Food distribution companies in many sections of the country should benefit from improvements in the economy, and from a return of modest inflation during the second half of 1994, according to securities analysts interviewed by SN.
But they also pointed out that improving economies could signal a new round of heated competition in more prosperous markets as alternative-format operators, such as Wal-Mart Stores and Kmart, see new opportunities to expand their supercenters, and as Meijer seeks additional locations for its hyperstores.
Excluding California and parts of the Northeast, analysts anticipate that strong, steady economic trends will boost supermarket sales through the balance of the year. Profits should also benefit because of the efficiency practices operators put into effect during the recession.
"Most companies have come to accept the fact that inflation won't exist in any substantial amount, and they must therefore run their businesses and improve profits without inflation," said Debra Levin, a principal at Morgan Stanley, New York.
According to Ed Comeau, senior vice president at Lehman Bros., New York, "Companies have done a terrific job during the first half managing expenses, and to the degree that the pressure of deflation is lifted, we should see better performances from most companies in the second half."
The big question surrounding inflation is how much the Federal Reserve will step in to control any upward movement. "It's very important for the industry to be able to have some moderate inflation in selling prices, but the Fed has tried to control inflationary pressures," said Jonathan Ziegler, vice president of Salomon Bros., New York.
One of the hottest battlegrounds in the next few months, analysts predict, could be the Midwest as Meijer, Grand Rapids, Mich., rolls out its big stores into additional markets.
"For many Midwest operators, it will feel like they're experiencing deja vu from the time Cub entered several Midwestern markets in the early 1980s," said Gary Giblen, first vice president at PaineWebber, New York.
The city most often mentioned as one of Meijer's expansion sites is Indianapolis, where Meijer and Kroger will face off, Giblen said. "In the end, both [operators] will be fine, but some of the little guys will be hurt in the crossfire," he noted.
As for Kroger, many analysts expect the company to do very well in the next few years as the economy recovers. "Kroger has positioned itself for sales growth during the slowest part of the recession, and that discipline will pay dividends in the form of improved profits," said Chuck Cerankosky, vice president of equity research for Hancock Institutional Equity Services, Cleveland. Regionally, many analysts expect Sun Belt retailers to see steady improvements, particularly Winn-Dixie Stores, Jacksonville, Fla. However, they predict A&P will have a hard time in the Atlanta market, competing with new arrivals Publix Super Markets and Harris Teeter.
In the Northeast, they see Stop & Shop Cos., Boston, as a solid competitor. "Stop & Shop has been getting good momentum and rolling out new stores aggressively, well ahead of competition, and it will continue to grow and dominate," Comeau said.
In my opinion, the economy will pursue a slow recovery. It won't go up and down a lot, but will just creep along and make a gradual improvement, though in some places, including California and Seattle, it will lag.
For supermarkets, the economy is a regional, not a national, issue. A rising tide lifts all boats, but if there are holes in the boat, it's hard for it to rise.
However, the supermarket sector will be a good place to be because people have to eat, and if people are feeling more confidence in the economy, they might buy more food.
I see no sign of any turnaround in southern California. The economy there is just bottoming out, and it's unlikely to recover during 1994. Southern California will remain dead in the water, and the only dynamic will be what Vons does as it tries to recover sales.
In Seattle, the Boeing layoffs have had a ripple effect throughout the economy, and the economy definitely turned down toward the end of 1993 and into 1994. As a result, QFC has had less growth.
Safeway's resurgence is a major factor on the West Coast, including Seattle, as it continues its same-store sales growth at the best rate in the industry while other operators there are experiencing softness in their sales.
In New England, the economy has stalled and is experiencing the nation's second-worst recession after southern California. Operators there are competing with unevenly matched programs because Stop & Shop is so dominant, and it will continue to be so.
In the Southwest, Texas is on a recovery plane and going up, but with Food Lion becoming less of a factor, the AppleTree stores changing hands and H-E-B stoking the competitive fires, there's no clear way to tell how that will all play out. However, Houston and Dallas are likely to become less competitive than they have been because of Food Lion's less significant role.
