How Grocers and Big Food Makers Are in a Different Kind of Price War

The consumer staples sector was widely seen by Wall Street as a haven for investors over the course of 2022 and part of 2023. While inflation wreaked havoc in other consumer-facing segments, it benefited the sector. Both CPGs and grocers raised prices to offset higher labor, production, and commodity costs to consumers, padding their top and bottom lines in the process.

Now that inflation is cooling—food at home inflation ticked up 0.1% in December, and is 1.3% higher compared to December 2022—there’s a new concern making investors skittish: deflation. Deflation is when prices fall instead of rise, leading to slower revenue growth and pressuring margins.
Walmart
CEO Doug McMillon’s comments last fall, which warned that the U.S. may be soon approaching a deflationary environment, sparked the first concerns, dragging consumer staples stock valuations lower.

These concerns have been hard to quash, despite Walmart executives since clarifying that deflation isn’t the company’s base case for the year ahead. Economists and analysts also say a more likely scenario is that disinflation—a decrease in the rate of inflation—will be the norm over the rest of the year, as it has been over the past couple of months.

“Grocery deflation is historically anomalous, and we think grocery inflation settling at the positive low single digits is the more likely outcome,” wrote Dean Rosenblum, analyst at AB Bernstein in an early January note. “And if we do see deflation, we expect it to be shallow and short-lived.”

Still, the bottom line is that Big Food’s pricing power is showing some cracks as consumers push back on increases, wrote TD Cowen’s Robert Moskow in a note this week. That means revenue growth will slow, unless companies are able to drive sales volumes higher.

Kimberly-Clark
and P&G’s recent earnings reports are proof, with both companies seeing a slowdown in revenue growth in their latest quarter compared with a year ago.

“The second half of the fiscal year will see less pricing benefit as we annualize more prior year increases,” said Andre Schulten, P&G’s chief financial officer, on a Tuesday call with analysts.

Grocers have yet to report earnings, but analysts are forecasting lower same-store sales growth for
Kroger,

Albertsons,
and
BJ’s Wholesale
—and even
Walmart
and
Costco Wholesale
—compared with the same quarter last year.

Yet while both grocers and CPGs are grappling with the same problem, the two sectors find themselves at opposite ends of the bargaining table. On the packaged goods side, companies are loath to scale back any pricing gains made in the past several years. Grocers don’t want massive price cuts either—but they may not have a choice.

“No matter what happens, the consumer still blames the retailer,” said Matthew Pavich, senior director of innovation and strategy at Revionics, a pricing optimization company, on a call with Barron’s. If shoppers don’t feel like they’re getting the best deal, they’re more than happy to turn elsewhere, eroding that retailer’s market share, he added.

The rift between the two sectors was evident earlier in January, when French grocer
Carrefou
r stopped selling
PepsiCo
products because the companies couldn’t agree on pricing. PepsiCo has said negotiations are still ongoing.

U.S. grocers probably won’t go to such drastic measures. But they may be taking a stronger stance with suppliers as they try to find that “critical balance” between shifting prices lower while maintaining margins, Pavich said.

And for the first time in a while, they may just have the upper hand.

For one, retailers’ private labels have grown more popular as consumers look for cheaper alternatives. That’s taken market share from CPGs, contributing to the decline in sales volumes the companies started to see in 2021. The volume shortfall was largely offset by higher prices—but disinflation removes that buffer. CPGs may now be compelled to institute more promotions to move stock, Rosenblum wrote.
Conagra Brands
and
General Mills
have already signaled they’re going to step up promotions, and others will likely follow suit.

“We’re inclined to think that the retailers have more tools at their disposal (private brand, retail media, merchandise mix, etc.), and that CPGs are more dependent on their retailer partners than the other way round,” Rosenblum said. “As such, the balance of power currently rests with retailers.”

Write to Sabrina Escobar at [email protected]