent compared to a year ago.

Jim Hertel, senior vice president of industry consulting firm Willard Bishop and Inman Analytics, said falling food prices expose store operations to greater scrutiny. Kroger, for instance, held off on $500 million in capital expenditures because profit growth didn’t hit targets.

“I think the key piece of it is that, for years, grocery retailers have counted on 3 to 5 percent food inflation as a source of profit growth, and when that’s not forthcoming, as we are seeing, it sheds lights on other parts of the business,” he said.

Why are prices down?

Commodities prices cycle up and down based on supply and demand.

In recent years, U.S. crop and livestock farmers enjoyed high prices caused by drought and strong export demand. To take advantage, they pushed to increase production, which then turned into overproduction as the drought receded, weather improved and global demand for U.S. exports slackened.

Grain prices and gasoline prices dropped sharply in late 2014, and meat and poultry prices started dropping sharply last year.

Eggs had a particularly sharp price drop. When the bird flu arrived from Asia in the spring of 2015, egg and meat producers in the West and the Midwest destroyed 40 million chickens to contain the infection.

As chicken and egg prices shot up, consumers and processed-food manufacturers cut back. The industry recovered in numbers faster than expected, but some of the demand hasn’t returned.

The result: a price collapse for eggs, down 29 percent from a year ago, according to the USDA.

Beef producers and packers saw a similar cycle, but it was spread out over more time. The Midwestern drought of 2011 to 2014 pushed up the costs of raising cattle, causing many ranchers to cut back their herds.

By 2013, the rains started to return, and farmers started holding back female calves to breed, adding to the shortage.

By late 2014 and into early 2015, beef prices were sky high. But as additional cattle started working its way through the system, prices started dropping.

As of July, beef prices are down 7.7 percent from a year ago.

Also from a year ago, dairy prices are down 3.1 percent and poultry is down 3.2 percent. Even the price of cereals and bakery products, such as bread or crackers, is down 0.8 percent, according to the USDA. Only the price of fresh fruits and vegetables was up, by 1.4 percent.

Compounding the problem for some grocery chains is that Wal-Mart, the nation’s largest grocer, has aggressively recommitted to lowering prices. The company is also dealing with food deflation but is better able than most grocers to absorb that, with its broad array of general merchandise products.

“You always want that customer coming away realizing that, on a basket of goods, they got the best deal at Wal-Mart. And that’s who we are as a company,” chief financial officer Brett Biggs said at an investor conference this month.

McMullen, Kroger’s CEO, said the company – which has focused its strategy on the customer experience rather than simply price – hasn’t seen much impact from its competitors, such as Wal-Mart.

How will this fix itself?

McMullen told analysts he expects deflation to continue into early next year.

“High prices solve high prices, and low prices solve low prices,” McMullen said in the conference call. “Farmers are smart, and they will start producing less of the things that don’t make money.”

As demand rises and supplies fall, prices will start to rise.

But Hertel, the industry analyst, said there may be some longer-term changes that gradually steer grocers away from being so dependent on the up-and-down swings of the commodities markets.

The more processing and preparation involved in food sales, the less commodities price swings will matter, he said. That dovetails with the arrival of the millennial generation and its bias toward more convenience and quality over concerns about price, Hertel said.

“Right now, the grocery industry is focused on food consumed at home,” Hertel said. “But you’re starting to see a real blurring in the midst of this deflation.

“One of the things creeping in is a move to more prepared foods in store. They’re called ‘grocerants.’

“And that move to more prepared foods will start to mitigate their dependence on some of the commodity price fluctuations,” Hertel said.

Starting at the 21st and Maize store and moving to six stores in the market by year's end, Dillons is adding online shopping. Customers shop and order online and pick up the next day at the supermarket. (June 10, 2016)