NEW YORK -- The world, and the food industry, have changed a lot in the decade since SN initiated its annual Financial Analysts' Roundtable.
When the event started in 1996, analysts reflected on an industry whose sales and earnings were up and whose future appeared very bright.
But the growth of Wal-Mart Stores prompted changes -- initially generating a drive by the conventional industry to become more efficient by buying better and utilizing new technologies, then pursuing mergers and acquisitions to seek synergies, then trying to integrate those acquisitions smoothly and finally learning, often the hard way, how to keep local customers satisfied by retaining the local flavor of the acquired stores.
Other changes occurred as the economy grew stronger and then weaker, with gross margins increasing and then decreasing to keep customers coming in.
The eight participants in this year's roundtable were asked to look back over the past 10 years to see how the industry's fortunes flowed and then ebbed during that period.
Their comments follow:
CHUCK CERANKOSKY: I think the prolonged economic expansion we saw during the 1990s convinced every chain that was trading its customers up that if you kept doing that, your gross margins would expand, maybe forever. At the same time operators like Winn-Dixie and Homeland represented marginal capacity that we would have liked to see go away, but it didn't. Alternative channels were building. And when the economy turned downward, the chains we now consider the most viable were suddenly faced with a very difficult period.
MARK HUSSON: I think the other thing to remember about the 1990s was American supermarkets were uniquely poor in terms of organization, inspiration and execution. Compared with Canada and the rest of the world, they are still poor, but back then they were pathetic. So what you finally saw was retailers realizing that private brand was a good thing and that it might be nice to have some technology in the store to find out what you were selling every week, and that technology investment of the early 1990s really started to pay off in the mid-1990s.
The industry was also talking about something called category management, which meant you didn't have to stock absolutely everything that anybody sought, which was a revelation for most American supermarket chains. Supermarkets also realized that if they bought a full truckload, they got a better price than they did buying by the case or for each division separately, which is what a lot of retailers had been doing. Kroger, for example, which is now a very effective centralized business, owned Dillon's, but Dillon's wasn't even consolidated and it wasn't buying manufactured goods from Kroger.
So the industry went from a position of being completely hopeless to being only half-baked, then to trading up, then to discovering how strong a competitor Wal-Mart was, which forced a structural change where it's actually been forced to look for segmentation and strategies rather than just tactics. Ten years ago, you just talked about what was in the circular, and that was really about as strategic as you got.
GARY GIBLEN: In the mid-1990s you had more food inflation and lower levels of general competitive intensity, so inflation was passed on and that was the magic bullet for profitability. Now food inflation is less, and it certainly doesn't get passed on. We also had the mega-mergers, which generally were pretty disappointing in terms of realizing the synergies and the magnitude of those synergies.
MARK WILTAMUTH: That was a big factor. We had many of these deals in the late 1990s that were going for 10 to 12 times EBITDA [earnings before interest, taxes, depreciation and amortization, or operating cash flow], and it's hard to really get to economic profits when you're paying that kind of premium on an acquisition in a low-margin industry. And I think the other big factor in the early 1990s was that Wal-Mart was kind of nowhere in food, and then by the late 1990s it was up to a 7% share, though that still wasn't enough to scare anyone. But now it's up to a 15% market share, and with sales of supermarket-related items growing to 16% and 17%, that's enough to disrupt the industry.
ANDREW WOLF: Return on invested capital was very high for this industry when these roundtables began in 1996. It went up for a while after that, and the industry was just begging for capital formation because capital goes where it can get a good return. Right now, the returns on invested capital are not terrible, and the better companies are still going to beat their hurdle rates for investing capital. The returns have just kind of normalized for some companies like Kroger. But you could see it coming as the chains basically expanded gross margins to the point where they got returns up but invited competition to step in.
CARLA CASELLA: Thinking back to consolidation back then, the answer to Wal-Mart was to expand and get as national as you could, and that led to a lot of expensive and probably stupid acquisitions being made that later triggered bankruptcies or asset divestitures or writedowns. The biggest difference today is, we're in a buyer's market, and those that are buying are buying very selectively in small markets. We see chains like Albertsons exiting where they're not strong and using that money to invest in their key markets.
HUSSON: I think Kroger's acquisition of Fred Meyer probably worked.
CASELLA: It did. I'm not saying they were all failures.
HUSSON: And ultimately you worry where Food Lion would have been if it hadn't bought Hannaford -- arguably there has been a reverse takeover of Food Lion by Hannaford management -- even though the deal hasn't generated economic value at 12 times EBITDA [the multiple Food Lion paid for Hannaford]. But what would have happened to Food Lion if it hadn't acquired Hannaford? History is an interesting thing.
The worst deals were anything Safeway did after it acquired Vons and Carr-Gottstein and some of Albertsons' acquisitions. Some of the reasons those companies screwed up was because people really didn't understand the power of the local brand. In the case of Safeway, some West Coast surfer dude showed up in Texas and started changing the private brands -- so in a state where the bumper stickers clearly say, "Don't mess with Texas," Safeway messed with Texas. And while Safeway arguably made Dominick's and Randalls better companies in terms of customer service, they weren't local anymore, and the locals rebelled against them and abandoned them in droves. We thought we had to scale back in those days, and I was a huge fan of consolidation because of the need for scale, but no one really thought to address the brand sensitivity issue then, and that's really what has disturbed a number of these deals in the way they've actually been executed.
CERANKOSKY: It was all about scale, and the merchandising disasters Mark mentioned did occur. Now we're seeing consolidation taking a much needed turn to get rid of some of this capacity -- brutally, if necessary. This is a very bad time to be selling stores, and the industry still has a lot of stores to sell in markets where more than a few chains have weak market shares but many stores to sell. I'm thinking of A&P's Farmer Jack stores in Detroit -- who wants to buy those? They're going to go for a fraction of the replacement costs.
SN: A reading of earlier roundtables comes up with a surprising amount of excitement about Wal-Mart because some thought it might make the industry more efficient, though the concerns about supercenters eventually became prominent. Why do you think there was initially excitement?
CERANKOSKY: I think the excitement came from the fact that there were some very clear efficiencies at Wal-Mart that people thought could be translated to the traditional food retailers, but without a lot of the pain of competition. The competition was clearly there, not only from Wal-Mart but also from companies like Super Target and Meijer that offer incremental capacity.
