FIRM DIAGNOSIS

NEW YORK -- The Northeast may be one of the major battlegrounds for market supremacy over the next few years, with companies with strong balance sheets likely to have an edge, securities analysts told SN in a roundtable discussion here.

rnstein, vice president of Grant-

chester Securities, a division of Wasserstein Perella Securities here, called the Northeast "a brutally competitive environment." He noted, however, that some of the better-capitalized competitors are making inroads, including Edwards Super Food Stores, Windsor Locks, Conn., a division of Zaandam, Netherlands-based Ahold; A&P, Montvale, N.J.; and Pathmark Stores, Woodbridge, N.J. -- "one of the sleepers" in the area.

Ed Comeau, vice president of Donaldson Lufkin & Jenrette here, said Pathmark is likely to emerge from the battle "[as] one of the winners or at least the survivors in this market, and I'm a believer in the current management's ability to do that."

Gary Giblen, managing director of Smith Barney here, said Pathmark could be "a huge winner because the history of the industry shows you can turn around even a quite tarnished franchise with astonishingly dramatic rapidity if you have the right management team in place."

Debra Levin, principal at Morgan Stanley Dean Witter here, said she expects A&P to emerge from the battle in good shape. Levin acknowledged that A&P is "very far behind vs. what competitors have done." But she added, "I believe that in their core markets, they're making the right moves and over time you're going to see a steady improvement."

Giblen said he disagreed, calling A&P "a perpetual underperformer. You simply do not have the catalyst in the form of new strategy or new management or proactive shareholder-oriented ownership [with] the Tengelmanns to achieve any sustained change there."

The roundtable also included a discussion on the merits of Hannaford's move into the Southeast, with Giblen taking the negative view that the company isn't making any progress after three years."

In contrast, Levin said she was more optimistic, noting that "the very fact that they'll be close to critical mass by the end of this year in terms of the number of stores they've got, and with their own distribution system, indicates that the cost structure is going to work."

Other analysts participating in the roundtable were Jonathan Ziegler, San Francisco-based vice president of Salomon Bros. here, and Gary Vineberg, first vice president of Merrill Lynch here.

The analysts' complete comments follow:

SN: Please pick out one or two of the companies you follow that you believe have particularly positive or problematic futures ahead of them, and why you think their prospects are good or bad.

BERNSTEIN: One of the companies I'm bullish on is Stater Bros. Markets, which operates 110 stores in the Inland Empire of southern California. And I really do believe they are one of the preeminent everyday-low-price operators out there. They've been able to thrive on low margins and use their pricing policy as a very effective competitive tool against potential new entrants into the market and against operators who have been in the market and who have subsequently left. They've set a pretty torrid pace in terms of same-store and adjusted EBITDA growth through the first half of their current fiscal year, and I don't see any reason for that to change dramatically. And as I said earlier, I think down the road at some point they are an acquisition or an [initial public offering] candidate.

SN: An acquisition candidate for somebody already in the market or for a new entrant?

BERNSTEIN: They have such significant market share in their market that I think it might be difficult for somebody else who has a large presence there to acquire them. Conceivably, somebody like an Albertson's is a possibility, I suppose.

Another company that I'd note is Shoppers Food Warehouse, which is a supermarket operator in the Washington D.C. area with about 35 stores, and they have kind of a wholesale price-impact presentation, where the core of the store is very warehouse-like, while on the perimeter of the store, they compete on perishables with anybody in the industry, and they've been able to carve out a very nice niche for themselves in the D.C. market by operating under the price umbrella that Safeway and Giant Food have provided. They are far and away the lowest priced operator in the market, and they recently have undergone a transition from a family-owned business, so I think you'll see some pretty decent margin improvement there and some cost savings going forward.

SN: Do you have some companies you're not so optimistic about?

BERNSTEIN: Yes. I think that in general, one of the more interesting things to watch over the next year will be how things evolve in the Northeast. It's just a brutally competitive environment there. You've got some fairly well capitalized operators like Edwards increasing its presence, you've seen a lot of capital expenditure activity from A&P in the form of new stores and remodels, and you've also seen them be very promotional in terms of price. As a result, things have gotten tougher in the Northeast and it's just reflective of a very fragmented environment.

Grand Union Co. has taken some very severe blows as a result of that, and they've really been facing tremendous competitive pressures since they came out of bankruptcy in 1995. Another one to keep an eye on is Penn Traffic Co., which has historically invested too much in acquisitions and too little in bringing acquired stores up-to-date.

