(By Michael Keara) Two basic staples, food and fuel, are eating a greater share of household budgets with prices growing at a faster rate than consumers' wages. Investors seeking to limit downside risk in the consumer defensive sector should own firms with business models that have the ability to deploy these inelastic products as category loss leaders.
Our moat analysis finds that companies able to use gasoline or food as a product loss leader have the least relative downside risk in an excessive inflationary environment. We believe wholesale clubs are the best positioned when food and fuel costs begin to strain consumer budgets, followed by the dollar stores and then the supercenters. Not withstanding current valuations, we find companies in these subsectors have the least risk to a decreasing denominator in any valuation multiple, because same-store sales (excluding fuel) increase when gas prices rise dramatically. With the exception of Whole Foods (WFM) and Kroger (KR), which also maintain or increase customer traffic when gas prices rise, we believe traditional grocery store operators are the most vulnerable.
- Warehouse clubs, such as Costco (COST), derive most of their operating profits from membership fees. Therefore, when necessary, these clubs can deploy their competitive advantage of offering gasoline and food without a retail markup to maintain customer traffic trends. BJ Wholesale Club (BJ) recently reiterated that its relatively lower gas prices are helping drive market share gains in other categories.
- Despite higher prices on a unit basis compared to supercenters and wholesale clubs, shorter travel distances and dollar pack sizes for necessities appeal to consumers living from paycheck to paycheck, driving customer traffic and sales at the dollar stores.
- Kroger, to a greater degree than other traditional grocery store operators, foregoes the typical $0.10-$0.12 per gallon (net of credit card fees) profit margin on gasoline to drive market share gains.