Staying the Course

MARK HAMSTRA

Alec Covington knows how to steer a ship.

That is true both literally — he's been an avid boater for years — and figuratively, as he seeks to guide Nash Finch Co. back to calmer seas.

Despite some recent turbulence, the chief executive officer of the Minneapolis-based retailer and distributor is keeping the company pointed dead ahead at the bearings he set when he took the helm three years ago next month.

“We put a plan in place at the end of 2006, and we have not wavered one inch since then — and we will not in the future,” Covington told SN in a recent interview. “One of the things that is common among companies that get in trouble financially is that they have a plan on Monday, and then all of a sudden Wednesday they have a problem and they go off and do something entirely different from their plan. They have a ‘strategy du jour,’ and not a clear, consistent plan. They end up confusing their employees, confusing their customers and confusing their shareholders.”

That's something Covington is clearly trying to avoid, even as the current economic environment poses fresh challenges he did not face when he laid out his long-term strategic vision — called Operation Fresh Start — for Nash Finch three years ago.

At that time, the company had recently acquired two distribution centers from Roundy's Supermarkets and was struggling to integrate them with its own systems. The management turnover rate was startlingly high, and it was not clear whether the company was ever going to be successful as a retailer.

In the three years since then, Covington has sought to address each of those issues, and he has made it clear what a company with three distinct lines of businesses is really going to be all about. Nash Finch would be one of the nation's leading suppliers to military commissaries; it would reenergize its grocery distribution business with new programs focused on helping its customers grow; and its retail business would be focused on developing concepts that could better serve its independent retail distribution customers.

As an illustration of Covington's philosophy to stick by his plan, he pointed to the December announcement by Nash Finch that it would acquire three military distribution centers from GSC Enterprises, Sulphur Springs, Texas, despite the financial turmoil that was occurring at that time.

“When we announced that, many people were wondering if the banks were even going to survive,” he said, recalling the meltdown that saw major financial powerhouses Lehman Bros. and Bear Stearns disappear in a pool of red ink. “People were looking at Nash Finch and scratching their heads.”

But growing the military distribution business was one of the goals Covington had set, and the economic malaise was not going to knock the company off its track.

“2009 has become a year of expansion for us,” he said. “We are expanding our military distribution business, just like we always said we would.”

Nash Finch has not been immune to the economy, however. After coasting through most of 2008 without a hitch — and enjoying one of the industry's best stock market performances — the company disappointed investors with its fourth-quarter earnings report last month.

Hispanic-oriented Avanza “has done extremely well.”

Net income came in at $6.2 million, or 47 cents per share, much less than the $8.5 million, or 62 cents per share, the company reported in the fourth quarter a year ago. It was also much less than the 91 cents that the company's lone stock analyst, Karen Howland of Barclays Capital, had projected.

She pointed out in a research report that the distribution business was weaker than expected in the fourth quarter, although most of the missed earnings came from non-cash charges. She also noted that the company seemed cautious about the first quarter, citing the negative impacts of commodity deflation.

“All in all, we were disappointed with earnings and the tone going forward, however [we] believe the drastic stock move is overdone,” she wrote after Nash Finch's stock price plunged 20%.

Covington explained that the underlying results were not that far off the company's plan, and Nash Finch has taken steps to shore up its performance, reining in capital spending and aggressively pursing productivity initiatives.

From the beginning of his tenure, Covington has made clear that he was going to run the company with a focus on growing EBITDA, rather than earnings per share. During quarterly earnings calls with analysts and investors, Nash Finch barely discusses per-share earnings, focusing almost exclusively on sales and EBITDA.

“In 2006, we set a long-term target of 4% EBITDA margins, and when I announced that to analysts at a conference, there were some in the front row who were actually laughing,” Covington explained.

The company has crept closer to that goal, however, moving from 2.2% in 2006 to 2.8% in 2007 and 3.1% in 2008.

Those improvements paralleled the company's goal of 2% organic sales growth, which it achieved in 2008 with growth of 3.1%. That followed declines of 2.9% in 2006 and 2.1% in 2007.

The company also achieved its goal in 2008 of obtaining a 10% return on assets — it actually reached 12%, following results of 8.7% in 2006 and 9.2% in 2007 — and has also improved it debt ratios and kept them in line with its goals, even with the GSC acquisition.

Although Covington described 2008 as a year of growth for the company, he also said the company took on more projects than it could handle.

The company also had to take on some additional debt to provide support to its best customers when the banks tightened their credit, he explained.

At the end of fiscal 2008, the company had loans of $35.5 million outstanding to 38 of its food distribution customers, net of reserves, and had guaranteed outstanding customer debt and lease obligations of $15.1 million, the company reported in its annual 10-K filing with the Securities and Exchange Commission.

Tied to Independents

The company has made distribution to independent retailers the centerpiece of its business, seeking to capitalize on an opportunity Covington said was created by the shift of some competing wholesalers to more of a retail profile.

