Financial results in the second half of 2010 are likely to be very similar to what the industry experienced in the first half, with few indications the economy is recovering, industry analysts told SN.
The first half was a tough period for the industry, the analysts said.
“A lot of it had to do with attempts to gain a competitive advantage, especially once Wal-Mart came out with its price rollbacks,” Meredith Adler, managing director for Barclays Securities, New York, explained.
“On top of that, one thing that made the situation even more difficult was the presence of inflation in some categories and the fact many companies chose not to pass that along.
“We also continued to see real malaise among most consumers, who remained quite cautious in their shopping — though we did see sales improving among upper-income customers who had previously been pretty cautious.”
Chuck Cerankosky, managing director for Northcoast Research, Cleveland, said first-half results were “a little soft, with a few companies like Kroger, Whole Foods and Harris Teeter showing slow but positive momentum; companies like Safeway, Winn-Dixie and A&P with negative results; and Supervalu showing very disappointing comparable-store sales numbers.”
Andrew Wolf, managing director for BB&T Capital Markets, Richmond, Va., said the first-half saw a continuation of competitive trends from 2009's fourth quarter, though some companies were able to show small sequential progress in profitability, albeit with little impact on sales.
Susan Anderson, senior analyst for Citigroup, New York, said overall results in the first half were better than in the first half of 2009, “with the competitive environment showing slight improvement in this year's second quarter as Wal-Mart backed off on its rollbacks, and we're hoping the trends in the second half continue along those lines — though with unemployment still high, it doesn't look like the environment will normalize.
“But the comparisons will be easier, and as inflation kicks in, chains should be able to grow their top lines and improve margins.”
Among the top 10 chains with public equity or debt, results for the first half of the calendar year looked like this:
• Average sales rose 8.4% over the first half of 2009 — due in large part to improved financial results at Whole Foods Market that far outpaced the rest of the industry, combined with the acquisition by Ahold USA of Ukrop's Super Markets.
• Comparable-store sales were worse, dropping an average of 0.7% in the first quarter, compared with an average gain of 0.4% a year earlier; in the second quarter, comps fell an average of 1.5% this year, compared with an average decline of 0.2% in last year's second quarter.
• Operating profits increased 10.7% over last year's first half.
Adler told SN she isn't sure how things will develop in the second half. “Kroger has said competition is becoming more rational — though that's not necessarily the case in some places, given that we've seen Food Lion become more aggressive on pricing and Winn-Dixie talk about becoming more aggressive.
“So at this point, the second half is still a big question mark.”
Another industry analyst, who asked not to be named, said overall results suffered in the first half “due to the hangover from the second half of 2009 when competition accelerated, which means that when compared with that period, the second half of this year should look better.”
Cerankosky said he agreed that comparisons will get easier, “but the consumer is still very cautious about buying incremental items that can make each basket more profitable; the jobs market is still weak; and household debt remains high and onerous for some shoppers — all of which have a dampening impact on buying patterns.”
Wolf said he anticipates “very slow improvement” in second-half results. “Same-store sales will probably still be negative for most operators through the balance of the year, while profit trends will likely show some improvement for some of the better operators. And with more inflation, operators ought to be able to pass those cost increases through rather than engage in further price wars.”
The analysts' comments on specific chains follow:
• KROGER CO., Cincinnati, whose sales for the first half of 2010 rose 7.5% to $43.6 billion, while comps increased 2.4% in the first quarter and 2.7% in the second, and operating profit dropped 9.5% to $1.2 billion for the half.
Kroger's results were strong, Adler pointed out, “because the company has a strategy, and it's been extremely disciplined about sticking with it.
“For some investors, however, Kroger went too far in 2009 when it became extremely aggressive on price, but it did a better job in the first half by striking a better balance between driving sales and generating profits.”
Wolf also said Kroger's results in the first quarter reflected the negative impact of some of the steep pricing adjustments it made in 2009, “but by the second quarter Kroger was able to maintain good sales levels with less price investment — and operating margins were better — and the chain is now positioned to lead the industry out of its competitive-pricing morass.”
According to Cerankosky, gasoline sales from the 900-plus fuel centers Kroger operates, combined with efforts to tie promotions to gas pricing, benefited the chain's top line during the half.
“But with management determined to drive the business from the top line, margins are under pressure, which is reflected in declining operating profits, though profits improved sequentially from the first to the second quarters — a trend that should continue.”
