Supermarket stocks are on a roll, even though shoppers are continuing to fill their carts with lower-priced food and household items.Supermarket stocks are on a roll, even though shoppers are continuing to fill their carts with lower-priced food and household items.

As of Tuesday's close, shares of three of the major traditional supermarket companies -- Kroger (KR), Safeway (SWY) and Supervalu (SVU) -- traded at or near 52-week highs. Together, the three companies' stock prices increased an average of 20% over the last 12 months.

While earnings for these companies are still lagging, investors are loading up on the stocks in anticipation of a growth year. There's a sentiment that shoppers will soon give up their stingy ways and return to buying at traditional grocery stores.

"Last year was pretty awful for the supermarkets, with deflation and cutting of costs, and lowered revenues," says Mario Barraza, research analyst with Kevin Dunn & Partners. "Supermarkets are finally getting their prices in line, and everyone is looking for a turnaround."

Waging Battle Against Wal-Mart

David J. Livingston, supermarket consultant with DLJ Research in Waukesha, Wis., says the sector isn't out of the woods yet, by any measure. He's seeing companies continuing to close underperforming stores, and he expects the battle to rage on with the Wal-Mart (WMT) behemoth.

Livingston notes that Wal-Mart continues to add market share around the country as it moves wholeheartedly into the grocery business. Last week's news that Wal-Mart was cutting prices on 10,000 products seems to be an attempt to keep snatching a bigger share of supermarket sales.

"People are still trying to find ways to cut their costs, and in many cases this means shopping at Wal-Mart instead of traditional supermarkets," Livingston says.

Kroger CEO Dave Dillon said in a recent investor's conference call that the company's stores, which include King Soopers, City Market and Ralphs, have been expanding their selection of value-priced items due to the down economy. This is a change from a past practice of trying to sell more higher-priced items to make up for the revenue losses.

Plus, Kroger is pushing a renewed focus on customer needs, including clean stores, faster checkout and a wider variety of products.

Traditional Stores Are Offering More Value Items

At least in the short term, the move seems to paying off because Kroger is seeing growth in spending by current customers, Dillon said. It's not just about offering what customers want, it's a response to increased competition from Wal-Mart.
Kroger reported last month that its supermarkets vie with about 1,190 Wal-Mart supercenters, an increase of roughly 60 new supercenters over last year.

"We think we stand out in those three keys (products, cleanliness and faster check-outs), and we think we will stand out even more as years go on," Dillon said at the Citi Retail conference on March 24. "I think that does distinguish us from Wal-Mart, and I think there's plenty of room for our success, even with their success."

As the economy slowly recovers, analyst Barraza expects a portion of customers who switched to Wal-Mart for their groceries returning to the traditional supermarkets. "It's all about comfort and presence," he says. "Some people see shopping at Wal-Mart as trading down in terms of quality as a trade-off for lower prices."

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