When Covington came on board, the company's much larger neighbor, Minneapolis-based Supervalu, had just acquired Albertsons, and Grand Rapids, Mich.-based Spartan Stores was also in the midst of a string of small retail acquisitions.

“Although I am not critical of those strategies, and it may prove the right decision over time for those companies, I didn't feel it was an appropriate strategy for Nash Finch,” Covington explained. “As I looked at the marketplace, I saw a real void of anybody who was really focused on serving the independent.

“In 2006, we decided that this will be the company that focuses on independent customers — we don't have any idea that we're going to go out and buy a bunch of retail chains and become a self-distributing chain. Our future is hitched to the wagon of the independent retailer.”

Covington explained that the company evaluated the landscape to make sure there was a customer base of viable independent retailers that the company could serve as customers, and came to the conclusion that there were plenty of independents that were thriving.

He cited as examples some of Nash Finch's current customers, including Hugo's Family Marketplace in Grand Forks, N.D., and Riesbeck's Markets, St. Clairsville, Ohio.

“Go to a Hugo's store, and they are large, they are well equipped, and they are modern; they are priced right and they are competing well in markets where there are Wal-Marts,” Covington said. “Has there been loss of square footage in the marketplace since Wal-Mart has expanded there? Yes there has, but it wasn't our customer. Hugo's put their pricing in place years ago, and they have not only survived with the market-share gains of Wal-Mart, they have grown.”

Likewise, Riesbeck's, a third-generation retailer, operates strong conventional stores with “everyday value pricing up and down the aisle, and they are making money,” Covington said.

He said that although there may be fewer independents around than there were 20 years ago, the ones that are left are larger, more well defined and more sophisticated in the way they operate. That led the company to the conclusion that it could indeed build a growing business around serving the independent retailer.

“We looked at that [in 2006] and said, if we were a $100 billion company, is there enough business to support us in our part of the world? The answer might have been no, or it might have been questionable,” Covington explained. “But for a company the size of Nash Finch — at that time $4.5 billion — we found there was enough business out there to not only double that business, but triple that business and do nothing else but focus on independent retailers.

“What there is a shortage of is not independent retailers, but people who are interested in building a business around independent retailers.”

Retail Formats

Although the company continues to operate 57 retail stores — about 13% of Nash Finch's total volume — Covington sees that portion of the business not as assets to be developed into full-fledged chains, but as laboratories for testing concepts that can someday be shared with its customers.

To that end, Nash Finch has shuttered more than 20 locations in the last three years and is narrowly focusing on the future potential of three retail formats: Avanza, the Hispanic-oriented banner; Family Fresh, a service-oriented banner with an expansive perishables offering; and Buy & Save, a discount banner that is still in the development stages.

“We measure the success of those formats with one simple question: Can this format exist in the market where there also exists a dominant large-box retailer such as Wal-Mart or Meijer?” Covington explained. “If the answer to that is no, then to us it is not a viable format long-term.”

Nash Finch had already begun operating some Avanza stores when Covington joined the company, but he said the potential for the format was clear right away.

“It was like finding a diamond out in the middle of chaos,” he said. “We thought it was great — there were some things we needed to do, but overall, it's a great format, and it serves the consumer well. So we said, let's figure out how to grow that.”

Avanza stores — currently there are three in Colorado and one in Omaha, Neb., with a fourth Colorado store planned in the Denver suburb of Aurora — are geared toward first- and second-generation Hispanic consumers, who seek authentic product at sharp price points.

“Avanza has done extremely well,” Covington said. “We are looking at sites all over for that — in parts of the West and also parts of the Southeast — for additional growth.”

The stores are often urban sites that have been repurposed from previous incarnations as traditional supermarkets. They can be built for about one-fourth the cost of the big-box Family Fresh stores.

The company recently ended its controversial “cost-plus” program at the stores, which had attracted some consumer lawsuits. In that program, 10% was added to the shelf price at the register.

Nash Finch debuted the Family Fresh banner last year at a refurbished, 57,000-square-foot store in Hudson, Wis., and the company is carefully eyeing opportunities for additional locations.

“Everything in that store is about service,” Covington explained. “You can't even buy packaged meat — they ask you what you want, they cut it right there on the spot, they wrap it in butcher paper and they sign it with their own name.”

In addition, the store includes significant space for prepared foods, and it has a fresh seafood department and an extensive selection of organic produce. It also features the services of Nash Finch's first-ever staff nutritionist and incorporates nutrition information throughout the store.

But one of the key elements of the store's positioning, Covington explained, is its pricing in the Center Store grocery offering.

“We took the lead from what a lot of other grocery stores have done, and we lowered prices to compete with just one retailer, Wal-Mart,” Covington explained. “In that store, the closest competitor is a County Market, across the highway, but we don't even price-check against them. We know that we are priced lower than we need to be to compete with the local competition, but that's not really the point, because the consumer looks to Wal-Mart as the benchmark to see whether you are competitively priced or not.