• SAFEWAY, Pleasanton, Calif., which saw first-half sales edge up 0.8% to $18.8 billion, despite a drop in comps of 3.1% in the first quarter and 2.3% in the second, and a decline in operating profits of 21.8% to $499.7 million.
Overall sales improved because of Safeway's lower pricing program, Cerankosky noted, “but that didn't completely reverse negative comps, nor has the price investment lifted sales enough to improve Safeway's operating leverage, though it has made some progress.”
Adler said Safeway's decision to lower pricing and boost advertising in the second half of 2009 did not yield a positive sales impact through the first half of this year. “It hurt profits, and the weak sales didn't help,” she said, “and there's still a lot of uncertainty there.”
According to Anderson, “Safeway says it's at pricing parity with its conventional competitors, but it still seems to be higher-priced than Kroger, so it appears consumers aren't buying in, and that hurt comp sales.”
• SUPERVALU, Minneapolis, where retail food sales fell 12.2% to $16.2 billion, comps declined 6.8% in the company's fourth quarter and 7.2% in the first quarter, and operating profits dropped 17.5% to $662 million. Retail food accounted for approximately 78% of total financial results at Supervalu.
Cerankosky said Supervalu's results reflect its ongoing struggles with the assimilation of the Albertsons stores it acquired in mid-2006, “and the economy has not been on management's side in that process, as customers have traded down and competition has become more promotional.
“In addition, the Shaw's division went through a painful strike, while Jewel in Chicago has not been in a position to really go after sales, and Acme in Philadelphia and Shoppers Food & Drug in the Washington, D.C., area have been hurt by tough competition.”
The decline in profits reflects reduced sales per store and the inability to leverage fixed costs at the stores, Cerankosky added.
On the plus side, Supervalu did “quite a good job” cutting expenses, Adler noted, “which is why results were not even worse. But Supervalu is still in transition and starting from a very low point, and it's only been in the last few months that the company has completed putting together a new management team.
“The company also had a lot of work to do in terms of technology and business processes, which made it hard to respond when the economy weakened, and it's still struggling with integrating its banners.”
According to Anderson, prices at Supervalu's retail stores are higher than those of either Kroger or Safeway, “and 25% or 30% higher than Wal-Mart's prices, and though it tried to invest in pricing during the half, it didn't work.
“The company lacks the strong cash flow to invest in price, though as it pays down debt and possibly sells off assets, it will have a stronger balance sheet, which should enable it to lower prices. That's what it has to do to compete.”
Supervalu's expenses remained high, Anderson added, “though efforts toward more centralization helped keep expenses down.”
AHOLD USA, Quincy, Mass., which saw first-half sales increase 4.8% to $12.6 billion and comps climb 0.5% in the first quarter and 1.4% in the second, while operating profit rose 0.1% to $565 million.
Part of the company's sales increase came from the acquisition late in the half of Ukrop's, the Richmond, Va.-based chain of 25 stores, which added more than $200 million to Ahold's top line in the half but also involved one-time conversion costs that impacted the bottom line.
“But Ahold invested in price a couple of years before the economy weakened, so it had its house in order,” one analyst told SN, “so it was ahead of the game on low-price appeal. And competing with Shaw's in New England and Acme in the Mid-Atlantic region also helped strengthen its results,” he added.
Wolf also cited the pricing adjustments Ahold made before the economy weakened as a positive factor in its first-half performance. “Those adjustments gave the stores a little traction,” he said.
DELHAIZE AMERICA, Salisbury, N.C., whose sales fell 1.6% to $9.4 billion during the first half, with comps down 1.8% in the first quarter and 3.6% in the second, and operating profits falling 12.9% to $459 million.
“The Food Lion division of Delhaize was late to adjust its pricing,” one analyst noted, “and with so much exposure in the Southeast to Wal-Mart and its rollbacks, the chain belatedly had to play catch up with promotions.”
Wolf said he agreed that Food Lion got hurt “before it decided to join the parade of price-cutters. But through the half it took a ‘wait-and-see’ attitude, hoping the pricing moves by others would pass.”
Hannaford Bros. continued to outpace Food Lion, he added, “because it already has a better price-to-value image, and there's less competition in northern New England.”
A&P, Montvale, N.J., which experienced a sales decline of 9.8% to $4.6 billion for the half, declining comps of 4.8% in the company's fourth quarter and 7.2% in the first, and a drop in EBITDA of 31.7% to $61 million off negative operating profits.