The Midwest has already had a recovery, so the economy there is fairly strong and steady. The big dynamic in that region is how Meijer will affect the markets it enters, which will likely result in a meaningful heating up of competition in places like Indianapolis.
For many Midwest operators it will feel like they're experiencing deja vu from the time Cub entered several Midwestern markets in the early 1980s, and we're likely to see a pitched battle between Meijer and Kroger. In the end, both will be fine, but some of the little guys will be hurt in the crossfire.
In the South, Winn-Dixie Stores continues to be resurgent, and that's hurting Bruno's. There will be a lot of Wal-Mart Supercenters opening in the area that also will have an impact.
The Publix and Harris Teeter entries into Atlanta will keep things heated up there, and in Florida, which is overstored, several smaller operators are going to get hurt.
In the East, I don't expect much to change. Pathmark will continue to perform solidly, and A&P will continue to do well in the New York metropolitan area.
In addition, Giant Food is moving into Delaware, where its competition will be limited. Chuck Cerankosky VP, equity research
The economy will continue to improve through the second half of the year. One important aspect to watch is employment levels, which will determine how fast household incomes rise. If employment holds steady and incomes rise as they have been, then consumer confidence will go along with it, and that will help food retailers, especially the larger chains that provide one-stop shopping.
However, in some of the more hotly contested markets, I still expect to see some downward capacity adjustments, where some operators are forced to leave the market. Some marginal retailers may wait a little longer to close their doors, but there are definitely pockets of overcapacity in the industry, and to the extent regional economies take longer to recover than the national economy, that lag might hasten the closing of some stores.
For example, most of the operators in southern California are likely to reassess their square footage. In the Midwest, it might take longer for square footage to be reduced if marginal players feel they just need one more quarter to succeed.
We should see recovery all over the U.S. except California, and California will start to make an upturn in the latter half of the year. The state is just coming off the bottom, while other areas will be experiencing uptrends for a while.
However, California operators will be faced with a longer period of tough competition because of the slow recovery. It took six to nine months of economic expansion before Midwest retailers saw signs of life during the second half of 1993, and California retailers will have to wait a while before they can expect improved profitability.
Lucky has gotten a head start on better profitability because of the pricing program it introduced there in early 1993. Vons is expecting slow but steady improvements, first in sales, then in profits, from its new merchandising strategy, though given the economy, I don't expect a quick turnaround. And in northern California, Safeway is well positioned.
Kroger will continue to do well in all areas because it has positioned itself for sales growth during the slowest part of the recession, and that discipline will pay dividends in the form of improved profits.
Stop & Shop should continue to execute a pretty good store conversion program, expanding smaller units into Super Stop & Shops. American Stores is putting needed capital dollars into its operations, so it should realize meaningful improvements in different geographic areas.
The economy in the second half will continue the momentum that's building now. The big question is, what will the Federal Reserve do about inflation and rising interest rates? It's very important for the industry to be able to have some moderate inflation in selling prices, but the Fed has tried to control inflationary pressures.
Despite improvements in the economy, there's been no inflation, so there's been a trade-off between inflation and stronger demand by consumers. Therefore, it's hard to predict what will happen.
The improving economy will be good for supermarkets. They have learned they are not as recession-resistant as they once thought. Rather than investing in new square footage, some companies should think more about acquisitions. Instead of adding new square footage, they should try to make existing footage more productive by buying smaller operators to add market share.
Even in California, the economy will pick up. As the U.S. economy recovers, it will drag California with it. We could be in the early stages of recovery in California now, though it will lag the U.S. economy.
Northern California has not been as hard-hit as southern California, and that has helped Safeway. However, Lucky is doing better in southern California than in northern California, where it's languishing.
Smith's Food & Drug would be a major beneficiary of a recovery in southern California because it's been expanding aggressively, though its stores are below the break-even level.
In the South, Winn-Dixie has positioned itself to be the low-price leader in the market. The South has been a more rapidly growing section than in the past, accelerated in part by Wal-Mart Supercenters. The economy in the South and Southeast has been very strong, and that has attracted new competition such as supercenters and Publix in Atlanta.