“So the fact that you might be competitive with the operator directly across the street kind of becomes irrelevant in the eyes of the consumer.”

He pointed out that consumers don't necessarily expect prices to be as low as those at Wal-Mart, but within about 10% to 15%, especially if the perishables offer is superior.

That first Family Fresh store is seeing sales gains “in double digits,” Covington said.

“It has been a raving success since day one — the perishables departments are up anywhere from 28% to 60%.”

Nash Finch has a second Family Fresh under construction in New Richmond, Wis., that is scheduled to open later this year, following some construction delays. Covington said additional rollout of the Family Fresh format will proceed slowly because of the cost of building such large, elaborate stores.

The company also is planning to debut a new concept this year — a smaller, price-oriented store for rural markets called Buy & Save, a banner for which Nash Finch already had the trademarks from a retail format it had previously operated.

In addition, Nash Finch continues to operate a handful of other banners across the Midwest, including Econofoods, Sun Mart, Family Thrift Center, Pick 'n Save, Wholesale Food Outlet and Food Bonanza.

Logistics Improvements

The core of Nash Finch's business is its distribution operations, which serve 1,600 independently owned stores across 27 states and operate from 16 warehouses.

This area has been the focus of some of the more innovative initiatives at the company, such as the recent reopening of the company's Bellefontaine, Ohio, warehouse to handle slower-moving items. Using the Bellefontaine depot — which Nash Finch owned but had previously closed — to handle slower-turning SKUs facilitates inventory turns at four other warehouse locations: Westville, Ind., and Bridgeport, Cincinnati and Lima in Ohio.

Removing the slow-moving items from those facilities has created “a far more productive selection pattern and inventory efficiency,” Covington explained.

It also reduces the number of shipping points for manufacturers of the slow-moving items, he pointed out.

One of the first initiatives Covington initiated at Nash Finch was a comprehensive implementation of category management in an effort to buy better for its customers, which involved installing new technology systems and hiring some specialized talent.

The moves are aimed at increasing distribution efficiency and therefore lowering costs to retailers in what the company calls its Every Day Value program, or EDV, which was recently rolled out at the Lima warehouse and is being rolled out to other distribution centers.

Through the EDV program, Nash Finch aggressively pursues pricing that allows retailers to price within a tolerance of Wal-Mart's price range. About 49% of products in the EDV program now include an off-invoice deduction that allows for that level of retail shelf pricing year-round, Covington explained.

“It is a fully integrated program from the retailer to the distributor back to the manufacturer, where everybody has full visibility of the results, and full visibility of the compliance of those programs,” Covington said, noting that it has been “very successful.”

Nash Finch is preparing to roll the program out to additional DCs.

“It is very painful to go through all that work that needs to be done to get there, but it is obviously very critical,” Covington said.

Such an effort required a sharp attention to the reduction of logistics costs, he explained, which the reopening of the Bellefontaine facility is designed to help achieve.

Another initiative on the distribution is called “one way of working,” which seeks to establish best practices for efficiency in the warehouse. It is being tested by a group of employees at the company's Cincinnati distribution center.

“They are looking at the best way to receive product; the best way to conduct inventory control; at what is the most efficient and productive way to create a selection pattern,” Covington explained. “With that, they take out a lot of the mistakes and a lot of the waste.”

The company plans to roll that program out to all of its DCs.

In addition, Nash Finch has aggressively pursued product-cost initiatives by seeking to control as much of the freight as possible — picking up product at manufacturers' facilities whenever possible, for example, in order to achieve better costs.

Covington said he believes the initiatives are beginning to pay off. Although the company lost a large customer in 2007 to rival Spartan Stores, it was able to build some new distribution business in 2008.

“I think it took a couple of years for people to really believe what we were saying,” Covington said, “that we were really going to be dedicated to independents and not go off in some other direction, because our history had been a little bit that way.”

Nash Finch's logistics expertise also fuels its performance in its third division, called Military Distributors of Virginia (MDV).

Unlike the supermarket distribution business, which procures product from manufacturers and then resells it to independent retailers, MDV instead distributes to military bases products that the government has already negotiated for.

In January, MDV completed the purchase from GSC Enterprises of three DCs — in San Antonio; Pensacola, Fla.; and Junction City, Kan. — which expands MDV's geographic footprint to the West. The company paid $80 million for the business, which is expected to generate about $740 million in sales.

The military business grew more than 9% in the fourth quarter — before the acquisition — and Covington said there has been interest from customers in adding product lines.

Also, he said, he sees opportunities to improve efficiencies in the acquired business and to add warehouses within the expanded geographic footprint.

Howland of Barclays Capital was optimistic about the deal, noting that she projected it to produce about $11.1 million of EBITDA annually.

“Overall, we view this as a very favorable transaction,” she said. “The military business has had strong growth, stable cash flow and strong returns.”

MAKING PROGRESS

The following table shows Nash Finch's performance for the past three years.