Takeover speculation stimulated stock activity during the first half of 1998, enabling food stocks as a group to outperform the general market, and that trend shows no signs of abating during the second half, securities analysts told SN. The SN Composite Index of 44 retail and wholesale food stocks, which includes a handful of mass merchandisers, showed prices up an average of 39.2% for the half, compared with increases of 14.4% for the Dow Jones Index and 18.4% for the Standard & Poor's 500.
Consolidation frenzy has certainly added luster to the group, said Debra Levin, an analyst with Morgan Stanley Dean Witter, New York. "The consolidations so far have enhanced stock prices, and future consolidation will continue to enhance stock prices," she said. "My sense is, the major chains are looking for their next acquisition and the smaller companies are the likely candidates. Investors see the industry benefiting from consolidation, and, as a result, stocks for companies that are involved with consolidation tend to do best."
Jonathan Ziegler, a San Francisco-based analyst with Salomon Smith Barney, New York, expressed a similar viewpoint. "If you look at supermarket stocks without regard to takeover or consolidation value, they are fairly valued but not great investments because of the tough competitive environment.
"What makes the group interesting, however, is the pressure to consolidate and strengthen individual players, and that's propelling much of the stock activity."
Chuck Cerankosky, an analyst with McDonald & Co., Cleveland, also attributed the industry's strong stock performance to the focus on consolidation, "which has caused investors to look for companies that could be acquired, and the smaller operators often appear to be the most likely candidates."
He said he expects second-half results to be heavily influenced by earnings performance. "Among larger chains, there are some names that have been mentioned more frequently in takeover speculation, and they will have to perform to meet expectations, because if earnings don't come through, then there will be some giveback of the price appreciation some of those stocks have enjoyed in the first half.
"And for investors who buy a stock because of takeover expectations, if there is no takeover, then earnings growth becomes all the more important."
Levin said she expects food-industry stocks to continue to show solid performance levels during the second half, "despite a tough environment and negligible inflation. And as more companies continue to be on the lookout for acquisitions, that should be beneficial to stock prices."
Examples of the effect of consolidation fever on stock prices abounded during the half, whether a company had been sold, could be sold, had made acquisitions or might make acquisitions:
Buttrey Food & Drug Stores Co., Great Falls, Mont., saw the price of its stock rise 33% on news of a proposed takeover by Albertson's, Boise, Idaho.
Seaway Food Town, Maumee, Ohio, did even better, with a 53% jump in its stock price, because it is considered a likely takeover candidate.
Giant Food, Landover, Md., experienced a rise of 27.2% in its stock price, because of speculation early in the year that London-based Sainsbury plc would buy a larger stake in the company than it already had and subsequently by the fact that Zaandam, Netherlands-based Ahold acquired the company.
Safeway, Pleasanton, Calif., had a gain in its stock price of 28.7% due in large part to speculation it is close to making another major acquisition.
Fred Meyer Inc., Portland, Ore., enjoyed a modest 16.8% jump in its stock price as investors took a "show-me" attitude following the acquisitions of Ralphs Grocery Co., Quality Food Centers and Smith's Food & Drug Centers over the past 12 months.
According to Cerankosky, most of the top performers during the half "were food stocks with low valuations to begin with -- mostly smaller regional chains that are not generally followed by investors -- so people looking around for companies likely to be acquired seize on some of those chains and run up the stock prices.
"And because there isn't a lot of stock outstanding at some of those companies, a little bit of trading can make a big difference in the percentage increase over a six-month period." The leaders in food stock gains during the first half of the year included Arden Group, Los Angeles (parent of Gelson's and Mayfair Markets), up 67.4%; Village Super Market, Springfield, N.J., up 57.3%; Seaway Food Town, up 53%; Carr Gottstein Foods, Anchorage, Alaska, up 49.4%; and Foodarama Supermarkets, Freehold, N.J., up 48.9%.
Two discount giants also saw their stocks undergo large percentage increases: Kmart, Troy, Mich., up 67.4%, and Wal-Mart Stores, Bentonville, Ark., up 54%.
At the lower end of first-half performers were Grand Union Co., Wayne, N.J., whose stock price fell 91.2%; Penn Traffic Co., Syracuse, N.Y., down 60%; Richfood Holdings, Richmond, Va., down 26.8%; Nash Finch Co., Minneapolis, down 20.7%; Eagle Food Centers, Milan, Ill., down 20.3%; and Smart & Final, Vernon, Calif., down 4.9%.
Looking at several stocks individually, analysts made these comments:
Seaway Food Town, with a stock price gain of 53%, which Cerankosky attributed to the company's strong fundamentals, good earnings prospects and potential takeover prospects. "It's a company with 70 stores, sales of about $630 million and a nice piece of the market in northwestern Ohio, and it would certainly prefer to proceed on its own. But in a consolidating environment, it's easier for investors to perceive Seaway as a consolidation candidate."
