The supermarket industry's competitive outlook is getting more complex. With consolidation gaining momentum and Wal-Mart about to unveil a supermarket-type format, retailers will be under more pressure in charting their future courses, according to participants in SN's annual Financial Analysts' Roundtable conducted in New York City.
American Stores Co. will lead to a host of integration issues and potential reassessments of some of American Stores' operations, including Acme.
Wal-Mart's scheduled launch of its 40,000-square-foot Neighborhood Market format could lead it to become an acquirer of existing retail chains and a more direct supermarket competitor.
Few merchandising opportunities are as important as home meal replacement, but supermarkets and manufacturers have a distance to go in making this concept work.
Discussing the direction of consolidation, Ed Comeau, an analyst with Donaldson Lufkin & Jenrette, New York, said, there are 35 or 40 regional operators with sales between $1 billion and $7 billion that are the most likely consolidation targets. "And if you're a family or a financial sponsor running [such a] business, it's time to partner up, sell assets, merge with someone else or do something to create value."
Debra Levin, an analyst with Morgan Stanley Dean Witter, said one of the major motivating factors for consolidation is economies of scale, citing Safeway's acquisition of Vons; Fred Meyer's purchase of Smith's Food & Drug Centers, Ralphs Grocery Co. and Quality Food Centers, and Ahold's pending purchase of Giant Food.
"In each of these instances, the companies looked at the synergies" -- including procurement, advertising, distribution, systems, administration and overhead reduction, Levin said. "They give out big numbers initially and then, down the road, they find more," she said.
Once domestic consolidation is done, "the industry has to start looking at some of the less-developed countries where there are a lot of mouths to feed and not a real organized infrastructure," said Jonathan Ziegler, a San Francisco-based analyst with Salomon Smith Barney, New York.
Wal-Mart's expected October opening of its new, smaller format is an event that holds importance for the industry, analysts said.
Levin said Wal-Mart's new format will pose a serious competitive threat. "Wal-Mart has such huge cash flow, and it will drive competition, which puts pressure on operating margins," she said.
Ted Bernstein, a high-yield analyst with Grantchester Securities, New York, said the Neighborhood Markets will pit Wal-Mart "directly against the good supermarket operators, and that will be interesting because Wal-Mart is not the best food merchandiser out there. It has a long way to go in that regard."
Mark Husson, an analyst with Merrill Lynch, New York, said he believes Wal-Mart will have to make acquisitions if it decides the new prototype is effective. "Where [else] are they going to get [additional] 40,000-square-foot units from?" he asked.
Chuck Cerankosky, an analyst with McDonald & Co., Cleveland, said that for Wal-Mart "the next logical step may be to jump-start the format's growth with an acquisition of an existing retailer."
Comeau said that Wal-Mart could recycle some of the discount-store locations it has shut down rather than make an acquisition.
"I think Wal-Mart will use the Neighborhood Market format as a means to recycle some of its older real estate that's either dark or that formerly operated under the Bud's name doing $2 million a year in volume," Comeau said.
Excerpts from the roundtable follow:
The Acquisition Road Ahead
SN: Is consolidation going to continue to accelerate?
MARK HUSSON: If you compare the United States to the rest of the world, you'll find that the United States is still relatively unconsolidated as a marketplace.
The Top 10 food retailers will account for about 39% of grocery sales after the Albertson's-American Stores deal is completed, while the Top 10 food retailers in most other world markets -- many of which are admittedly much smaller than the States -- typically account for between 70% and 90% of grocery sales in a marketplace.
Consolidation has really only existed in the United States on a regional basis up until now. But that's what used to be the case in the rest of the world.
Certainly France is not an inconsiderable market in terms of size. In 1990 there were 12 major food retailers there, and by 1995 there were six. They all just bid for each other, and there was a domino effect. The first big one goes down and then+
Try to think of this process of consolidation as if you're at a disco and it's 8:30. There are only so many people there, and only so many attractive targets, and you've got to plan your strategy. Do you go to the bar and start drinking and watch everybody else and wait, or do you make your best play right away? As the number of potential partners decreases, the more likely it is that people are going to make a play for the more attractive characters that are still out there -- a very limited supply of them. You don't want to be left alone in the bar at 11:30. And I think that's what's going to happen in this industry.
DEBRA LEVIN: One thing that is firmly embraced by the entire industry is an understanding of how significant economies of scale are in an acquisition. Economies of scale have certainly motivated a lot of acquisitions over the last year -- you've seen Safeway purchase Vons, Fred Meyer purchase Smith's, Ralphs and QFC, and Ahold moving to purchase Giant Food, and Albertson's agreeing to a merger with American Stores.
And in each one of these instances, I think, the companies looked at the synergies. They give out big numbers initially, and then down the road they find more -- more in procurement, more in advertising, more in distribution, more in systems, more in administration and overhead reduction. It's just tremendous.
