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Retailers face shake-up as US consumers trade down to beat rising prices

As the sale of discounted cat litter started to pick up, Matthew Farrell knew something new was going on with US consumer spending.

For more than a year, Church & Dwight’s chief executive has seen sales of premium brands such as Arm & Hammer Platinum Clump & Seal outpace its lower-priced offerings. However, that changed in the last quarter. In cat litter, water flossers and laundry detergent, customers began to prefer the company’s cheaper options.

“That was a canary in a coal mine,” Farrell told analysts this month. “We would expect this to get worse.”

With inflation at its 40-year high, gasoline averaging over $5 a gallon, and fears of a recession weighing on consumer confidence, Church & Dwight isn’t alone. In earnings calls and investor conferences over the past few weeks, several US retailers have indicated that customers have switched to cheaper products. Others are bracing for more to do so in the coming months.

“Customers are aggressively starting to buy our brands,” Kroger, the $33 billion supermarket chain, told analysts last week. Like-for-like sales of its store brands rose 6.3 percent in the last quarter, compared to total growth excluding fuel sales of 4.1 percent.

Line chart of monthly mentions of 'trade down' or 'trading down' on calls from US retailers showing 'Trade down' is on an upward trend

The trend is fueling market concerns about the sector, which is exposed to rising prices, excess inventory and unreliable supply chains, but analysts also expect it to produce some winners.

Discount stores and private label makers in particular will benefit if more consumers switch to cheaper alternatives and private label products.

About 15 percent of U.S. adults said they bought cheaper alternatives at the grocery store in May, more than three percentage points more than in April, according to research data from Morning Consult. About one in five people who bought a car, computer or mobile phone was traded in – an increase of 6-7 percentage points month over month.

Mentions of “trade down” and “trading down” on the analyst talks and investor presentations of US retail and consumer companies are now higher than the previous peak they reached during the global financial crisis of 2009, according to data provider Sentieo.

And while some chains say they haven’t seen any signs of significant substitution yet, retailers, including Walmart, report seeing customers buying half a gallon of milk instead of a gallon, or choosing private label luncheon meats and bacon over branded versions.

Steven Oakland, CEO of TreeHouse Foods, praised the new value-seeking mood among consumers last month with delivering a quarter that exceeded expectations for its private label producer, which supplies food items ranging from pita bread to pickles to retailers.

Private label goods have gained unit share in each of the past three months, according to data from market research firm IRI. Retailers as big as Best Buy, Costco and Dick’s Sporting Goods have all pointed to the acceleration.

Some have described how strong the change has been, with SpartanNash, a Michigan-based supermarket chain, reporting a year-on-year increase of nearly 14 percent in the first quarter. Big Lots, the homeware and grocery retailer, said its private label products had made up nearly 30 percent of its total sales for the period, up “particularly from the mid-1920s” a year earlier.

Past cycles have shown that “when disposable income tightens, consumers find ways to increase their budget,” said Jack Kleinhenz, chief economist at the National Retail Federation, a trade organization.

However, not all consumers are equally affected. Morning Consult poll shows that baby boomers, who tend to allocate more of their budget to essentials, were the most likely age group to trade in in May, while lower and middle-income buyers were also more likely to goods than higher-income Americans.

“What we’re seeing is a bit of a split,” Kohl’s CEO Michelle Gass noted during a conversation with analysts last month, adding that the company has seen continued strength in the luxury categories, even as some buyers switched to cheaper products.

Higher prices would force some consumers to forgo purchases altogether, said Gregory Daco, an economist at EY-Parthenon, but in relative terms, “the two extremes of retail are likely to outperform the other.”

Discount retailers would likely benefit from more pervasive inflation, he said, while “the luxury segment of the market is likely to outperform due to the healthier household finances of luxury individuals.”

Joe Feldman, an analyst at Telsey Group, echoed the sentiment. “Discounts are where there will be more power” in the coming months, he predicted, noting that they tend to outperform as consumers feel pressure on their wallets.

“The inflationary environment is one that will drive much more polarization in retail,” said Neil Saunders, a retail analyst at GlobalData, who sees low-priced chains like Aldi, Dollar General, TJ Maxx and Walmart benefit from the spending shift.

However, he added, “In general, it’s not a very helpful environment for anyone.”

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