UPDATE 1-Goldman Sachs cuts Safeway, Kroger on inflation fears

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Mon Jul 25, 2011 4:13pm BST

* Cuts cos to "sell" from "neutral"

* Says further price increases may not be accepted by consumers

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July 25 (Reuters) - Goldman Sachs cut its ratings on the top two U.S. supermarket operators Kroger Co (KR.N) and Safeway Inc (SWY.N) to "sell" from "neutral," saying continued inflationary pressures and price increases would drive consumers away and hurt the retailers' margins.

Like other retailers, the two chains have increased prices and passed on the modest inflation to customers. This has helped them expand their operating margins

(excluding fuel), the brokerage said in a note dated July 24.

"However, as inflation moves above 5 percent ... we see greater risk of margin pressure as price increases are not accepted," analyst Stephen Grambling said.

Consumers, who are already feeling the pinch of higher gasoline prices, may end up looking for cheaper options and discounted offers.

The brokerage set a 6-month price target on the Safeway stock at $20, compared with an earlier 12-month price target of $25.

On the Kroger stock, it set a 6-month price target of $23.50 compared with an earlier 12-month price target of $25.

The brokerage indicated concern over Safeway's second-quarter results and weak outlook announced last Thursday. [ID:nN1E76K0D3]

Safeway -- the second-biggest U.S. supermarket operator -- had said it cut costs to boost profits, but was not looking to cut prices to attract customers.

In mid-June, Kroger had also said it would abandon deep discounting and pass on higher costs for staples like beef, milk and produce to customers. [ID:nN16172122]

Shares of Safeway were trading at $20.97, while Kroger was down 1 percent at $24.95 on Monday morning on the New York Stock Exchange.

(Reporting by Arpita Mukherjee in Bangalore; Editing by Roshni Menon)

((arpita.mukherjee@thomsonreuters.com; within U.S. +1 646 223 8780; outside U.S. +91 80 4135 5800; Reuters Messaging: arpita.mukherjee@thomsonreuters.net)) Keywords: RETAILSUPERMARKETS/RESEARCH GOLDMANSACHS

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