In the Midwest, the economy is expanding in terms of the housing market, the employment market and the supermarket. Unlike the East and West coasts, the Midwest is an area that has been relatively strong for a longer period of time.
The Midwest market was relatively strong in the back half of 1993 and early 1994, so it won't explode in the second half of this year.
Kroger is continuing to recover in Michigan, which will continue to help it in the back half of the year.
Kroger has really been struggling to get its operating cost structure down while remaining aggressive on pricing. The improving economy will help same-store sales and drive higher-margin products. But that success will be a magnet for new competitors, like Meijer and Kmart.
Jewel should benefit from American's program of controlling costs and remodeling stores. The returns would be quicker in an improving economy and would encourage others to invest in more square footage.
We will see overall better economic performance and reasonably good momentum in the second half. Sales will be stable, but there'll be a slight pickup in food inflation. We saw some inflation in the second half of 1993 that was hurt by a decrease in brand prices. Unless a price decline reoccurs, we should see some food inflation. If that occurs in a stable economy, it will be good news for most food chains.
Companies have done a terrific job during the first half managing expenses, and to the degree that the pressure of deflation is lifted, we should see better performances from most companies in the second half.
Southern California is the exception. The recession will struggle on there for another year. Northern California is reasonably stable and might show some improvement. But southern California will stay very competitive, sales will be tough to come by and there will probably be some consolidation, with some second-level stores closing.
The Northeast will see a mixed recovery. Massachusetts and Rhode Island will show more improvement, while New Hampshire, Maine and Vermont will see a more gradual recovery. Connecticut will have a difficult time economically and financially.
The metropolitan New York area seems to be experiencing a modest recovery, with the competitive environment heating up, then easing, and it should remain competitive. ShopRite seems to be the catalyst for turning on and shutting off competition.
Stop & Shop is getting good momentum and rolling out new stores aggressively, well ahead of competition, and it will continue to grow and dominate. In northern New England, Hannaford also has the ability to run good stores and open stores faster than the competition.
In the Mid-Atlantic region, there's a faster recovery going on, and the area is coming back quicker than the Northeast or California, which should benefit Giant Food.
The South has more stable economic growth, and it's possible that Florida can get back to the rapid growth clip of the 1980s. In Atlanta, the A&P-Big Star combination will have some difficult times as it loses share and has to close some stores. But Kroger and Winn-Dixie will probably do OK, particularly Kroger, which is very reflective of chains operating outside of either coast.
My outlook for the economy overall is still cautious, though I'm less conservative than I have been because we've seen a pickup in sales as well as a slight amount of inflation.
The most important factor for the industry is that most companies have come to accept the fact that inflation won't exist in any substantial amount and they must therefore run their businesses and improve profits without inflation. That puts more focus on managing costs to help companies improve their profits.
The California economy is still very difficult. It's a mixed bag in terms of how companies perform, and I see no great recovery there. Lucky and Albertson's are up 2% in same-store sales and Ralphs is down about 2%, while Vons is down about 5%. Those operators should be able to improve on those results because comparisons are easing, but I don't see them taking any big step up.
In the Northeast, the economy may be improving, particularly in northern New England, where Hannaford is doing well, but there's still a lot of new competition -- Wal-Mart and Kmart supercenters -- coming into New Hampshire and Maine, and the economy will remain very tough there.
In the South, Atlanta will be tough. It's a red-hot spot because of expansion by Publix and Harris Teeter moving there. The chain that stands to lose the most is A&P, because half of its stores there are small, weak competitors, and they may be forced to close some locations.
Bruno's same-store sales have been trending well, but the chain is having a tough time improving its operations. It has cut back expenses, which may help management focus on improving operations, but it's likely to lag the industry on improvements.
The Southeast seems to be doing better. Winn-Dixie sales have picked up, and it's in a position to improve substantially, despite tough competition, as it remodels and builds new stores. It will also benefit from the closing of 60 Food Lions in the area.
In the Southwest, Smith's sales seem to have improved, though the addition of food in Fred Meyer's Utah stores will make things tougher. Phoenix is a good market that's improving.
In the Midwest, Kroger seems solid and steady. The expansion of Meijer into new markets, including Indianapolis, will make it tough.