So given the competitive pressures in the industry, which are not declining, I think you will definitely see more consolidation activity. I expect to see it happening among a lot of the smaller, regional chains that will look to be acquired by entities with deeper pockets, and you'll see them gobbled up.
JONATHAN ZIEGLER: Pressures are also building because of the 800-pound gorilla, Wal-Mart, which has announced plans for a 40,000-square-foot Neighborhood Market in addition to its supercenters. In addition, with no available labor in a lot of markets, it pays to grow through consolidation as opposed to organically.
The industry is over-stored anyway, so consolidation makes sense. I don't think some of these smaller regional guys have really woken up yet to the pressure of Wal-Mart, but they will. So we should see more consolidation for a period of time.
CHUCK CERANKOSKY: Consolidation should pretty much keep up with the current pace, which has been above average in the past year.
Some acquirers, like Safeway, have made their intentions very clear, while others are less vocal about it. Some matches are made in heaven, and companies with a strong balance sheet, management talent and an infrastructure in place to support growth should be going after such matches.
At the same time, some smaller regional chains in single markets without economies of scale to run multitiered distribution strategies and who can't spend money on advertising or promotions or systems like the larger companies do -- companies like Dominick's, Marsh, Eagle, Seaway Food Town and Weis -- ought to consider the advantages of partnering up with a larger organization or similar-sized chain.
We're likely to see more medium-sized mergers in the future, but lightning can strike when you least expect it, and while everyone is waiting to see what big deal the larger players are making, maybe Wal-Mart will get into the supermarket business in a bigger way through acquisition.
And there's always the potential of new foreign buyers coming into the U.S. market.
TED BERNSTEIN: This consolidation trend isn't new. It's been going on for years, but it's just now gaining momentum.
The Albertson's-American Stores deal is certainly a significant transaction. And we're going to continue to see people like Fred Meyer, Ahold, Albertson's and Safeway consolidate the industry.
The industry remains incredibly fragmented. It's a very mature industry, and so it's very, very competitive. As Debra was saying, one of the ways to alleviate that is to seek economies of scale and, in some cases, of scope.
And I think a lot of the larger regionals are prime candidates. I personally continue to believe that if anyone is going to consolidate the Northeast, Pathmark is the place to start.
In the Midwest, I would expect Dominick's to trade, and maybe some of the smaller chains, like Marsh. And in the West, perhaps Stater Bros. in southern California.
So I think this consolidation trend is going to continue -- I don't know how far into the future -- but I think it's something that certainly has to happen in this country.
ED COMEAU: I think there's one more big deal coming, and that will be a Safeway deal.
My guess is that's the only remaining big one to go, and from there on it's probably going to be $2 billion to $3 billion sales companies. So you'll see a consolidation of a lot of the smaller guys.
There are, I believe, 35 to 40 companies with sales between $1 billion and $6 billion to $7 billion, and half of them are owned by families or financial sponsors, so asset values are at very high levels. And if you're a family or a financial sponsor running a business, it's time to partner up, sell assets, merge with someone else or do something to create value at these levels.
Shaping the New Albertson's
SN: Let's talk about the announced Albertson's-American Stores deal. How do you think these companies plan to go about joining each other?
ZIEGLER: Given that it took Albertson's eight months to complete its acquisition of Buttrey, I'm wondering how long this deal is going to take before Albertson's can complete it, if the other one was so difficult.
But assuming that it gets done, there's overlap in New Mexico and California, and I've sort of penciled in 75 store closings on my model.
Beyond that, it's difficult. Albertson's has not talked at all about closing distribution centers, and I imagine that some of that has got to happen down the road.
And then the big question I have is, what happens to Acme. Albertson's has said it's going to build in the East, but I'm not sure I really believe that. LEVIN: American Stores has spent a tremendous amount of time, energy and money centralizing procurement. And Albertson's has a procurement system that it's been using for years that works very, very well and that gives it flexibility to do procurement centrally or at its distribution center. I suspect that the supermarket side of the business will maintain the Albertson's programs.
But looking at the drug store side, that's what American Stores brings new to the table. And I think Albertson's would use American's drug store systems. The pharmacy systems are certainly something that Albertson's can benefit from because American Stores has invested heavily in those systems.
In terms of overall systems integration, it will be tough, but one of the great things is that the companies have got a lead time of at least six months to really think this through before they start -- the deal is going to close early in 1999 -- so I think they'll have time to really work through some of the very big issues.
HUSSON: With year 2000 coming up, there may be a temptation for Albertson's to just slow down systems integration until the zeros have clicked over to see if there are any potential problems with various bits of the system.
And even if they do shut American Stores systems down, I foresee a period of double running anyway. That would be the most prudent thing to do.
And Debra is dead right on the pharmacy side. And American Stores also has a pharmacy benefit management business that is something Albertson's would be keen to penetrate -- something that's going to really improve Albertson's ability to compete in the third-party arena and open up a number of plants that perhaps it hasn't had access to until now on the West Coast and certainly improve their bargaining position inside those plants.
