Kroger has been focusing heavily on capital expenditures, among other areas. What is Kroger's outlook?
ms like supercenters don't affect them too much, it has affected Kroger. They are still going to have supercenter [competition] continually grow, [yet] every year you are going to have more stores recovering. So it will be like a bomb blasting over Arkansas. Every year, the circumference of the [Kroger] stores that are hit gets wider. More and more stores are being hit, but more and more stores are recovering. Kroger is in its being-hit and recovering phase, and will be like that for the next couple of years. I'm not sure EBITDA growth will stop. That is not to say the fundamentals of their business are not improving.
Levin: One of the positives of Kroger is that it can be viewed as [a leveraged buyout] that worked, even though it truly was never an LBO. It was a public LBO. It is a company that has really taken to heart and understands that financial returns are crucial to long-term success. They have figured out how to build a new store that is very effective. They have figured out how to effectively compete with the supercenters. In fact, I would argue that even though the supercenters are going to be there for Kroger, they are going to start seeing a diminishing number of supercenters competing against them every year. That's a positive. They'll still see a very competitive landscape as other operators expand. They will also have some cannibalization themselves with an aggressive [expansion] program.
During the second quarter of this year, you'll see [Kroger] start to benefit significantly from the distribution consolidation they have been investing in for the last few years. There is a lot more that they can do with category management and improving the efficiencies and systems throughout the whole chain. They are getting better at getting different divisions to communicate effectively. They are figuring out what the best practices are, and getting those best practices off the ground.
Giblen: There are a couple of strengths we haven't addressed. Private label is one. They have one of the highest mixes in private label. They make at least half -- or maybe more like two-thirds -- of it themselves. It's a very well-established private label and has a high quality acceptance from the consumer.
Another thing is labor. Yes, they compete in some nonunion markets. But they are also averaging down their labor costs because now they have two-tier labor union contracts in those markets. If you are generating good same-store sales or building new stores, you are adding lower-cost labor. There is a potential here for Kroger to leverage their SG&A [selling, general and administrative expenses] structure as they average down their labor costs.
Ziegler: Kroger is experimental. They are combining the best of the regional and local operators. They are taking the best of being a national chain and backing it with logistics. They have a long way to go in taking the basis points out of the business. They are trying to do front-end merchandising -- ahead of everybody else -- and looking at what works and what doesn't work.
I am particularly keen in what they are doing in Atlanta. They are doing impressive merchandising experiments down there. Not all of this will come out chainwide, but at least they are doing it market-by-market. They are taking advantage of combining local attitude with a national distribution. They are taking the best of both and making them come together.
Comeau: The two observations I had with [Kroger] over the years is they probably have taken decentralization a little too far and still suffer from that. The second thing is that the company strives to moderately keep a conservative budget every year, and doesn't do too much better than that. They are hitting numbers eight or nine quarters in a row and beating estimates. I don't know if they are going to allow their earnings to grow at a faster rate; they should.
They should be a far more profitable company than they are today, based on their store base, market share, regional management and the regional economies they operate in. I don't have any good reason why they are not. Supercenters are a factor, but supercenters are also a factor for Albertson's and others.
AMERICAN STORES
What about American Stores? Their procurement program is drawing great interest, and their capital expenditures have been strong. What is their outlook?
Giblen: I think they have a very bright future. They are doing two things. One, they started spending at a competitive level in capital expenditures a few years ago. So the benefits of that are kicking in now. This is a company that had been spending 1% of sales for many years, which is barely enough to replace a leaky freezer case -- never mind maintain a competitive store base. Now they are spending upwards of 4%, which is a good, healthy amount. And two, the corporate level re-engineering, which is going on now, should produce benefits in late '96 or early '97.
The basic fact is they [American] had totally uncoordinated regional operations, which they acquired separately instead of all at once. Now they are achieving that coordination.
Husson: They have gone from the least coordinated operation to aiming to be the most coordinated large retail operation. That is a huge leap. No one has ever done that before. There is no blueprint for that to happen. They are feeling their way, to a certain extent. They have a reputation for getting there in the end and doing it in a more integrated way.
