Saturday, January 23, 2010

the grocery game how to play

The Retail HOLDRS (RTH - commentary -Trade Now) may be the best play on the retail push into groceries.

This week, Target (TGT - commentary - Trade Now) announced that it plans to spend close to $1 billion to renovate 340 existing stores,Marketwatch reported Friday. One of the top initiatives in the plan is to expand and accelerate the firms' grocery section, according to The Wall Street Journal.

Walgreen (WAG - commentary - Trade Now) announced this week that it too wouldincrease efforts to offer fresh foods and prepared meals.

The weak economy has consumers focused on necessities, and the push into groceries is initially a signal of the industry's overall strength. Year to date, supermarkets have outperformed the discount retailers, aided by solid earnings from Supervalu (SVU -commentary - Trade Now).

However, the increased competition from the big-box retailers could dampen the performance of the grocers. Although Target and Walgreen aren't expected to make as large a splash as Wal-Mart (WMT -commentary - Trade Now), firms like Kroger(KR - commentary - Trade Now) and Safeway(SWY - commentary - Trade Now) will still face new rivals.

Currently, funds with some of the heaviest weighting in the supermarket industry are the Retail HOLDS, the PowerShares Dynamic Food and Beverage Portfolio (PBJ - commentary - Trade Now) and the First Trust Consumer Staples AlphaDEX Fund (FXG - commentary - Trade Now).

With only 5% weighting in firms like Kroger and Supervalu, I don't expect the uptick in competition to have much of a damaging effect on RTH. On the contrary, if Target's and Walgreen's recent efforts are a boon for the firms, the net result would be a positive for the fund because TGT and WAG currently account for nearly 9% and 8% of RTH's portfolio, respectively.

Wal-Mart is RTH's largest holding, accounting for more than 20% of the fund. This firm, which has caused excessive pain for grocers, should continue to prove strong for the instrument.

The story is different for the PowerShares Dynamic Food and Beverage Portfolio and the First Trust Consumer Staples AlphaDEX Fund. These instruments hold firms such as Safeway, Weis Markets (WMK -commentary - Trade Now) and Whole Foods Market (WFMI - commentary - Trade Now) among their holdings. In all, grocers account for close to 6% of PBJ and 10% of FXG.

Though the allocations to grocers are small, these funds are much less buffered against the influx of discount retailers into the grocery store business. Neither Target nor Wal-Mart is present in their index, though WAG can be found as a small 3% holding in FXG. With little to no hedge, these funds could suffer if grocery store stocks underperform due to big-box competition



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