Carr Gottstein Foods, up 49.4% "as a result of turning in a better performance than a lot of people expected," said Ted Bernstein, a high-yield analyst with Grantchester Securities, New York. "The company has shown good margin improvements despite a slowdown in the Alaskan economy and an absence of top-line growth, and it remains a potential acquisition candidate, though the geography makes it a little difficult."
Costco Cos., Issaquah, Wash., up 41.3%. Ziegler said he considers Costco "one of the best-managed companies, and it's always looking for ways to drive sales and create excitement. Since prices are already so low, the company is able to focus on changing merchandising to draw people in. In addition, same-store sales have surprised investors and the company itself for the past two years, and with half its mix in general merchandise, the strong economy helps a lot."
Fleming Cos., Oklahoma City, up 30.7% "as it recovers from the depressed levels resulting from its past litigation problems," Bernstein said. "With those issues behind it, Fleming appears to have gone through a strategic rethinking of its re-engineering program and made its pricing somewhat more palatable to customers."
Safeway, with a stock gain of 28.7% for the half. According to Ziegler, "Safeway is viewed as a core holding. If people want to participate in a supermarket investment, they often look to Safeway first because of its strong management, strong sales momentum and the belief it will announce another acquisition soon that will be incremental."
Cerankosky said Safeway's recent performance "has not been all that remarkable," noting that the stock performed well in 1997, reflecting substantial benefits from its acquisition of Vons Cos., "but now it needs another catalyst to give it a boost, and investors are waiting for the next acquisition."
Ahold USA, Atlanta, up 22.5%. "Ahold is benefiting from consolidation and from its re-engineering efforts in the United States, and the stock price reflects that and the anticipated benefits from the Giant Food acquisition," Levin said.
According to Ziegler, "Ahold is a company that has shown a great amount of prescience in building a strong base for the future, both in the United States and globally. The common stock offering it had earlier in the year drew attention to the stock, and its acquisition of Giant Food dovetails beautifully with its existing holdings."
Dominick's Supermarkets, up 22.1%, "probably because of speculative activity of a takeover, since its performance this year has been lackluster due to problems stemming from the conversion of the Omni stores [to Dominick's Fresh format]," Ziegler said. "Dominick's has the No. 2 market share in a major market, Chicago, and it's a one-market chain, which is a desirable characteristic in a takeover." Levin said Dominick's "stumbled a bit" during the second quarter as it converted the Omnis, "but the company is back on track, and it's benefiting from the strong square-footage growth and improved profitability that's resulting from better procurement and the sharing of best practices with other Yucaipa-related companies."
Food Lion, Salisbury, N.C., up 22%, "is still a screamingly good value," Ziegler said. "The company had strong comparable-store sales in the first and second quarters, and it's delivered the numbers, and more people have taken an interest and climbed aboard."
American Stores Co., Salt Lake City, up 17.6%. According to Cerankosky, American has recovered from its earnings disappointments of 1997 "and has met expectations year-to-date, but there's a little bit of speculation among investors that the company could be acquired or broken into pieces and sold, and that's influencing the stock price."
Levin said the stock price has been affected by the company's performance, which continued to show negative earnings through the first half, leading to persistent trade reports that the company might be for sale. "American's weak earnings translates into a lower-than-average price-earnings ratio, which fuels reports that it might be ripe for the picking," she said.
Ziegler noted that American's individual assets "are pretty attractive, given that Jewel and Acme have the No. 1 market shares in Chicago and Philadelphia, respectively, and Lucky Stores does very well in California."
He characterized American as "a volatile stock that's disappointed investors and management because of soft same-store food sales and expectations that the Delta re-engineering program would drive earnings, which has not happened."
Fred Meyer Inc., up 16.8%. The stock outperformed the market dramatically last year, Ziegler said, "but so far this year, its gain has been more moderate because of a lot of uncertainty about bringing together the various acquired chains in different markets, so the company has to build credibility -- and it will, at which point the stock will perform better."
Levin said Fred Meyer has benefited from the Smith's acquisition last year and the Ralphs-QFC acquisitions this year, "but the stock is up less than the market, which indicates it has gotten a little ahead of itself and it still has not established a price base."
Winn-Dixie Stores, Jacksonville, Fla., up 16.7%. Levin said the company had a lackluster performance in sales during the first half "as it continues to fight difficult sales trends while not yet realizing the benefits of its investments in newer stores."
Kroger Co., Cincinnati, up 16.7%. Levin said the company is benefiting from positive though moderate same-store sales gains and from its investments in new stores, distribution systems and technology.
According to Cerankosky, Kroger stock experienced a run-up earlier in the half and then backed off, possibly on a flurry of rumors that have surfaced involving Kroger as either an acquirer or an acquiree.
