Smart & Final Format Getting a Fresh Start

ELLIOT ZWIEBACH

LOS ANGELES — Smart & Final here will reportedly try to upgrade the perishables offering at its core warehouse stores to resemble something closer to the Costco model as a result of acquiring 35 natural food stores and a perishables distribution center from Wild Oats.

The deal, which is expected to be completed within weeks, will also give Smart & Final its first toehold in Texas — a state it has wanted to expand into for several years — albeit with a different concept than its core stores; and with the deeper pockets of its new ownership, the company may be able to upgrade the retail chains with more capital investment, observers suggested.

The stores Smart & Final is scheduled to acquire include 27 Henry's Markets in Southern California, mostly in the San Diego area, and eight Sun Harvest Markets spread across Texas, which account for a combined annual volume estimated at $300 million-plus. The deal also includes a 240,000-square-foot perishables warehouse in Riverside, Calif., that Wild Oats opened in 2004.

“Smart & Final has never had the opportunity to operate a temperature-controlled facility, so this deal will give it the ability to make a bigger push into perishables at its existing warehouse stores,” one industry analyst told SN.

“When Apollo Management acquired Smart & Final earlier this year, one of its goals was to improve the company's business, and a large component of that strategy was to push the stores more into perishables, which is a category that is under-penetrated at Smart & Final.

“The object is not to have a Whole Foods-type of perishables presentation,” the analyst added, “but something closer to what Costco does, and Apollo saw that opportunity in this deal.”

Scott Van Winkle, a Boston-based analyst for Canaccord Adams in Vancouver, British Columbia, said Smart & Final's interest in perishables is similar to the interest of consumers in general. “The fresh-market concept resonates with consumers, who are spending more effort buying produce and other perishables,” he explained.

Smart & Final officials declined to comment, beyond noting they plan to continue operating the 35 stores under their current formats — high-quality, low-priced farmers' market concepts.

Observers said Whole Foods opted not to include Henry's and Sun Harvest in its acquisition of Wild Oats to avoid the possibility of forced divestments because of its strong competitive positions in Southern California and Texas.

Smart & Final operates 255 stores, including 200 non-membership warehouse stores under the Smart & Final banner in California, Oregon, Washington, Arizona, Nevada, Idaho and northern Mexico, and 55 Cash & Carry stores in the Pacific Northwest and California.

The majority of the stores it is acquiring are in the 20,000-square-foot-plus range, “which is in line with what it is used to operating at its warehouse stores,” one analyst said.

“Though these retail stores are heavier on the perishables side, it shouldn't be a massive stretch for the company. And operating as a private company, without the scrutiny of the public marketplace, Smart & Final should be able to have more flexibility to experiment a little bit.”

Jay Jacobowitz, president of Retail Insights, a natural food consultant based in Brattleboro, Vt., said the store acquisition “will allow Smart & Final to buy expertise and brand equity in the natural space and to build on that as part of a longer-term strategy.”

The financial resources behind Smart & Final could mean positive things for the retail stores, said Wild Oats spokeswoman Sonia Tuitele.

“With its strengthened capital base, Smart & Final has a real opportunity to invest in both the Henry's and Sun Harvest brands, and the regional teams that are in place, along with the stores' employees, should help provide any expertise management is lacking — though without the support from Wild Oats that it will lose once the deal is completed, Smart & Final will have to determine whether it will have to add some new positions to its retail operation going forward,” she noted.

NEW CEO

“While Smart & Final's previous CEO [Etienne Snollaerts] had no retail perishables experience, the new CEO certainly does,” according to one analyst.

That chief executive officer is George Golleher, a 28-year industry veteran who held top-level positions at Boys Markets, Food 4 Less and Ralphs in Southern California before becoming president and chief operating officer of Portland, Ore.-based Fred Meyer Inc., a position he left in 1999.

Golleher joined Smart & Final shortly after completion of its sale in June to Sharp Holdings Corp., an Apollo affiliate.

Several of those queried told SN they believe Smart & Final probably had to acquire the eight stores in Texas to get the Henry's stores in Southern California. “I doubt Smart & Final targeted Sun Harvest as a primary candidate for acquisition,” Van Winkle said, “though it could certainly use Sun Harvest as a beachhead for expansion in the Texas market or for store relocations to larger spaces.”

