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INVESTORS CAUTIOUS FOLLOWING SHARE PRICE SLIDES

Most publicly traded food-retail stocks posted double-digit declines in 2002 as investors abandoned a sector that in the past was viewed as a defense in bad economic times.The SN Composite Index, which tracks shares of 33 food-retail and wholesale companies, turned in its worst performance in a decade in 2002 as only eight companies posted gains. Even alternate-format retailers posing major competitive

Most publicly traded food-retail stocks posted double-digit declines in 2002 as investors abandoned a sector that in the past was viewed as a defense in bad economic times.

The SN Composite Index, which tracks shares of 33 food-retail and wholesale companies, turned in its worst performance in a decade in 2002 as only eight companies posted gains. Even alternate-format retailers posing major competitive challenges to supermarkets had trouble in the stock market last year. The few shares that performed well were from companies that don't reflect the mainstream U.S. business, including natural food-oriented retailers and Canadian distributors.

Financial analysts told SN they are taking a cautious stance for the new year regarding how fast the anemic economic environment in food retailing will improve.

"Nobody can predict when the fundamental problems will change," said Gary Giblen, senior vice president, director of research for C L King Associates, New York. "All the negatives and industry factors are going to be there for the first half of year. As soon as there is some light at the end of the tunnel that industry factors are improving, then some stocks will perform a lot better. At this point, supermarket investors have to be long-term disciplined and have thick skins."

Analysts are monitoring where inflation, interest rates and food prices are headed. They also believe that passage of an economic stimulus package can help jump-start the economy.

"I think it's important that we see a tax cut in 2003," said Chuck Cerankosky, managing director, McDonald & Co. Cleveland. "Fiscal stimulus is much preferred over a monetary policy."

Some analysts wondered if investors will return to the food sector anytime soon given the fact that some companies like Nash Finch have yet to resolve their issues with the Securities and Exchange Commission.

Said Meredith Adler, analyst, Lehman Bros., New York, "For small-cap stocks especially, there isn't a lot of interest. Then people hear about SEC issues, they sell the stock and it's very hard to get anybody to pay attention again.

"My feeling is the economy will start to move up slowly. I am not expecting an immediate rebound. I think we hit bottom," Adler said.

There were a few surprises on SN's composite in 2002. Several Canadian companies -- North West Co., Sobeys and Loblaw Cos. -- surfaced among the top stock gainers. Natural food retailers were also up. Whole Foods, in particular, proved recession-resistant to the conventional supermarkets and alternative retailers. There may even be some lessons to be learned from this year's few gainers, said analysts, as to protecting business in the face of difficult times.

Each week SN tracks prices and performance of the publicly traded food-retailing and wholesaler stocks. The SN Composite Index takes into account share price and number of shares outstanding of the listed stocks. The positive showing by Canadian shares did not surprise some observers.

"The market is different in Canada than the U.S.," noted Bill Chisholm, vice president of Dundee Securities, Toronto. As a consolidated market, most Canadian food retailers have been able to protect themselves from encroaching competition by developing multiple retail formats, especially in the discount channel. This has allowed many Canadian food operators to convert properties located in areas that were no longer economically viable into viable discount formats, Chisholm explained (see related story on Page 33). Chisholm said U.S. food retailers can learn lessons from their Canadian neighbors in protecting market share. He cited A&P's expansion of its Canadian Food Basics format into the U.S. market as an attempt to do what many Canadian retailers have done.

Natural food retailers -- Whole Foods and Wild Oats -- benefited by being outside the mainstream food-retail sector. Throughout the recession, Wild Oats was able to produce 10% comp-store sales, said Andrew Wolf, an analyst with BB&T Capital Markets, Richmond, Va. "Natural foods is the only retail sector that I've ever seen that turned out to be recession-resistant, and traditional food retailers turned out not to be," said Wolf. The reason, according to Wolf, is a large demographic shift of consumers concerned about their health and the food they eat. Much of Whole Foods' gains came from the retailer's ability to capture new shoppers. Also, natural food retailers didn't experience the trading down that took place at conventional supermarkets, said Wolf.

Most of the 25 companies that reported losses saw their stock prices fall off precipitously, dropping double digits. Even stock prices of the alternative formats that had been performing strongly and cutting into conventional supermarkets' food sales wound up in the negative.

The SN Composite, down 22.06%, turned in the worst year in a decade. However, the food sector was not alone. The Dow fell 16.8%, the worst percentage decline since 1977. The S&P was off 23.3%, the steepest decline since 1974. Every sector on the S&P from consumer staples to information technology showed declines.

A series of events, both external and company-specific, worked to compound an already-difficult operating environment in 2002, which only got worse by the end of the year.

The external factors that put pressure on the sector were:

The poor economy, shadowed by a recession that began in March 2001, continued to cast a pall over consumer spending. By the end of the year, the slowdown had its effect on food retailers with drops in same-store sales, missed guidance figures and complaints of continued trading down by consumers.

Deflation squeezed already-low food-retail margins and compressed sales and earnings. Consumer confidence again fell off four points in December to 80.3, following what was a mostly depressed index throughout the year. Rising unemployment, a discouraging job outlook and weak holiday retail sales were reasons cited for the latest decline.

