Delhaize, Ahold Tripped by Slipping Food Inflation

Food inflation is ending, and J.P. Morgan has downgraded Ahold and Delhaize after determining that supermarkets may find it tougher to cope with the competitive environment as a result.

Food inflation gained 6.6% in 2008. For food retailers, that brough two benefits. First, it gave them cover to raise prices. Because the media extensively discussed the reasons, increased fuel costs and problems with crops such as wheat, supermarkets knew that they could raise prices amid consumer resignation about increases. Plus, supermarkets would be raising prices at the same time, which certainly makes the competitive issue less troublesome.

Then, food inflation provided supermarkets with a reason to tout their private label products. With most offering multiple private labels that address different needs, supermarkets could raise prices and simultaneously push their customers toward less expensive but higher margin private labels developed as equivalents to national brands or as lower quality bargain alternatives.

Even when supermarkets don't get a margin boost, a modest price increase adds a few more cents to transactions, which tells against fixed costs and can help profitability.

The expansion of supercenters, warehouse clubs and other value food retailing concepts has helped keep food inflation low for two decades as they can count on general merchandise and lower operational costs to enhance their profitability. So last year's surge was a real opportunity for supermarket operators to boost their returns. Now, though, J.P. Morgan has downgraded Delhaize, which operates the Food Lion, Bloom and Hannaford Bros. chains, and Ahold, which operates Stop & Shop and Giant, based on lower food inflation in the recessionary economic environmental. Clearly, J.P. Morgan has reached the conclusion that food inflation was the best bet Delhaize, downgraded from neutral to underweight, had to pace the market and Ahold, downgraded from overweight to neutral, to stay ahead of it.