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Morningstar submits: By Michelle Chang Although economic conditions improved throughout 2009, domestic grocery store operators have not benefited due to food deflation, a heavy promotional environment, and labor costs. According to U.S. Census data, grocery stores are expected to generate roughly flat growth in 2009 from the prior year, after generating a compound annual growth rate of 4% from 2002 to 2008. The beginning of 2010 appears to be challenging, as consumers are still grappling with a high unemployment rate and tighter credit. The Fight for Consumers’ Dollars Intensified in 2009 and Will Likely Remain Tough in 2010 In food retail, switching costs for consumers are virtually nonexistent. Individuals largely choose locations based on price, and the situation intensified as the downturn progressed. Grocers reacted by lowering prices to retain traffic. For example, Supervalu’s ( SVU ) Jewel-Osco chain lowered prices by as much as 20% in certain categories to appeal to price-conscious consumers. Safeway ( SWY ), which had previously spent time investing heavily in its stores, also moved to a low-cost, low-price strategy. Even Kroger ( KR ) , which had been the most proactive in repositioning stores to better compete with deep discount formats, lowered prices to maintain market share. We believe competition will remain intense, particularly as Wal-Mart ( WMT ) (the largest food retailer in the U.S. with approximately $130 billion of grocery share, around 20% market share) has renewed its low-price policy with a vengeance, and Target ( TGT ) is testing a new store format that increases its presence in perishables. While all operators have been negatively affected by the competitive environment, we believe the grocers we cover can withstand these pressures better than smaller independent chains. The grocery industry remains highly fragmented. Kroger is the second-largest food retailer with an approximate 10% share of the market, according to our calculations. The next three largest retailers in terms of sales, Costco ( COST ), Safeway and Supervalu, each hold around 5 share by our estimates. We believe that these larger operators are poised to take share from smaller regional chains that have struggled and gone bankrupt amid the economic downturn. Complete Story