US grocers: class war

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Anyone writing a 2013 update of the Thorstein Veblen’s classic Theory of the Leisure Class would do well to devote a chapter to the American supermarket. The US upper middle classes love to flaunt their success and taste while food shopping. So much so, indeed, that two of the best-performing initial public offerings of this year are of the conspicuously upscale grocers Fairway and Sprouts.

Just as the proletarian food retailers Safeway and Kroger are learning to compete with the astonishingly low prices of super-dupermarket Walmart (the shares of the pair are up more than 40 per cent this year) the successful listing of Fairway and Sprouts shows that Whole Foods will face increasing competition at the high end.

Fairway listed its shares in April and they are up a third since then. Factoring the IPO price, its shares are up 75 per cent. The company has just 13 stores, concentrated in the New York area, but is steadily adding locations. Fairway offers high-quality fresh and gourmet foods and, at the same time, stocks standard grocery items at a lower price than other organic or speciality retailers. It is a cunning strategy: paying a low price for detergent makes the clientele feel virtuously thrifty even as they line up to pay $20 for a little lump of Brillat-Savarin cheese. The result: gross margins of 33 per cent last year, against 20 per cent at Kroger.

Sprouts 165 stores in crunchy California and the Southwest offer “natural and organic” fare. At $37, its shares have more than doubled since they debuted a month ago. Where Fairway fulfils the bourgeois need to be seen as both an economical consumer and a discriminating connoisseur, shopping at Sprouts’ assures the class aspirant that their high grocery bill is evidence not of vulgar self-indulgence but health and environmental uprightness.

The two chains’ shares, unsurprisingly, come with high (or perhaps artisanal?) valuations. Sprouts’ enterprise value is 28 times to forecast 2013 operating cash flow; Fairway, 19 times. Compare that to Whole Foods on 14 times, or Safeway and Kroger at 7. Sprouts does expect almost double-digit comparable store growth this year. Same store sales growth at Fairway, however, was just 2 per cent in the latest quarter, but its new stores should contribute to growth. Nevertheless, given the lofty prices, this class war was won, as usual, by the insiders who participated in the IPOs.

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