FRENCH OPERATORS SHINE AS U.K. CHAINS STRUGGLE

MARK TOSH

Food retailers in the United Kingdom are feeling the effects of competitive pressure and low inflation.

This is most notable in the declining gross-profit margins the two largest U.K. chains reported in their recent year-end 1993 financial results.

J. Sainsbury, the largest retailer in the United Kingdom, saw its gross-profit margin decline by about 40 basis points in the year ended March 12, according to Tony MacNeary, a securities analyst at County NatWest, London, who follows European food retailers.

At Tesco, the second-largest food retailer in the United Kingdom, gross margins fell about 70 basis points in the year ended Feb. 26, MacNeary said.

County NatWest has "hold" recommendations on the stock of both Tesco and Sainsbury.

"Gross margins have come down in the U.K. market since last November," MacNeary said. This is an operational issue U.K. retailers have not confronted for quite some time, but trends have completely reversed in the past six months with the advent of discount retailing and other competitive factors.

Retailers in the United Kingdom began to reap the benefits of higher gross margins in the 1980s with their aggressive rollout of the superstore format, MacNeary said. The larger superstores enabled retailers to offer wider product ranges, with more private-label, fresh food and other higher-margin items. Operating costs, which were basically fixed, were then leveraged against increased sales.

"You were basically seeing very large stores having more and more volume put through them," MacNeary said of the superstores. "So their economies of scale were growing."

Today, an amalgamation of factors is putting new pressures on gross margins, MacNeary said.

"It's not just discounters, although it's partly that," he said. Additionally, chains that were once thought to be weak operators are now turning up the competitive pressure with major price promotions.

For example, Gateway launched an aggressive price-promotion program about a year ago that has proved successful, MacNeary said. And Asda, another second-tier chain, has "managed to resurrect itself very strongly," he said.

In response to the ongoing price competition, the major retail groups are "endeavoring to basically cut operating costs," MacNeary said. "I don't think there is much hope of gross margins being rebuilt strongly in the short term. So attention is focused very much on hoping to keep margins stable because inflation is virtually nonexistent here."

Retailers also must go back to their suppliers to get "better terms of trade, but that's not going to be easy," MacNeary said.

With U.K. food retailers' prospects for improving earnings looking dim, some investors have turned their attention to France.

Leading French retailers -- such as Carrefour and Promodes -- have been active in international expansion for a number of years and already have footholds in a number of other markets.

These long-term international opportunities, coupled with solid market shares at home, help make the stock of French retailers among the most attractive in European food retailing, according to MacNeary.

MacNeary and David Shriver, another NatWest securities analyst, recently completed a study on French food retailing. Their findings resulted in "buy" recommendations on the stock of three French retailers: Carrefour, Promodes and Docks de France.

"We do have a very positive view on Carrefour as we do French food retailers in general," MacNeary said. The stock of Casino, another French food retailer, is rated as a "hold" by NatWest.

One of the strengths of Carrefour, according to the NatWest report, is that management has recognized "that it must begin to eradicate diseconomies in buying, sourcing and logistics if it is to capitalize on its industry leadership on a domestic and international basis."

Earlier this year, Carrefour announced a plan that "embraces a major restructuring of management in France" and which represents another step toward centralization, the NatWest report said. "While recent shifts in strategy toward greater control from the center carries risks, it is also the key to the company's long-term development," the report said. "1994 and 1995 will be the critical years for Carrefour [to determine] whether it can successfully make the transition to a more focused and less entrepreneurial culture."

Promodes, which NatWest called "one of the most exciting growth vehicles in European food retailing," already has benefited from centralization. In 1992, the company set up Promodes World Trade as a Geneva, Switzerland-based central buying office. This office will procure as much as 8% of Promodes worldwide sales by the end of the year.

"The purpose of Promodes World Trade is not to bludgeon manufacturers into accepting volume-related discounts, but to identify savings in the cost of production and distribution for the manufacturer, which Promodes will share," the NatWest report said.

Docks de France, a medium-sized French food retailer, exceeded NatWest expectations in fiscal 1993 with net income of $79 million, an increase of 16%. Docks is "capable of sustaining market share by astute management of its brand franchise across a number of key formats," the NatWest report said. "A strong domestic position is reinforced by an excellent Spanish operation."