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We are downgrading our recommendation on Companhia Brasileira de Distribuicao (CBD - Analyst Report) or Grupo Pão de Açúcar to Underperform from Neutral due to a sluggish retail industry.

Why the Downgrade?

The retail sector has been experiencing economic slowdown since 2012. This has not only led to a decline in consumer spending but has also eroded consumer confidence. The continued weakness in consumer expenditure is impacting the company’s home appliances segment.

Although the company has initiated cost saving measures and opened new stores to counter the situation, low disposable income of consumers is restricting consumer spending, mainly on appliances and electronics. The slowdown in the sales of appliance and electronics is forcing the company to divert its focus toward its supermarket business.

Further, inflation in Brazil is denting CBD’s food business. The company is struggling hard to keep prices down. The company is thus counting on a turnaround in its appliance division to make up for the shrinking profit margins in its supermarkets category. The company is relying on the profitability of its Viavarejo electronics and home furnishings unit to deliver stable profit margin for the group. However, this may take some time.

Currency translation headwinds and tough employment conditions, particularly in Europe also remain a threat. In addition, the company faces intense competition from its rivals, such as Carrefour SA and Wal-Mart Stores Inc (WMT - Analyst Report) as well as from local players. In the food retail sector, the company competes with a number of large multinational retail food, general merchandise and cash-and-carry chains as well as local supermarkets and independent grocery stores.

In the home appliances sector, large multinational chains and other specialized Brazilian companies pose a threat to the company’s secured market share. Moreover, the sour relationship between the holding groups of the company remains a significant overhang.

We expect both the U.S. economy and consumer sentiments to recover at a mild pace. Therefore, Companhia Brasileira de Distribuicao carries a Zacks Rank #5 (Strong Sell) for the near term.

Other Stocks that Warrant a Look

Not all stocks in the supermarket retail industry are performing as poorly as Companhia Brasileira de Distribuicao. Companies that are presently doing favorable business include Ingles Markets Inc (IMKTA - Snapshot Report) and Spartan Stores Inc (SPTN - Snapshot Report), both carrying a Zacks Rank #1 (Strong Buy).

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