This is the second article in the Gordon Brothers look into the future of retail.
Once again, the analysis is very American, but they do focus on global trends.
The retail sector bounced back during the summer of 2020 from early spring lows, posting year-over-year growth of 6.6% in June and 7.4% in July. Yet the recovery has been deeply uneven. The pandemic has awarded winners and penalized losers. To compete — or in many cases to survive — companies have been forced to pivot virtually overnight. As a trusted partner to our retail clients, Gordon Brothers has deep respect for the resilience and innovations these challenges have engendered.
Essential goods providers and discounters have been well positioned to endure the crisis. By quickly adding safety features such as one-way aisles, temperature checks for employees and store occupancy limits, they have put shoppers at ease and maintained orderly distribution of the food, drugs and cleaning supplies households need.
This article examines the trends affecting essential goods providers and discounters during the COVID-19 pandemic.
The article is part II of a series examining the pandemic-era landscape to understand issues important to the retail sector, such as whether trends constitute secular shifts or short-term changes. Part I takes a closer look at the dramatic increase in e-commerce. Part III considers pandemic-related fads, such as pet adoption, home improvement and sporting goods purchases.
Stocking up on essentials
Demand for groceries and other essential products has remained robust throughout the pandemic. Sales at grocery stores soared 28.5% year-over-year (YoY) in March as consumers stocked up on indispensable items. As lockdown orders loomed, anxious shoppers purchased shelf-stable products such as dried beans (up by 63%), rice (58%) and chickpeas (47%) according to Research and Markets. Grocery spending eased as food service establishments reopened and lockdown orders ended, yet sales remained elevated by 10-15% YoY through July, before ebbing to about 7.6% YoY growth in August.
When shoppers visit stores to purchase food and other essential items they have been buying more, although that trend has been easing. Compared to the 2019 average, grocery store cart size rose by more than 30% in early April, declining to about 13% in late June. Cart size for shopping at other essential-goods suppliers remains elevated as well. By contrast, Americans were less inclined to spend as much on discretionary items in the near term, with the exception of groceries, non-food child products, household supplies and entertainment, according to McKinsey.
For their most recent fiscal quarters, large grocers posted hefty same-store sales growth (excluding fuel):
- Albertsons Companies Inc. increased 26.5% (quarter ending June 30);
- The Kroger Co.’s identical sales grew 14.6% (July 31); and
- Publix Super Markets Inc. 19.9 % (June 27).
Smaller grocers were typically posting revenues more than 20 % higher YoY in March-May, compared to 5 % declines at other small retailers according to JP Morgan.
In addition to anxiety, a shift toward eating at home also helped grocery sales. In mid-March, fewer than half of U.S. consumers said they cooked at home according to Goldman Sachs survey data. By the end of March, this figure rose to more than 75 % . For some, having time to cook at home was a pleasure or an opportunity to eat healthier. Famously, sales of baking yeast surged by 647% for the week ending March 21, and sourdough loaves began popping up on Instagram. Yet according to an April survey cited by The New York Times, though nearly a third of Americans were eating healthier, a quarter — dominated by young adults aged 18-29 — were consuming more sugary and salty snacks.
Of course, the home cooking surge has not been driven by choice. Food-service closures forced consumers to prepare their own meals. Food-service spending dropped by more than 50 % in April, and remained depressed through August. The drop in food-service spending from March through August was $116 billion compared to the same period in 2019, far exceeding the $50 billion increase in grocery store spending during that time.
It’s unclear whether the home-cooking trend will last. Fear of COVID-19 and crisis-driven wallet consciousness is still forcing people to prepare their meals at home. It is likely that at least some consumers who never cooked before will continue doing so, for pleasure, health reasons or to save money. However consumers less financially harmed by the crisis may flock to restaurants once they feel safe.
The pandemic has meaningfully impacted American household budgets. Disposable personal income declined month to month in March (by -1.7% ), May (by -12.9% ) and June (by -1.3% ), and rose just 0.2% in July. It was up by 14.7% in April, largely due to the disbursement of $2.6 trillion in economic impact payments. Although government stimulus outlays were relatively modest by July ($32.8 billion), they were nearly equivalent to most of that month’s disposable personal income increase ($39.9 billion). This suggests the potential for further pressure on discretionary spending due to the congressional impasse on passing another stimulus. The Conference Board’s Consumer Confidence Index — an important indicator of willingness to spend — rose by 15.5 points in September, from 86.3 in August. It is down by about 30 points compared with February. Yet many economists are projecting strong Q3 gross domestic product growth from the lows of Q2, driven by pent-up consumer spending.