One of the sleepers that a lot of people in the high-yield market might be overlooking is Pathmark, which has a real chance to turn things around. I think they will be better focused on spending appropriate levels of cap-ex on their core store base going forward. I think there's a big push under way at Pathmark to train employees to have a more solicitous attitude and be more helpful in stores. I think you're seeing them cut costs in terms of administrative head count and systems, and going forward they may be one of the self-distributing chains that goes outside and contracts for a nonunion distributor. VINEBERG: Obviously, somebody's got to win in the Northeast, as Ted said, and to some degree it might be a battle of balance sheets, which doesn't necessarily mean that Pathmark loses, but I suspect that if Grand Union loses, maybe A&P comes out a winner, or at least one of the winners in that market. Edwards is clearly positioned, and if it had better penetration in the market, they'd have more to win. But I think A&P has one thing going for it -- I think there is a battle of balance sheets going on in the Northeast, and they have a better balance sheet than some of these other operators.

SN: What about other companies that are not high-yield?

VINEBERG: The losers as a class will be second- and third-tier highly leveraged regional chains, who will be in real trouble over the next five years. I'm talking about the Grand Unions and the Penn Traffics in the unionized, sort of urbanized, protected markets where they have been afforded some protection and have milked markets for a long time. And the Southern unionized chains like Bruno's, which are better operators and have better facilities than their Northern counterparts, have to withstand a lot of supercenter competition, and Winn-Dixie Stores and Publix Super Markets rolling out unlimited numbers of stores. Randalls Food Markets, Bruno's and the like are having a real tough time, and as a class that group of companies is in real trouble.

I think the winners are basically the two large private chains, H.E. Butt Grocery Co, San Antonio, and Publix. I still think growth is possible in this business -- Albertson's is trying it -- but as a public company, it's very difficult to balance what you need to do in the short run to get growth going and get into new markets because a lot of analysts just don't think it's worth entering new markets with the kind of facilities they want to build.

Publix doesn't really care what Wall Street thinks. They went into Atlanta and carved out a 20% market share in three years. It costs you a lot of money to do that, but 20% of Atlanta is worth having, and I think there's a real advantage to being a private nonunion company, and H-E-B and Publix have really been the best growth companies in this industry in the last few years.

GIBLEN: I'd second the idea that Pathmark could be a huge winner because the history of the industry shows that you can turn around even quite a tarnished franchise with astonishingly dramatic rapidity if you have the right management team in place, and certainly [Pathmark chief executive officer] Jim Donald's record from Safeway, and prior to Safeway, is extremely strong, and he really did a land-office job revitalizing the Safeway D.C. division. I think Quality Food Centers, is going to be a real winner. There's every reason to believe it can get a lot of success out of its acquisition integrating stores, plus it has the core growth in Seattle, which remains very strong; and it's opened up a new theater of war in Portland, Ore., and that's going to be big because it will probably get bootstrapped by an acquisition -- just a few stores here and there. So I think that is the company whose reach really is the most ambitious. They're pursuing hyper-growth, and they have a unique holding-company structure and they will be able to execute it. Safeway, absolutely, has a lot of gas still left in the engine, and the big surprise could be if they continue to make some acquisitions and basically keep on rolling the clock back on reproducing at each of the acquired companies what they did in nine separate Safeway divisions. I've been a fan of American Stores Co., and it's worked out pretty well. I think it's just kind of shooting fish in a barrel in terms of the kinds of improvements they can effect, and they are implementing it well, so that should be a winner. Many of the same turnaround steps are in place there as at Safeway. On the negative side, I do have concerns about Hannaford Bros. I think new market entry is tough, and that's been proven -- I can think of virtually no examples where it's been a success. The Publix example [in Atlanta] had some unique characteristics to it, and they were far better positioned to go into Atlanta, which was semi-contiguous and they didn't have union labor. But Hannaford has a host of structural disadvantages in the Southeast, they've executed rather poorly, it doesn't look like they're making any progress, and in three years they haven't achieved a whole lot. Hannaford is kind of stuck between a rock and a hard place, or maybe more to the point, between Sobey's in Canada and the Southeast, so they had to make a new market entry, though it hasn't gone particularly well.

And A&P remains a perpetual underperformer. You simply do not have the catalyst in the form of new strategy or new management or proactive shareholder-oriented ownership in the form of the Tengelmanns to achieve any sustained change there.

COMEAU: Of the companies I continue to watch, I echo what Ted said about Pathmark. That will probably be a company to watch in the next couple of years, as they likely could be one of the winners or at least the survivors in this market, and I'm a believer in the current management's ability to do that. Of the publicly traded companies, I think Safeway is going to have an interesting year. They should have a continuation of very good earnings for the next year or so. There will be some issues with sales with the rest of the industry, and they are clearly in the spotlight all the time -- week to week, month to month, quarter to quarter -- and I think they'll deliver good numbers in the next year or so. It'll be a good stock, and we're all waiting to see what the next step after this is -- whether it's an acquisition or something else -- and that will probably be a stock in the spotlight for the next year or two. On the negative side, I'd still be fairly concerned what happens to Albertson's. I don't necessarily think they'll have an enormous amount of success in the next year. I think they'll do OK and push their initiatives ahead and do what they need to do to try to get their business on a little more competitive footing from a service and marketing or merchandising perspective. But the balancing act between doing that and delivering earnings is a difficult one, and I don't think they'll be overly successful in doing that. So my sense is that you'll see the continuation of relatively weak top and bottom lines.