Anderson said the severe sales declines at A&P were due primarily to issues related to the chain's Pathmark banner, “where everything just fell off the cliff. Pathmark operates the highest-priced stores in the market, and it can't lower prices because it doesn't have the dollars or the volume to invest, so it's stuck.
“A&P can't afford to lower Pathmark's prices, and without lower prices, the stores can't attract customers.”
WHOLE FOODS MARKET, Austin, Texas, where first-half sales soared 14.3% to $4.3 billion, with comps rising 8.7% in the company's second quarter and 8.8% in the third, and operating profits up 58% to $234.8 million.
Whole Foods experienced “relative recovery” during the first half after being hit hard by the credit crunch, Adler noted. “The recovery came from a combination of improving its price engine, becoming more aware of the competitive environment and offering more choices in terms of pricing,” she pointed out.
“All that was helped by a recovery in spending by the upper-income customers that make up its core customer base,” Adler added.
Cerankosky said strong top-line results reflected the chain's ongoing new-store expansion, while the strength of comps indicates “the older stores have been attracting more customers who are buying more merchandise as Whole Foods benefits from the recovery of the stock market, given its demographic.
“And the growth in profits reflects how good it's gotten over the last two years promoting its pricing program.”
WINN-DIXIE STORES, Jacksonville, Fla., whose sales fell 0.3% to $3.4 billion, while comps declined 2.2% in the company's third quarter and 5.2% in the fourth, while operating profits dropped 28.4% to $35.1 million.
Cerankosky said the flattish top-line sales reflect strong results among stores that have been remodeled, while the declining comps reflect sales at non-remodeled stores.
“Further, the drop in fourth-quarter comps reflects Winn-Dixie's decision to husband its cash flow by being less competitive, at a time Wal-Mart, Publix and Food Lion were all being quite aggressive,” he said. The drop in profitability reflects low sales levels per store that prevent the company from leveraging operating expenses, he added.
“Winn-Dixie operates in a tough competitive environment, and while the strong management team has kept it competitive and you would expect some positive rebound, the Florida economy has been slower to recover than the national economy,” Cerankosky explained.
Adler offered similar comments, noting that Winn-Dixie had some success getting customers back into its stores through remodeling and upgrading, “though the Florida economy has made that particularly difficult.”
Results were also impacted by the chain's decision not to be as promotional as its major competitors, she pointed out — a decision Winn-Dixie management said it would reverse as it moved into the second half.
Anderson said Winn-Dixie performed relatively well during the first quarter of 2010, aided by price investments and some deflation, but as it was faced with Wal-Mart's rollback programs and more aggressive pricing by other competitors, Winn-Dixie opted to maintain margins by not promoting, she noted.
“And gross margins took a hit of 10 basis points because Winn-Dixie didn't pass along all inflation costs,” she pointed out. “On the plus side, though, the remodeled stores showed better results than the rest of the chain.”
HARRIS TEETER, Matthews, N.C., which saw first-half sales rise 5% to $2 billion, comps decline 1.3% in the company's second quarter and 0.7% in its third, and operating profit rise 2.7% to $90.2 million. Harris Teeter is a division of Ruddick Corp., Charlotte.
Overall sales were strong, Wolf said, “because Harris Teeter is very competitive, and being a non-union operator, it has more flexibility in its variable-cost structure, so it's been able to bring costs down at the same time it's lowered gross margin.”
Cerankosky said the positive overall sales growth at Harris Teeter is due to ongoing new-store growth, with the new stores in the northern Virginia-Washington, D.C., market generating better volumes than the rest of the chain.
“However, some new stores are cannibalizing existing stores, which affects the comps. Profits, however, remain surprisingly robust.”
STATER BROS. MARKETS, San Bernardino, Calif., whose sales fell 4% to $1.8 billion, with comps down 3.1% in the company's second quarter and 1.2% in the third, and operating profits down 26% to $54.6 million.
Bryan Hunt, managing director for the Charlotte, N.C., offices of Wells Fargo Securities, San Francisco, said Stater Bros. revenues were hurt by increased price competition and high unemployment in the Inland Empire — the San Bernardino-Riverside counties area in which the chain operates most of its stores — while operating cost increases weighed on results.
The sale of Santee Dairies in the year-ago third quarter reduced sales for this year's quarter by about $23 million, Hunt noted, while comps were impacted by intense price competition and an unemployment rate approaching 15%, as well as by sales cannibalization from new stores.