So I foresee a slow integration of the businesses. And a lot of that depends on how the two different teams get on culturally, and I guess that's a broader question.
CERANKOSKY: There's an enormous amount of due diligence that Albertson's will have to do. Albertson's is buying a very large company that operates under a variety of names, coast-to-coast, but with relatively few coast-to-coast efficiencies.
And Albertson's will have to integrate this chain with its own methods of doing things, and that's a very large project and one with significant risks along the way. But it's being done by a very good management team that will ultimately resolve any problems and difficulties it encounters.
COMEAU: I look at the acquisition in two parts. One part involves getting all the costs out as quickly as possible, and I think Albertson's will be very diligent in doing that within the first six months after the merger is completed.
And while Albertson's certainly wants to make sure it doesn't have any systems problems or glitches or any year-2000 issues, I think it will err on the side of taking costs out first, and making sure it gets at least a minimum contribution worth of synergies, which implies a pretty severe downsizing in Salt Lake City, if not a total elimination of that whole operation pretty quickly.
I don't think it'll be as fast as all the pink slips that went out at Vons when Safeway took over, but I think it'll be along those lines.
And the second part of the acquisition is, can Albertson's run the retail side of the business? American Stores has had its share of problems and continues to lag behind the rest of the industry on the food side of the business, and Albertson's has done a reasonable job of keeping in line with the industry but hasn't really solved a lot of its own sales problems, and I'm not exactly sure it's going to want to tinker initially with much of American Stores' retail operations, such as Jewel or Acme.
So I would think the first couple of years might be sort of hands-off, with Albertson's concentrating on trying to improve what it has but not really making any meaningful changes at retail.
CERANKOSKY: Both Albertson's and American Stores face similar challenges in terms of strengthening sales, so Albertson's may find solutions to both by investing more in store promotions and improving the physical plants to satisfy customer needs and wants. Beyond that, I don't think anyone knows right now what is likely to happen. Albertson's is facing some unforeseen challenges, and even aside from any FTC-ordered divestitures, it would not be surprising for Albertson's to decide it wants to sell one group of stores or another.
That may very well happen if it gets a good offer for some operation it hadn't expected to sell. For example, if someone buys Dominick's, then someone else might make an offer for Jewel. Or a group of stores Albertson's thought it would sell might have a quicker turnaround than expected and it decides to hold on to it.
We're going to have to wait a year or two for Albertson's to have a clearer picture of where it's going and a clearer picture of what other chains' needs might be at that time.
LEVIN: On the issue of store closings, I suspect Albertson's will take the opportunity to close some of the older, smaller, weaker stores that American operates. I'm thinking particularly of Acme, where Albertson's certainly has a lot of opportunity to downsize some of the operations there. It said it plans to take a sizable one-time charge, so there's no reason why it won't take the maximum in terms of getting rid of stores it doesn't want to operate longterm.
BERNSTEIN: I agree that, as far as store closures go, you might see a number of Acme stores going, because, overall, I think those are the weaker stores. In addition, a lot of what's going on in Pennsylvania right now is interesting in that Penn Traffic is trying to get rid of its Bi-Lo stores, and perhaps someone ambitious might come along and try to package the two store groups.
Assessing Acme's Future at Albertson's
SN: Is Albertson's likely to spin off any of the companies it's acquiring from American Stores?
LEVIN: I think Albertson's wants the drug chain. The drug chain was a real jewel in this whole acquisition. It will strengthen Albertson's own pharmacy business, and it's also a format it wants to expand. Albertson's sees what's going on in the drug-chain industry. There's a lot of growth there. As for keeping Acme, I think it's going to have to study the situation carefully. Acme is the problematic portion of this acquisition, just because it has so many weak stores. But I think for the near-term, Albertson's will keep investing in Acme and try to improve it.
HUSSON: I'm going to take a slightly different view of Acme. Historically, it has had a lot of weak stores in the marketplace, and if you think about what American Stores is trying to do -- although Jonathan absolutely is right, it has been glacial in terms of adding new stores -- 55% of Acme's sales are coming from the new, larger stores, so it has just about got critical mass of new stores.
But it's going to take a long time before the Acme brand is fixed, because there are still so many awful stores out there.
LEVIN: But if you close down a lot of those stores, you can all of a sudden get that percentage to jump up even higher.
ZIEGLER: But they're positive cash flow.
HUSSON: That's right. You take a dent to cash flow, and you take a loss in volume if you close them down.
ZIEGLER: And that real estate is still pretty priceless, I think. Albertson's hasn't traditionally been a central city operator that I can recall. It's been more suburban-rural, and now all of a sudden it's in Chicago and Philadelphia, so this is all new for them.
COMEAU: I think it will keep Acme. I think Albertson's may even make an acquisition and build on it. I take it at face value that that's what it's going to do.
Acme is such a small piece of the whole thing, and I think Philadelphia is a pretty attractive market longer term. So unless something goes horribly wrong with Acme in the next two years, I would think the next move is an acquisition in the area.