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Kroger 'a significant beneficiary' of food inflation, analyst says

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Bank of America Analyst Robby Ohmes joins Yahoo Finance Live to discuss the impact of grocery inflation, retail performance, recessionary risks, and the outlook for the economy.

Video Transcript

[MUSIC PLAYING]

BRIAN SOZZI: Inflation and slower consumer spending continue to pummel the bottom lines of most retailers, setting the stage for weak second quarter earnings reports in a few weeks. But food retail stocks may be a little more insulated from the headwinds. Let's dive into this more on the phone with Bank of America Analyst Robby Ohmes. Robby, great to get some time with you. Another hot read on inflation this morning, and the CPI up 9.1%. What retail stocks-- what food retail stocks might do pretty well in this backdrop?

ROBBY OHMES: Yeah, thanks, Brian. Thanks for having me. Kroger is one we've been highlighting as being a significant beneficiary of the high food inflation environment. You know, and that's because the environment we're in is forcing all the food retailers to pass through the cost inflation. But at the same time, the cost to operate Kroger, or Target, or Walmart on the food retail side aren't rising as fast, which can create a situation for margin expansion-- or even margin expansion.

So Kroger is a name that we've been highlighting. We have a note out this week, and we also talked about Albertsons. But, really, all of the food retailers, including Walmart, are seeing very strong grocery businesses in this environment.

BRAD SMITH: It comes on the same day that Kroger is also trying to really beef up its loyalty program, as we know Walmart has been trying to woo even more of its existing members with some of those loyalty rewards and so forth-- Amazon doing the same through Prime. And so with all of that considered, how much might we see consumers actually opting in in a time of their own kind of constraints budgetary wise in order to perceivably get some deals from the major chains that are out there in Kroger, and Walmart, and Amazon as well?

ROBBY OHMES: Yeah. I think that's exactly right. You know, Kroger had some announcement out today about their new boost loyalty program. Walmart has had success with their program as well. And you're seeing consumers-- I think Prime started the trend and the brick and mortar retailers are learning how to use that to help consumers get extra value versus what they would have without those programs.

So we think it's a trend that's going to continue. And it is going to, over time, build into being very strong advantages for Walmart and Kroger.

JULIE HYMAN: Robby, it's Julie here. I'm also curious about the role of private labels at a time like this-- the store brands. Traditionally, if people are trading down and trading down to the private label items because they're cheaper for them, those tend to be higher margin products for these various grocery chains. Is that, though, still the case with input cost inflation being what it is? And are we going to still see that trend?

ROBBY OHMES: Yeah, Julie, that's exactly right. So we are absolutely seeing that trend towards private label. We're hearing about that from Walmart, from Kroger-- the penetration of private label is going up. There are probably cost pressures in private labels similar to what those companies would be seeing with their CPG company partners.

But those are probably also being passed through. So when I'm talking to people about this private label phenomenon, one of the things I'm reminding them is there is trade down, you know, in rising penetration of private label, which would maybe normally show up more visibly as a headwind to sales. But given the inflation numbers we continue to see in the food at home inflation, including that 12.2% June number that came out today, I don't think you're going to see it show up as a sales headwind because it'll be more than offset by the overall food inflation that's raising and supporting sales growth at all of the food retailers right now.

BRIAN SOZZI: Robby, I think these retail stocks are still taking their cue from that Target, really, mess last month with that big warning. When do you buy a stock like Target?

ROBBY OHMES: We did downgrade Target last month to neutral. You know, what we talked about then and what we're still seeing is this rapidly changing industry backdrop with excess inventories and discretionary categories, particularly apparel and home-related soft items and small appliances, and things like that. So you have this raised back half uncertainty for margins on the discretionary side, which Target has a lot of exposure to.

And you know, Target's competitors in those discretionary areas also are expected to potentially take higher than expected markdowns to clear merchandise so that the back half looks more challenging on the discretionary side of Target's business, whereas the inflation numbers and what we're seeing in grocery trends look very healthy, and probably you're going to see strength in grocery in the back half.

Even our economists now expect a mild recession in the back half of this year. So again, that would be something that could pressure Target's discretionary sales maybe more than the consensus numbers currently expect.

BRAD SMITH: How long do you expect it will take these retailers to churn through this backlog in inventory that they do have?

ROBBY OHMES: That is a great question. I think companies like Target are doing a very good job working through it. Target, I believe, has canceled a fair amount of orders and is trying to rightsize the inventory for the tougher environment that they identified relatively quickly after they reported earnings. However, there are long lead times for a lot of the goods that are imported.

And so the risk I see is that you are still seeing flows of goods coming in-- some early, some maybe are going to be later than expected, but a lot of goods still flowing into these retailers. And they're all going to have to manage excess inventory on the discretionary side in different ways. That may show up to a greater extent when you get into periods like the back to school selling period.

BRIAN SOZZI: Bank of America Analyst Robby Ohmes, always great to get some time with you. We'll talk to you soon.