I think American Stores' story is the bravest story out there. Maybe it's the most foolhardy, but who knows. I think certainly it is the bravest and most optimistic. You sort of have to salute their courage.
Comeau: They have become a much more professionally managed company. The way they were managed before was basically as a holding company. It's wonderful what they are doing, and they should be commended. But they realize that they have taken some missteps in coordinating and centralizing procurement. They are doing dry grocery right now, and dry grocery is one of the most difficult areas to coordinate. It's the bulk of your business. As Mark [Husson] points out, they are going from the most disorganized to the most organized, which is a pretty bold step.
Levin: When I look at American Stores, I think it's going to take a while for everything to come together. The idea behind the re-engineering program is terrific. But it's going to be the second half of '97 before we see anything really powerful come through from the investment and the merchandising.
What I worry about is [American Stores] going on tangents. Why do they have two [fresh-format] stores in Utah? Why did they start the warehouse operation in California? They are not as focused a company, I would argue, as some of the other companies, like Albertson's. There is this huge potential for [American Stores] longer term, but it is going to take a while before everything comes together for the company.
SAFEWAY
Let's turn to Safeway. We talked about how their turnaround has been quite remarkable. Of course, the latest news on Safeway has been very much on the labor front, but they have put most of that behind them. What's Safeway's outlook?
Giblen: Safeway is really the best company in the industry, by any benchmark. They will continue to beat that. I have spent a lot of time visiting divisions, and I would say there are clearly some divisions that are less-developed than others. That tells you there is a long way to go. The question is how much more can they accomplish?
We have seen that they have been effectively implementing category management, which should produce dramatically better numbers. Then there are certain operating divisions that are not up to snuff. It's only logical that that would be the case. The divisions that are further from Oakland, where they have less dominant market share, have developed more slowly. But they are turning the cycle. In the second leg, there are increased capital expenditures for new stores and major remodels. Labor, I think, is one negative among a sea of positives, but it's a pretty minor negative. It shouldn't be a big deal.
Ziegler: Plus they have good news with labor in the East with the resolution of the distribution [workers contract], which worked out the way they wanted it to.
Husson: Considering how much labor matters, it's amazing how little labor matters for Safeway.
Ziegler: Steve Burd [Safeway's CEO] did a remarkable job with labor, and maybe that is why things are OK. But under the old management, I don't even think labor was considered. [Burd] went up to the Alaska stores. He goes out to the stores and brings labor into the act and has them participate in what's going on. I think that is what Vons is copying. You have the whole program of getting labor into the decision-making process and seeing what [workers] are doing on the front lines. That can make the whole process more efficient. But it does make it much more participatory. That is great for employee morale. You can tell the difference in the stores, compared to before he came in.
Vineberg: Well, they practice a certain kind of brinksmanship in a lot of these labor negotiations that worked pretty well until British Columbia. I don't know what they got out of that situation except that they're losing a lot of money in the extension of the existing labor contract. You look at some of the serious strikes that have taken place in this industry over the last couple of years -- northern California, Denver, British Columbia -- and they have all involved Safeway in one way or another. They are doing a lot of people a favor by practicing this brinksmanship and partnering with other people to try to rationalize some of the inequalities that exist in these markets. They are favored over [a company] like Kroger, which again has to compete with a lot of the Publixes of the world and a lot of the other nonunion operators in those Southern markets.
Comeau: I think [Safeway is] the only big company out there that has an appetite to buy struggling, underperforming, poorly managed companies.
AHOLD
Ahold has made a lot of moves recently, including the acquisition of Stop & Shop and a realignment of banners and executives in various U.S. markets. What is the outlook for its pursuits in the United States?
Levin: I think that just reinforces the pursuit of synergies. They are essentially consolidating and taking out one of the divisional offices. They are going to use their advertising revenues, I think, in a very smart fashion. They will have one trade name per area. What happens to Edwards in the long term, as a trade name or a franchise, sounds like it could be a bit of question mark.