Regardless, with millions of workers unemployed and household debt near record highs at $14.27 trillion, the pandemic has prompted greater price consciousness among many U.S. consumers. In mid-August, most believed economic recovery was at least four months away, and about 40% were looking for ways to save money while shopping according to the McKinsey survey. Nearly 60% of the survey’s respondents said the search for value drove them to try a new brand in recent months.
As a sign of price consciousness, the Private Label Manufacturers Association stated store brands posted double-digit US sales growth during the first stages of the pandemic, significantly outpacing pricier national brands. In Q1 of 2020, store-brand sales grew 14.6% in dollar volume and 12.8% in unit volume, outpacing 11.5% and 9.2% , respectively, for national brands. The strongest gains occurred in the mass segment, which includes mass merchandisers, club and dollar stores. Fitch Solutions noted in March imports of cheaper food and drink products surpassed imports of more expensive alternatives, indicating growing price sensitivity among US consumers.
As seen in the global financial crisis, lower discretionary income typically helps value-focused retailers, dollar stores and other discounters. These stores are performing well. Costco same-store sales soared by 14.1% YoY in the quarter ending August 30, with strong sales of bulk groceries, cleaning supplies and home furnishings. Dollar Tree Inc. and Dollar General Corp. have had strong sales growth during the pandemic, somewhat mitigated by civil unrest challenges, social distancing and additional pandemic-related costs. Overall, after some challenges in the early months, discount retailers appear to be adjusting well to the new circumstances.
For example, Dollar Tree Inc. reported a similarly robust level of same-store sales growth in Q1 (7.0%) and Q2 (7.2%). In Q1, ending Dollar Tree reported margin pressure from merchandise mix, tariffs, Easter merchandise markdowns, and higher payroll costs, partially offset by stronger same-store sales. In contrast, Q2 earnings included 180 basis points of margin expansion, driven by improved merchandise costs, stronger same-store sales, reduced markdowns and improved shrink results, partially offset by higher distribution costs, including $11.4 million in COVID related payroll costs, and incremental tariffs of about $10.8 million. The company’s earnings report also cited “store damage, lost inventory, and other costs of $16.8 million related to civil unrest in certain communities.”
Some discounters that had been required to close temporarily during lockdown also saw comparable sales rise once they reopened. For its fiscal second quarter ending August 1, tween-teen discounter Five Below Inc. reported “reopened period comparable sales increased approximately 6% ” although comparable sales for the full quarter dropped 12.2% due to a 19% decrease in comparable operating days. While Five Below hasn’t issued a Q3 outlook due to COVID-19 uncertainties, President and CEO Joel Anderson said “The third quarter is off to a strong start.”
Price consciousness would appear to benefit off-price retail companies such as TJX — including the TJ Maxx, Home Goods, Marshalls and Sierra chains. As Gordon Brothers discussed last quarter in What’s in Store for Post-Covid-19 Retail, many department stores have inventory that needs to be offloaded or sold at high discounts due to store closures and low foot traffic in March to May. Off-price chains are capitalizing on this opportunity to buy hot items at an attractive price, yet in Q2 their results were down. At TJX, the industry leader, foot traffic is significantly lower. Remote work has depressed demand for apparel, and fear of the virus is keeping some shoppers out of stores according to company management. On the positive side, thanks to the dual trends of value shopping and (forced) nesting, TJX “saw especially strong sales at our HomeGoods and HomeSense chains and in our home categories within all of our other chains across our geographies.” In aggregate, “open-only” comp-store sales were down 3% for Q2.
While discounters are facing extraordinary costs from payroll premiums, tariffs and civil unrest, they have also benefited from price resilience. By summer, promotional activity had decreased given the strong demand for essential items. Only 21% of fast-moving consumer goods (FMCG) were sold on promotion in the 30 days ending June 13, versus 30% in June 2019. Yet as scarcity wanes for some of the most sought-after products, stores will need to reset and be attuned to price elasticity.
Caution will drive demand
Overall, we expect value and caution will continue to drive consumer decisions during the crisis. Essential-goods suppliers and discounters are likely to continue benefiting from this, in the form of greater demand, larger cart sizes and elevated same-store sales. On balance their earnings are poised to remain relatively strong, even while their margins face some pressure from payroll premiums and extraordinary costs.