UPDATE: Grocery Chains Downgraded Over Price War Threat

By Matt Andrejczak

SAN FRANCISCO (Dow Jones) - Shares of U.S. grocery-store chains fell Tuesday after an analyst warned a "price war" will hurt profits as rising unemployment threatens sales.

Citigroup downgraded Kroger to hold, and cut Safeway to sell. The broker pared the full-year profit target on Kroger by 10%, Safeway by 4%, Supervalu by 11%, and Wal-Mart 4.5%.

"While we expect the 'trade in' from restaurants and 'trade over' to private label to benefit the supermarkets, we do not believe it will be enough to offset pricing pressure from competitors," analyst Deborah Weinswig said in a research note.

In late morning trading, Kroger shares fell 9%, Safeway dropped 7%, Supervalu tumbled 10% and Wal-Mart slid 3%.

The price war is in its early stages, led by wholesaler Costco and regional grocers Weis Markets and Wegmans. To help stretch shoppers dollars in lean economic times, Wegmans has cut prices on hundreds of products, while Weis Markets instituted a price freeze through April 1 on 2,400 items. The grocers operate on the East Coast.

Costco has been cutting prices on milk, eggs, butter and other key food items.

The U.S. economy has shed more than 2.6 million jobs over the past year, elevating consternation among some analysts that consumers will do even more bargain hunting and spend fewer dollars at grocery stores.

Pali Capital analyst Bob Summers said Feb. 5 that industry sales for food retailers will be "dismal and much worse that many are currently anticipating."

Food prices have shot up as food makers enacted price increases to cover rising costs for basic agricultural staples from corn to oils. Grocery-store food prices jumped 6.6% in 2008, the largest annual spike since 1980.

And for the past year, Supervalu, Safeway, and Whole Foods all have struggled to grow comparable store sales - a key barometer of retailer health. Kroger has fared better.

Wal-Mart, who has been grabbing a larger share of the grocery business, is poised to make a bigger push into private label products, said Citigroup's Weinswig. She estimates the retailing behemoth's private label penetration in food could hit 40% by 2012.

Citigroup also lowered stock price targets on the food retailers: Wal-Mart was cut to $60 from $65, Kroger to $23 from $32, and Safeway to $18 from $24.