While renewed interest in merger and acquisition activity put a little sex appeal back into supermarket stocks in 2005, old-fashioned performance-through-sales-and-earnings might have been the market's biggest story.
Solid, if not spectacular, percentage gains in the share prices of Safeway and Kroger followed gains in same-store sales and earnings for the retailers during the 2005 calendar year - performance that some analysts said signaled a positive sign for the industry overall. For Kroger, a 7.6% share-price increase reversed a loss of 5.2% during the 2004 calendar year. For Safeway, 2005's 19.9% gain represented the company's first calendar year percentage gain in five years.
"I think the market, accurately, saw the fundamentals improve for Safeway and Kroger," Andrew Wolf, analyst, BB&T capital Markets, told SN. "The fundamentals may not be unambiguously good, but they're better than they were a few years ago, when they were unambiguously bad."
Both Safeway and Kroger outperformed the SN Composite Index of 30 publicly traded food retailers and wholesalers, which fell 3.94% overall. By comparison, the Dow Jones Industrial Average fell 0.61% and the S&P 500 gained 3% on the year. In 2004, the SN Composite had gained 6%, while the S&P 500 grew 9%.
However, three out of the five largest percentage gainers for the year - not to mention many of Wall Street's biggest losers - felt the heat of a new flame of industry consolidation: Companies that made a deal, announced a deal or perhaps were believed to be close to making a deal, saw double-digit (or in the case of A&P, triple-digit) gains or losses. Albertsons, which pursued a deal only to call it off later, saw its stock swing double digits in both directions.
"It's almost like running a supermarket won't do anything for your stock price, but an outside event will," said Jonathan Ziegler, an analyst for J.M. Dutton & Associates, El Dorado, Calif. "You had companies that did better selling stores than selling groceries. It was like, if you can't do it in the real world of nickels and dimes, do it in the headlines."
In the nickel-and-dime world, analysts pointed to gains by Safeway and Kroger as evidence the market will reward hard-fought improvements in sales and earnings. Both companies, along with Albertsons, had taken a beating on Wall Street in recent years as they struggled to implement changes in the face of a retail landscape radically altered by low-price leader Wal-Mart. These changes included accepting lower margins in exchange for higher sales (Kroger), a costly brand and store-model repositioning (Safeway), and a painful strike-lockout in Southern California affecting all three companies.
While "the big three" ceded market share in Southern California as a result of the strike, in 2005 they began feeling the effects of lower labor costs and put the earnings impacts of the work stoppage behind them, Wolf said.
More importantly, he added, they gained same-store sales, which investors see as a signal of sustained or future earnings growth.
"Safeway benefited more than Kroger because their sales improved more than Kroger, going from bad to good, whereas Kroger continued same-store sales gains from the year before," Wolf said. "Safeway really got a lot of credit for their sales turnaround."
Chuck Cerankosky, analyst, KeyBank Capital Markets, Cleveland, said the Kroger and Safeway stock performance during the year was a positive sign for the industry in 2006.
"We saw a little improvement, with more to come," Cerankosky said. "Safeway and Kroger showed they could take sales, and that they were strong operators recovering from the Southern California work stoppage. Another year of solid earnings growth, buoyed by improvement in Southern California, is really going to help those two stocks."
Albertsons, in the meantime, got less credit than its peers, and management's frustration over a sluggish share price led to events that made it, at year-end, the most volatile stock in the SN Composite. Trading near $20 in late August, the company's announcement that it would seek strategic alternatives, including a possible sale of the company, shot its shares as high as $26 in September. But when a potential deal to buy the company at that price was rejected in December, Albertsons tumbled back down and it closed the year at $21.35, down 10.6% for the calendar year.
"Once they didn't sell the company, it went back to trading on fundamentals, which were worse than Kroger's and Safeway's," Wolf said.
Deal speculation - and consummation - proved better news for A&P and Pathmark.
A&P stock for the year finished up 210%, or $31.78 a share on Dec. 30 vs. $10.25 on Dec. 31, 2004. A&P was up 22% in 2004. The major event for A&P was a spectacular $1.475 billion sale of Canadian assets to Metro, announced in July. The sale allowed A&P, despite suffering stateside woes, to retire hundreds of millions in debt and have enough left over to invest in its U.S. stores.
"It was a very creative, strategic move," Wolf said. "They created a lot of shareholder value."
The deal's effects were felt on trading floors in New York and Toronto. Montreal-based Metro, which paid around 11 times the operating earnings for A&P's Canadian stores, was up 26.5%, closing at $30.50 on the year. Karim Salamatian, an analyst for BMO Nesbitt Burns, Toronto, said investors in Canada are "pricing in a fairly flawless integration of A&P," including plans to slash $60 million in costs over two years and improve in-store merchandising.
The "loser" in the A&P sale was also a winner in 2005, Salamatian noted. Stellarton, Nova Scotia-based Sobeys may have lost out on a rare opportunity to gain market share in Ontario, but kept its balance sheet clean. Investments in its own stores brought better margins and sales than Sobeys' publicly traded competitors. Sobeys was up 9.3% for the year, compared with 3.6% in 2004.