Is there a sense of what Ahold's next acquisition could be?
Levin: They want to get larger. For long-term growth, the company is focused on the Far East. They will look for opportunistic acquisitions in the United States, but not necessarily as large as the Stop & Shop acquisition.
Husson: [Ahold] said they have three companies in their sights already that have between $1 billion and $3 billion in sales.
Comeau:: They have their work cut out for them in the next one or two years before they'll want to do anything in terms of a sizable acquisition. They are opportunistic, but I think they'll prefer to take a breather for one or two years before they'll do anything sizable.
Giblen: I would second that. Absorbing Stop & Shop will be challenging because Stop & Shop itself was experiencing a change in its competitive situation. Stop & Shop is under pressure. They have to absorb that, and they have to absorb the acquisitions Stop & Shop has done with Purity and Melmarkets [a Foodtown chain]. [Melmarkets] is particularly tough because it is a unique operation. You have people in Long Island, N.Y., that were first dealing with Stop & Shop, and now it's going to be Edwards. It's going to be a long time before Melmarkets is functioning smoothly.
In the long term, Ahold will pull off a terrific growth strategy. I think you make the acquisitions and then you have to go through an awkward period of absorbing them. Red Food was an example of that. It's working better now, but it was a little painful for them before.
Comeau: The strategy of having Stop & Shop not operating in New Jersey and Long Island, I don't know if I fully agree with that. It's hard to believe Edwards is the right format for New Jersey and Long Island and that Stop & Shop won't fit into that strategy. I would say Stop & Shop should be a dominant piece of this Northeast territory, and [Ahold] should take responsibility for it to grow rather than limit it to New England.
Vineberg: They have a lot to do here to rationalize their U.S. operations. It's going to be easier to do it in the North. The Southern operations are going to be more problematic, primarily for competitive reasons.
Levin: Ahold has done a tremendous job in terms of the distribution in the Netherlands, but they still can't translate that over here because of the logistics and the store size. They are at the beginning of this huge synergy program that a lot of other companies like Kroger, Safeway and American Stores have well under way. [Ahold is] just in the process now. They just established a task force, but it will take some time to execute. Bringing in a top-notch management like Stop & Shop should help that effort.
Vineberg: I think Ahold realizes there are big structural differences between markets, but they approached it in too much of a piecemeal fashion. They learned that buying [chains] like Finast and Mayfair is not going to get them anywhere in the U.S. market. They are pretty quick learners about this market, and they obviously changed their strategy appropriately. But they have a long way to go.
ALBERTSON'S
Albertson's has been aggressive with customer service and other initiatives. What is their outlook?
Levin: Albertson's is one company that has done a tremendous job in being consistent. They have one of the strongest EBITDA margins in the industry. They are still looking for more efficiencies. But Albertson's focuses on top-line growth, and that is why they put so much energy into new store programs. Their store square footage should be growing 8% or 9% annually. If they have the opportunity to push it a little higher, I think they'll take it.
Ziegler: I sort of describe them as a glorified Food Lion in that they are really focused on keeping the labor [costs] down, [selling, general and administrative expenses] down and doing huge volumes per store as opposed to going for market share. They got hurt a little bit when Safeway came back to life and started taking share in the Northwest and Colorado.
They are looking at their business differently. They are putting more labor into the stores now. Their home-meal replacement program is in southern California, where they tested it. Evidently, it was successful enough that they are now rolling it out. I think they are accelerating it because they are going to have it chainwide by the end of this year, which I think will raise [comparable-store sales] next year. But it's going to put a little more cost in as they add labor at the store level to execute that program.
They still seem to be the most conservative operator I follow in terms of not making acquisitions. The last major [acquisition they did] was in '92 and, frankly, they killed those stores.
Giblen: They are getting less conservative. They just made significant management changes at the end of '95. Dick King [president and chief operating officer] is a whole different kind of person than their prior number two [executive]. You can see the changes in terms of the mixture of everyday-low and high-low [pricing]. There is more focus on getting new stores up and running and ramping up their profitability faster. They are pretty much below average in penetration of private label compared to the other good chains. That is a huge margin driver.