Gary Giblen, managing director of Goldsmith & Harris, New York, said, “I'm not sure what Smart & Final can do with Sun Harvest. Maybe it should re-format those stores into Hispanic-oriented perishables stores.”

The Sun Harvest stores include three in San Antonio, two in Austin and one each in Corpus Christi, McAllen and El Paso.

While Giblen said he sees Henry's as a unique operation that is likely to do well under Smart & Final's ownership, “Sun Harvest is no treasure. It's a small chain right in Whole Foods' backyard, with not much brand equity, and Smart & Final probably had to take those stores to get Henry's.”

On the plus side, however, the Sun Harvest acquisition will put Smart & Final into Texas, Giblen noted. “The company has talked for years about Texas as a logical place to expand because of the similar demographics to other areas in which it operates, and the warehouse format makes sense there,” he explained.

Giblen said he's not sure how well Smart & Final will do in Texas. “Apollo probably believes, like other private equity firms, that it can walk on water, especially when it comes to retailing, so it is buying those stores and expecting Smart & Final to get the job done.”

According to Mike Gilliland, the founder of Wild Oats who left that company in 2000, shortly after engineering the acquisitions of Henry's and Sun Harvest, “Henry's has been successful for decades, and Sun Harvest is a good business in some B-minus real estate locations that perhaps has never had all potential opportunities exploited, and there is plenty of room there for fill-ins.”

Jonathan Ziegler, a Santa Barbara-Calif.-based analyst with Dutton Associates, El Dorado Hills, Calif., said the deal “makes absolutely no sense to me.”

“When I followed Wild Oats, I always wondered why it bought Henry's because I was never impressed with the concept,” he said. “I think the boxes are generally too small to convert to Smart & Final stores, and I don't know where Apollo will find the management to operate them. Perhaps Apollo simply wants to build a retail empire by developing real estate locations to convert ultimately to a more productive concept.

“As for the eight Texas stores, my response is a giant question mark, although I believe it is a logical market for the expansion of the Smart & Final warehouse store format.”

Henry's has “a pretty successful niche, with a concept as a neighborhood natural food store that's clearly differentiated from most everything else,” said Andrew Wolf, an analyst with BB&T Capital Markets, Richmond, Va.

“And since Henry's has been run pretty much separately from Wild Oats, there's a lot of management talent available there to Smart & Final.”

SLOW GROWTH IN TEXAS

Another analyst said that, once Smart & Final moves into Texas with the Sun Harvest acquisition, Apollo is likely to give it sufficient time to strengthen its foothold there.

“No one at Apollo is trying to get out of that investment for the next several years, and Smart & Final has a viable concept that is clearly under-penetrated in the Texas market, so Apollo will give the company time to grow because this could be a definite opportunity to expand the warehouse format in Texas.”

Wild Oats acquired Henry's in September 1999 and Sun Harvest three months later.

“The uniqueness of the formats is why Whole Foods is not interested in those stores,” Tuitele said.

At Henry's, the decor and customer experience is reminiscent of an old-fashioned produce stand, she said, with signs on wooden boards that look hand-painted; low-profile shelving to enable customers to see the entire store at once and to make navigation easier; and a broad array of locally grown produce, all merchandised at low prices.

All products in the store are free of artificial flavorings, colorings or additives, Tuitele said, “though the standards are a little less stringent than at a Wild Oats,” she pointed out.

Stores are in the 24,000- to 26,000-square-foot range.

Henry's has been a growth engine for Wild Oats, Tuitele said, with 14 stores opened in the last eight years — including five in Phoenix that were shut down last December when new management determined there was not enough brand awareness in that market to support Henry's entry there.

“Henry's is a very strong brand, especially in San Diego, and we were able to move it north with three openings in Orange County, plus entries in Riverside and Coachella counties and one store in Los Angeles County, in addition to three or four remodelings,” Tuitele said. “Smart & Final should be able to build on that.”

The Sun Harvest stores are slightly smaller than Henry's, ranging from 10,500 to 27,400 square feet, with most in the mid-20s, Tuitele said.

“Those stores are among the most profitable in the Wild Oats chain because they are smaller and they've been around for a long time, so the real estate costs and operating costs are low relative to sales volume,” she said. “Henry's is also a lot cheaper to operate than Wild Oats because of some of the same factors.”