A&P, Montvale, N.J., up 12%. According to Levin, A&P has been generating weak results recently "because it's faced a number of competitive markets. And although it's just starting under Christian Haub's leadership, it has put new strategies in place that are already showing positive results in terms of improved earnings."
Albertson's, Boise, Idaho, up 9.7% -- a modest increase in the stock price, Levin pointed out, because the company was up against tough comparisons during the half because of a fast jump in the stock price a year earlier.
Cerankosky said Albertson's has seen its stock price rise and fall during the half, depending on the direction of same-store sales comparisons. "Comps have clearly improved, which has helped the stock price recover from early in the half, and the market views Albertson's favorably because of its acquisitions of Buttrey and other smaller companies."
Marsh Supermarkets, Indianapolis, up 9.1%, which Cerankosky said he attributes to a recovery in its earnings "as investors have started to become more comfortable with it." Bernstein said investors have been encouraged by "the admirable job Marsh has done fighting off new competitive openings by Meijer and others in Indianapolis. The company has an appealing format and a lot of goodwill built up in the community, and it continues to show solid results -- and it is ultimately an acquisition candidate."
Supervalu, Minneapolis, up 6%. "That's a company with strong management," Ziegler said, "and, in a very mature industry, it's starting to deliver strong numbers." Cerankosky said Supervalu, like other wholesalers, is a more complicated company for many investors to understand "because of its orientation toward logistics execution, compared with a pure food retailer."
Ruddick Corp., parent company of Harris Teeter, Charlotte, N.C., whose stock price rose 3.9%. "People are watching this stock," Cerankosky said, "because there was talk of a spinoff of Harris Teeter earlier in the year, but the stock price was hurt later by the impact on Ruddick's thread business of the economic turmoil in Asia."
Hannaford Bros., Scarborough, Maine, up 1.3% because of the effect of the chain's home-delivery service on earnings (10 cents per share), tough competition in the Southeast and the expectation that the increasing presence of Wal-Mart supercenters in the Northeast is likely to have a strong effect, Levin said. Cerankosky said Hannaford finished 1997 in strong fashion, "but investors looking ahead overlooked the trials and tribulations of starting the Home Runs program."
Homeland Stores, Oklahoma City, unchanged. "There's a lot of uncertainty among investors over Homeland because it's small and under-followed," Bernstein said. "It's experienced same-store sales declines and margins have fallen somewhat, but it's been able to maintain a relatively flat performance."
Smart & Final Co., down 4.9%. "It's been a disappointing stock, with disappointing earnings," Ziegler said. "It's had problems with its acquisition in Florida, and I think Costco has gotten so good in California that it's been tough for Smart & Final to generate sales."
According to Cerankosky, Smart & Final experienced "continual deterioration in Florida last year that has been slow in recovering, and its comparable sales in southern California have been weak, which raises questions about its ability to re-ignite its growth, especially since it targets the food-away-from- home market."
Eagle Food Centers, down 20.3% "because of terrific competitive inroads, which are pressuring sales and earnings growth," Cerankosky said. According to Bernstein, competitive encroachments against Eagle have resulted in negative same-store sales and margin erosion, "and the company has been rumored to be on the block for quite some time, though it doesn't look like anything will happen anytime soon.
"Eagle management has done a great job bringing the company back from the near-death experience of a couple of years ago. But the decision to make a relatively significant push toward Chicago is a gamble that will require a big dollar investment, and it's uncertain whether that will help Eagle's results or make it more attractive to a potential acquirer."
Nash Finch Co., down 20.7% after experiencing relative softness on both the wholesale and retail ends of its business, Bernstein said. The hiring of Ron Marshall as chairman and chief executive officer should re-energize the company, he said, though that isn't yet reflected in the stock's performance.
Richfood Holdings, down 26.8%., which Ziegler said was due to Ahold's acquisition of Giant Food. "Giant Food of Carlisle, Pa., has been a Richfood customer, while Giant of Landover [Md.] has been self-distributing, and there's some investor concern that Richfood may lose the business of Giant of Carlisle," Ziegler explained.
Penn Traffic Co., down 59.9%, "as the company continues to struggle with a declining market share and still-negative same-store sales comparisons, although the losses have moderated somewhat," Levin said.
Cerankosky said the company has "major top-line challenges, as decreasing revenues create margin pressures that result in earnings disappointments."
According to Bernstein, Penn Traffic stock has been under pressure as a result of continued weakness in its operating results, with significant deterioration in same-store sales over several quarters. "And although management has achieved some cost savings over the last year to 18 months, it still faces significant problems with ongoing sales erosion," he said.
Grand Union Co., down 91.2%, "because when a company files for bankruptcy, as Grand Union has, its stock is typically worthless," one analyst said.