"From January to July, Sobeys stock was strong because it was expected to buy A&P Canada," Salamatian said. "The stock sold off when they didn't buy it, but it came back because it has a very under-levered balance sheet and financial flexibility. They're growing better than [competitors] Loblaw or Metro."
Pathmark was down 23.6% on a difficult 2004, but shot up 71.9% in 2005 on news that its strategic-alternative pursuit resulted in a $150 million investment by billionaire investor Ron Burkle and Yucaipa Cos. Yucaipa summarily introduced a number of new directors, a new chief executive and new merchandising initiatives, but analysts say the potential for Pathmark to be a consolidator has kept the stock price up.
Another stock seemingly benefiting from deal speculation was Spartan Stores, which gained 56.9% on the year on top of a 32% gain in 2004. In Spartan's case, pressure to share cash flow came from a New York hedge fund, which became the company's largest investor, but Spartan resisted most of its efforts and pursued its plan to continue a turnaround based on investments in stores.
"Sales and earnings in both [retail and wholesale] segments of [Spartan] have generally improved, and there is a certain amount of takeover speculation with specific investors thinking the company should be sold," Cerankosky said. "In the meantime, management, which we think has been pretty good, has been growing the company internally with the recent purchase of D&W."
Companies placed in growing niches of the retail food industry - and largely free of takeover speculation - also performed strongly in 2005. Natural/organic retailer Whole Foods was up 62.3% and Wild Oats Markets increased 37.1%. But Whole Foods was up 42% in 2004 while Wild Oats was down 31.9%.
"Whole Foods benefited from flat-out spectacular performance. They're a very well-managed company that drove the top line even as they stepped up the store development program," Cerankosky said. "They've got their niche well-defined, their operators are executing well and I think the improving economy helps them a little, too."
Wolf added that Whole Foods' positioning in the natural/organic and gourmet arenas places it "squarely in the sweet spot of all the growth in the industry." He also believes it benefited from having no real competitor in its niche, Wild Oats notwithstanding.
"Wild Oats is similar to conventional supermarkets, in that while things didn't get too good for them, they got less worse," Wolf said. "Their earnings still aren't good but their sales got better. They still need scale."
According to Cerankosky, "Wild Oats' management strengthened and maybe saved the company," and investors rewarded its sales growth in 2005.
Investors also took notice of regional companies turning in strong sales in 2005. These included Springfield, N.J.-based ShopRite operator Village Supermarket, up 62.7% on top of a 20.4% gain in 2004. Village posted sales gains on the strength of new stores in the competitive New Jersey market that was getting the better of Pathmark and A&P. Foodarama, another New Jersey-based ShopRite operator, gained 29% on the year, much after its controlling family announced it would buy back shares it did not own at a premium to its trading price.
Asheville, N.C.-based Ingles Market gained 26.3% after a 20.6% gain in 2004. Shares of Weis Markets, Sunbury, Pa., were up 11.6% for the year. Weis, as of its fiscal third quarter, had reported year-to-date comparable-store sales gains of 3.7% and a 7.7% gain in earnings per share.
Several of the largest losers in the SN Index made headlines of their own in 2005, led by distributor Nash Finch, burned by difficulties following an acquisition, and Marsh Supermarkets, which announced it was looking to sell in what analysts called a buyer's market.
Nash Finch, which was one of 2004's largest percentage gainers at 69%, tumbled 32.5% in 2005. It slashed earnings forecasts after encountering difficulty integrating two distribution centers it acquired from Roundy's.
Indianapolis-based Marsh, in the meantime, struggled to move the needle on earnings and by year-end announced it had suspended dividends and was on the selling block. "It's a company that's had some strong competitors in its face and despite having what to me looks like a good physical plant, just hasn't generated the earnings," Cerankosky said.
Disruptions resulting from internal restructuring - as well as market anxiety over a Canadian Wal-Mart invasion - kept investors away from Loblaw, Salamatian said. Shares of the Toronto-based retailer fell 21.7% in 2005 after gaining 7.8% in 2004. "They started this year embarking on some pretty significant restructuring of its supply chain, head office and general merchandise program, and it created a disruption in their ongoing operations, including sales weakness in the most recent quarter as a result of problems getting merchandise onto the shelves," Salamatian said. "Late in the year it became public knowledge that Wal-Mart was going to open some of their supercenters here in Canada, so there's more concern from discount competition on the food side, similar to what happened in the States."
Shares of Dayville, Conn.-based distributor United Natural Foods fell 15.1% in 2005, following a 73.2% gain in 2004. Analysts noted investors got skittish when its chief executive officer, Steven Townsend, resigned in November. Otherwise, United Natural showed strong performance in a growing segment of the industry.
"If [United Natural] traded only on the fundamentals, it would have had a very good year," Wolf said. "It had very solid internal sales growth."