Recovery Watch: Supermarkets Struggle

New York (TheStreet) -- Supermarkets could be in for a rough quarter, as food-price deflation and intense competition push down on profits.

Credit Suisse analyst Edward J. Kelly said today that food-price deflation will reach historic highs over the next several months -- which will pose a problem for supermarkets like Kroger(KR Quote), Safeway(SWY Quote)and Supervalu(SVU Quote).

Traditional grocers are also up against discounters like Wal-Mart Stores(WMT Quote), Target(TGT Quote), Costco Wholesale(COST Quote) and BJ's Wholesale(BJ Quote), which have been benefiting from shoppers trading down.

As a result, supermarkets have been forced to lower prices and offer promotions to lure shoppers.

Nonetheless, a Labor Department index of food sold to be eaten at home fell for the seventh time in eight months in July. The index dropped 0.5% during the month and is down 0.9% year-over-year.

But Kelly said 2010 will see improvements for the sector.

Kelly rates both Kroger and Safeway as outperform, but says Supervalu is still struggling from its acquisition of Albertson's in 2006. He rates the stock neutral, but says Supervalu's stock is cheap, and new management could be a catalyst to propel upward movement.

So far this week, shares of Kroger are up 0.2%, closing at $21.95 on Thursday, while Safeway jumped about 1.5% to $19.90 and Supervalu spiked 5% to $15.69.

-- Reported by Jeanine Poggi in New York

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