LEVIN: I disagree with Gary on [his assessment of] A&P. I look at the company and say, yes, they are very far behind vs. what competitors have done, but they are investing in stores, they're investing in technology, they're improving how they run the stores. It's very slow. It's not a company that is by any means consistent everywhere, but I believe that in their core markets they're making the right moves, and that over time you're going to see a steady improvement -- and in fact their operating earnings have continued to climb since they were at the bottom in 1994, and I expect you'll see earnings growth year over year. On Hannaford, I'd also be much more optimistic than Gary is because Hannaford never anticipated the Southeast would be immediately profitable, and maybe instead of the Southeast being profitable for them in five years, it's going to take six years. But the very fact that they'll be close to critical mass by the end of this year in terms of the number of stores they've got, and with their own distribution center, indicates that the cost structure is going to work, and once you get into 1998 and beyond, it's going to be better -- though it probably won't be profitable for them until 1999 or 2000. But there's no question in my mind that the investment they're making in the Southeast is going to pay off. I am also most enthusiastic about Safeway and Kroger Co. and American Stores -- large, multiregional companies who are very adept at improving operating profitability Safeway has gone the fastest. There's still more room to grow, but I think they'll be able to do a lot with Vons Cos., and there will be acquisitions in the future, but major ones could be two years off or longer. Kroger does not have the same level of EBITDA margin that other major players do, but year by year they continue to improve it, and I expect they will continue as some of the investments they've made in distribution and technology pay off. American Stores is at a very interesting place. Right now they're just at the cusp of starting to see a payoff on the Delta program that they've been investing in for over three years. And I actually think Food Lion's acquisition of Kash 'n Karry Food Stores, even though it's delayed in terms of when it's going to pay off for Food Lion, is going to help the company significantly in 1998. Of the companies that I'm negative on, I'm concerned about Winn-Dixie. They certainly showed some poor results in their most recent fiscal year. Their cost structure seems to have gotten out of hand, and every quarter they've reported over the last year to two years, their expenses are rising faster than their gross margins and they haven't really gotten enough sales in the new stores that they've built.

And I have some skepticism as to whether Penn Traffic will be able to turn the company around or how quickly they'll be able to turn it around. I'm encouraged by the new management, but the sales trends are weak and the competitors are not standing still.

VINEBERG: I think so many people want to get into the Southeast, Hannaford would have no problem selling that division. They could sell it tomorrow to a number of people. One of the reasons why the Southeast is so competitive is because too many people are trying to build there, and if Hannaford decided that they want to sell, there are a number of companies who would be very interested, bigger companies like Albertson's and Publix and whatnot, who would be very willing to pick up a turnkey operation with a distribution center in the market and existing stores in the right sizes -- I don't think they'd have any problem. I think the Northeast is probably more of a problem [than the Southeast] because even though Ahold would be interested in buying the Northeast, I think a lot of the domestic operators really have no interest in northern New England because they see the population growth there as being too limited, and that's why Hannaford went to the Southeast. GIBLEN: The Southeast has plenty of real estate and wide-open spaces, and it's pretty easy to build new sites, so the value of the Hannaford sites is limited and a lot of operators would rather start a new site than inherit problems that existed in the past. There's a saying that applies here -- don't lie down in a sick man's bed -- so I don't see a lot of buyers for the Hannaford stores.

ZIEGLER: The most dynamic company among traditional operators is probably Quality Food Centers. I think putting Dan Kourkoumelis down in Los Angeles is going to do wonders for the Hughes operation. I think he's got a tough challenge to make Hughes more like Quality Food Centers, but I think the Quality Food Center operation up in the Pacific Northwest has a terrific opportunity to expand, not only in Portland, Ore., but also pushing out into the expanding Seattle suburban market, where there's a lot of opportunity. I would also mention Safeway. I see a very exciting change in this company, not only in their stores and their private label, but in their employee attitudes. You can't go into a Safeway now without being greeted by an employee, and I think it's a remarkable change that will continue. And I like [CEO] Steve Burd's philosophy about acquiring Vons and his absolutely stated program that he's going to make further acquisitions -- and since I'm a believer in consolidation, I think this is a company that is going to do it, so I'm very excited about them.