Albertsons Earnings: Weak Results Likely Caused by Tough Competition and Abating Food Inflation

No-moat Albertsons’ fiscal fourth-quarter results reflected the grocery industry’s tough competitive landscape as identical sales growth of 1% underperformed our 2% estimate. Sales ticked up for the quarter primarily due to strength in the firm’s pharmacy business, while its nonperishable and fresh food categories (over 80% of sales) posted a low-single-digit decline. The 28% gross margin (up 20 basis points annually) was impressive at first glance, but gross margin contracted nearly 60 basis points, excluding favorable inventory accounting effects and fuel, amid higher fulfillment costs related to digital orders and an unfavorable sales mix (pharmacy sales typically carry a lower margin). Ongoing investments in digital fulfillment and delivery capabilities also contributed to a 60-basis-point reduction in fourth-quarter adjusted operating margin to 2.5%. We surmise that less-pronounced food inflation has prompted grocery stores’ pricing gains in recent quarters to abate, and we expect promotional activity to increase as stores compete for customer traffic to drive growth. Because Albertsons lacks a durable cost advantage over lower-priced peers like wide-moat Walmart and Costco, we maintain our forecast for weak comparable sales growth and slight operating margin degradation in fiscal 2024. We do not plan to materially alter our $28 fair value estimate and currently view the shares as undervalued.