I also think they are going to look more closely at acquisitions. There are some obvious ones that have gone by the wayside and they did not choose to do. But my impression is that management is somewhat chastened by the realization that they have let some opportunities slip by.
Husson: Albertson's has gotten to be the best by being second- or third-best at everything and not by being the best at any single thing. The one thing that helped them historically was the fact that it was a family-run or quasi-family-run business. They didn't go into the massive bouts of decentralization and regionalization that some of the other retail chains went through. They are missing the boat to a certain extent on things like systems. Private brand was always very slow, and self-distribution has been somewhat slow, too.
Vineberg: I disagree with just about all of that. There really is very little in the way of weakness at Albertson's. Their assets are tremendous. Their store base is modern. Their geography is good. Their infrastructure is good. They should be a much bigger company than they are. I think they are facing the structural challenge. This management team could be running a $25 billion or $30 billion business.
The problem is getting there, and they could get there by acquisition. They clearly have the financial capacity to do that. But as Wal-Mart, Home Depot and every great grocery operator in the United States has learned, you don't build a great franchise by buying other people's bad real estate. And there is not a lot of good stuff out there to buy. [Albertson's] wants to build their own stores and control the integrity of the asset base. The big problem for them is getting from 3% national market share to 6% market share in an industry that has structural barriers to consolidation, that favors smaller and neighborhood operators, and where the overall population is not growing that fast.
VONS
Vons reported strong results for the second quarter and first half. What is ahead for them?
Levin: Vons now is doing everything right. If you look at their same-store sales gain of 7.1%, it reminds you of the good old days when there was some inflation. The private label is helping, but they are just running much better stores. And they have improved the merchandising and product mix.
Ziegler: They are also a leader in their frequent shopper program. Every time I talk to them, they have some new example of how they are using the program to rationalize making a sale, getting the average transaction up and making it a more profitable transaction. They also have reduced ad pages. It has been a really rational [program] coupled with the fact that everyone is waking up to the fact that southern California is alive again and in a very dynamic economy.
Giblen: I don't think of it as a very favorable competitive position. Structurally, I always felt southern California was kind of an average competitive field. If you make a mistake you'll get trounced, but there are all of three operators there -- Ralphs, Luckys and Vons -- that have been there for some time. So it is not really that competitive.
Vineberg: Vons tied a lot of the right strategies with perfect timing. I think their sales per square foot now is probably lower than it was a few years ago, and there probably is an upside to that. All the planets are lining up perfectly for them right now. But they are still a regional operator, and it's still an unstable market. And I wouldn't expect Lucky and Ralphs to continually give up share the way they have.
Food Lion has launched numerous growth programs. How is their comeback going?
Ziegler: Food Lion is another interesting chain. They were low, and now they are really coming back. Their [comparable store sales] are leading the South right now. You learn from the mistakes you have made, and they learned.
Vineberg: They may have learned, but there are serious questions about Food Lion's future and whether it has successfully reinvented itself. Everybody would agree that Food Lion is not the company that was a great growth company for 20 or 25 years. It doesn't have that kind of future ahead of it.
Levin: Nobody can grow 20% anymore. That is just too much. It's the companies that really overextended themselves that got into trouble. Companies now have adopted a more realistic growth strategy, where you are looking to expand square footage 5% to 10%. Food Lion is experimenting with some stores and looking at what they can do with perishables. They have become more focused and more savvy about their merchandising.
Ziegler: They are not adding a lot of units but are adding square footage to existing areas, which will be much more productive. Even though their margins are high, they will go higher. They are a leader in home-meal replacement programs, which they are rolling out and can play it effectively with their smaller, conveniently located stores. It is a well-designed concept for meal replacement.
Giblen: Food Lion is the strictly defensive catch-up story. They are better now, but you have excellent operators in the Southeast. They totally have to reinvent the company. Their own customers have told them that. They have to spend a lot of money and reinvent the company.