Competition really heated up in 2002 as supermarkets resorted to pricing wars to maintain their market share from further erosion by Wal-Mart and other alternative players. The economy and Wal-Mart hit the leading supermarkets hard, said Adler. "The market saw the impact the economy was having, but believed it was Wal-Mart causing the weakness. By end of year, however, as Wal-Mart's food sales also weakened, investors started to recognize the impact the economy was having at the same time [food sector] stocks had gotten to a much lower level."

It turned out to be a year were few escaped deterioration of their stock prices. Even the alternative players saw trading down among their clientele, said analysts. "In 2002, consumers were very cautious. They weren't just grabbing another high priced item. General merchandise was not being bought up as aggressively as in the past. Even in core Wal-Mart discount stores, there was trading down as well," said Cerankosky. Looking at the gainers and losers on the SN Composite, analysts assessed some of the factors that affected individual companies.

NORTH WEST CO., Winnipeg, Canada, up 28.1% -- a company most U.S. analysts have not even heard of.

"It's unique," said Perry Caicco, CIBC World Markets, Toronto. "There is almost nothing like it in world." North West provides both food and general merchandise to the extreme northern markets in Canada and Alaska, reaching north of the Arctic Circle. Said Giblen, "That's the only place [where] there are no price wars." North West faces little, if any, competition. However, the retailer, which does about 35% to 40% of its sales in food, is expanding with a new discount format -- Giant Tiger -- in western Canada, said Chisholm. "It's almost like dollar general stores that sell food. The market is optimistic they can roll them out. They opened two stores in 2001 and a third in 2002. Four or five more are expected this year."

SOBEYS, Nova Scotia, up 24.2% -- is beginning to benefit from the acquisition of a national company it bought in 1999. "It's basically a turnaround company," said Caicco.

Chisholm said new management that came in two years ago is spending money and upgrading the store base. "It's paying off for them. Their margins are still low by industry standards, but still there is room for margin growth," he added.

WHOLE FOODS, up 21% -- was outside the loop when it came to the economy. "Whole Foods executed extremely well and clearly segmented their format away from everybody else towards a very upscale shopping experience, not only in terms of the quality of products but the lifestyle message they are sending," said Cerankosky.

Said Wolf, "Whole Foods is building bigger stores and attracting more people and from a broader base."

"Whole Foods didn't change sales guidance. They didn't worry about the competitive outlook from Wal-Mart. They didn't have any food-price issues. They had their own sourcing, and they didn't suffer from deflation," commented Adler.

WEIS MARKETS, up 11% -- was attractive because of its dividend yield.

Said Giblen, "Weis has been viewed as a big takeover candidate, and it had a 3.5% dividend yield at a time of lower interest. Not many supermarkets have dividends. The combination of perceived takeover, dividends and operationally they didn't blow up provided them with modest performance."

WINN-DIXIE, up 7.2% -- surpassed expectations and proved to be a true turnaround company.

"Winn-Dixie is a turnaround, and they demonstrated progress this year. They are starting to reap the benefits of centralized procurement instituted several years ago. Their loyalty card was the most important thing because it has been successful in getting customers back into the stores and driving sales," said Adler.

Giblen said, "They were able to take advantage of the disarray of some key competitors and have done pretty well as a turnaround company from low expectations by the market."

WILD OATS, up 3.9% -- not only benefited as a natural food retailer but turned in a dramatic turnaround. "Wild Oats was headed into bankruptcy, and when it started doing quite well in a turnaround and making positive earnings, it forced the street to reassess the company," said Giblen.

SPARTAN STORES, down 87.3% -- the company suffered in a very competitive market. Said Cerankosky, "They were caught in battle between A&P and Kroger in the Detroit-Toledo corridor. Kroger is being very competitive, and Spartan has a great percentage of retail facilities in that general market area." Adler noted that it's a market where the economy has been unusually bad.

PATHMARK, down 79.4% -- the company was vulnerable in a heated competitive-price battle in the New York metro region. "It was a combination," said Giblen, "of top management taking its eye off the ball and the competitive environment lead by ShopRite that caused it to be vulnerable. I have some hope they will do better with new focused management"

NASH FINCH, down 75.1% -- on top of internal problems, they were hit by the economy. "They have thin operating margins and SEC issues plaguing them that haven't been resolved yet. That has compounded everything," said Adler.

A&P, down 66.1% -- disappointed as a turnaround story. According to Giblen, "Again there were high expectations for A&P. It was being recommended as a long turnaround. Instead, A&P melted down. There was management turnover [and] accounting issues that raised uncertainty. The company fired its auditors. The company became a falling knife." DELHAIZE AMERICA, down 64.8% -- could have been hurt by its international structure. Besides disappointing sales, it is a highly leveraged company, Adler pointed out. "Their structure hurts them as a U.S. company that trades overseas. It's an overseas stock and it's really hard for U.S. investors to get comfortable with the stock and overseas investors to get comfortable with what's happening in U.S."

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