Over the past year, we’ve heard countless stores about how the Whole Foods/Amazon.com (AMZN) merger was set to disrupt the grocery industry. Big grocers such as Kroger (KR) saw their shares slump in the wake of the news. However, grocery stocks have largely bounced back – so far, reviews of the new Amazon-run Whole Foods have been pretty mixed. And this week, some interesting comments came out from Whole Foods co-Founder/CEO John Mackey:

I’m sure that Amazon has probably gotten more disagreement from me than any other single person, and possibly more than everyone else combined.

While Amazon’s purchase doesn’t look like a failure by any means, it’s hardly been the grocery store industry destroyer that we were hearing about this time last year.

And yet, while the Amazon threat hasn’t severely dimmed the grocery store industry’s prospects, at least not yet, a new danger looms. Coming from Germany, Lidl Stiftung & Co. KG, or Lidl for short, entered the US grocery store market last year. Lidl has long been a big competitor of Aldi in other markets, and now they’re bringing that fight to the US.

Lidl is a hyper-discounter, so supporters of more upmarket brands assumed they’d be relatively safe from the Lidl threat. On top of that, the company got off to a slow start in the US; they’ve only opened roughly half of the 100 stores that were planned to have launched by now, and early reports said customer traffic has been underwhelming.

Lidl Is Poised To Succeed

Grocery store chains, and their investors, who thought Lidl wasn’t a threat need to reconsider, however. A comprehensive survey from consulting shop Oliver Wyman shows that while Lidl got off to a slow start, they’re about to surprise the industry (the survey was run entirely independently of Lidl). The survey results, reported in this article in Food Dive are noteworthy for investors in grocery stores and the REITs that own the properties. Let’s dive in.

“Incumbent grocers should be quite worried that Lidl is viewed by consumers as being on par [with them],” – George Faigen, Oliver Wyman consultant.

Discussing the company’s slow start in the US, Faigen noted that the company operates in more than 20 other countries and went on to add that:

We expect that they’re going through a similar process in the U.S., tuning to the American consumer with the expectation of a long-term success …I see them as an agile company that finds a way to continually match the needs of each local market they serve.

The 20 countries comment might even understate Lidl’s reach. Their corporate parent, the privately-held Schwarz Gruppe, is the world’s fourth largest retailer by revenue. So unless Lidl was a total flop, its growing presence in the US should be a concern. And they appear to be increasingly successful in the states.

The survey found that fully 61% of under-45-year-old customers that ever go to Lidl shop there at least twice a month – millennials are the most loyal shoppers at Lidl by age group. It turns out millennials are attracted to low prices as much as older shoppers. In addition to making inroads with a key demographic, Lidl is doing increasingly well overall; last year, only 58% of Lidl shopping trips resulted in $20+ purchase baskets. That figure is up to 84% this year.

Lidl is taking customer dollars away from a broad cross-section of other retailers. This is a surprise to the industry. The Food Dive article notes that:

Lidl’s repeat customers are those who used to shop more often at other stores. The study found repeat Lidl shoppers coming from all store categories — 40% also shop at regular groceries, 49% shop at other discounters, 52% also shop at hypermarkets, and 66% do some shopping at warehouse clubs. [Oliver Wyman consultant] Ebner said they were surprised to see these numbers were so high.
“In our conversations with supermarket executives, they are surprised to learn the number is this high, and it’s clear that customers are moving more quickly in the direction of Lidl than the industry commonly has viewed,” Ebner said.

Impact To Grocery Stores

Since Lidl is taking share faster than expected, that means we should be asking who is losing as Lidl wins. Since Lidl is privately-held, unfortunately, the simple way to play this – buying their stock – is not an option. However, there are potential losers here to think about with caution as Lidl continues its expansion.

We can see from the quote above that warehouse clubs are taking the most brunt of customer defections. This is a problem for the likes of Costco (COST) and Walmart’s (WMT) Sam’s Club line of operations. Also, notably, BJ’s Wholesale Club (BJ) is planning an IPO soon. BJ’s has a large number of stores on the East Coast, where Lidl has based its US operations, potentially putting BJ stock in harm’s way in coming years.

While Lidl is drawing fewer customers from traditional grocery stores, the 40% figure reported is still a meaningful impact. Particularly for less upscale grocery chains, there is a significant risk of Lidl hitting margins. As the Food Divearticle put it:

Lidl [is] going to continue to eat away at the customer base for other stores. Two-thirds of shoppers surveyed reported a “Lidl effect” at other stores — prices fell to offer similar deals to what a shopper would find at the discounter.

This is a huge problem for said other grocery stores, since Lidl only spends 4-5% of their revenues on employee wages, compared to 9-12% of sales at traditional grocery operations. Given existing paper-thin grocery store margins, widespread price matching could be a disaster.

Bad News For Consumer Staples, REITs As Well

Lidl has the potential to significantly harm two other classes of stock. The first of these are the consumer staples companies.

Lidl sells a ton of private label products. Other stores had hoped that Lidl’s lack of big-name brands would keep shoppers away. But judging by how well Lidl is faring in customer satisfaction, this may be less of a problem than anticipated for consumer acceptance. And that’s bad news for packaged foods companies.

Take cereal for example. Lidl’s website lists 44 different cereal offerings, many with names quite close to classic branded products such as Fruit Rings in place of Froot Loops. All told, of their 44 branded cereal offerings, just three have a trademark, with the rest being generic offerings. For example:

Lidl website

A future where a substantial of frosted flakes that sell are of this variety, rather than from Kellogg (K) and their famous tiger is bad news for packaged foods companies indeed. For those curious, the term frosted flakes by itself can’t be trademarked since it is a product description not a specific product name. Multiply across the wide variety of product types that Lidl sells, and these sorts of private label products could be a serious issue for packaged foods players.

The other class of stock at risk are retail REITs. Diversified REITs such as Realty Income (O) have a surprisingly high amount of money at stake in the Lidl battle, as they count Kroger, BJ’s, Walmart/Sam’s Club, and multiple dollar store chains all as top tenants. And the grocery-store anchored shopping center plays, such as Kimco (KIM), Brixmor (BRX), and Urstadt Biddle(UBA) are all at risk as well.

Of course, Lidl could rent from these REITs if and when they drive other chains out of business. Lidl previously built all their stores from the ground up – bad news for REITs with existing empty boxes to fill – but Lidl is reevaluating that strategy now.

Now, of course, one new grocery store chain – particularly one that is still regional at this point – is hardly going to plunge the industry into crisis. Lidl plans to eventually grow to 600 US stores, a chunky number, but again, not enough to kill off other players outright.

But it’s worth watching these sorts of disruptions closely. There’s a lot more going on out there than just Amazon-eating-retail. Behind the scenes, competitive disruption can come from more mundane sources. The hyperdiscounters such as Lidl and Aldi could cause investors headaches in coming years, and you should build that possibility into your investing outlook now, before other investors become more aware of the potential risk.