OBSTACLES AHEAD

SN STAFF

Executives are expecting a tough uphill climb in meeting their financial projections during the second half, despite healthy tax rebates and an economy that is slowly showing signs of an uptick.

Most executives interviewed by SN said they met their first-half-year projections and performance goals. However, rising labor costs, individual states wrestling with budget shortfalls, a less-than-confident consumer, and overall competition were cited as big issues of concern going forward in the next six months.

The fallout from the bankrupt Dallas-based Fleming Cos. proved to be an opportunity for Save Mart, Affiliated Foods Southwest and Unified Western Grocers as these companies look to reap the benefits of new business in the second half (see related news on C&S Wholesale Grocers' bid to acquire Fleming's grocery wholesale business, Pages 1 and 18).

Most executives expected the sluggish business climate to continue into the second half. Ron Marshall, chief executive officer, Nash Finch, Minneapolis, said his company is prepared to face a second half that isn't much better than the first.

"In the summer of last year, we began to see a lot of uncertainty and nervousness in the marketplace, and we began to prepare accordingly," he said. "We began then to see people going to cheaper cuts of meat, lower-priced brands and more private label, and that accelerated in the fourth quarter.

"Our expectation is that conditions will not get any better through the rest of this year," he added. "A lot of people were expecting a 'victory bounce,' but I don't see that happening. We don't expect any robust rebound in the third and fourth quarters."

Commented Jerry W. Davis, "Business hasn't been bad; it just hasn't been good." The chairman, president and CEO of Affiliated Foods Southwest, Little Rock, Ark., added, "Normally, business goes up and down, but we haven't had an up-and-down business environment. We've had what I call a stalemate. Hopefully, we'll see that change."

Always a Challenge

A main concern for executives is the unrelenting squeeze from the competition -- namely Wal-Mart and alternative channels.

Craig Cole, chairman, president and CEO of Brown & Cole, Bellingham, Wash., echoed the feelings of others when he said, "Everyone would like to see stronger sales growth, but it's very competitive out there and you have to fight for every dollar."

The biggest challenge is Wal-Mart, Cole noted. "We're doing better against them in general, but the big challenge is to level the playing field so we're not at a disadvantage in terms of the wages and benefits we pay."

According to Neil Golub, president and CEO, Price Chopper Supermarkets, Schenectady, N.Y., "Wal-Mart will continue to open stores in every city, village, hamlet that you can think of, and that will be a challenge for everybody."

He noted how quick the competitive landscape was apt to change. "You've got a lot of these other guys that are opening food stores: the Aldis, the Save-A-Lots, the Price Rites. They're all going up at the same time, changing the way the pie is divided up."

He said Price Chopper will compete by rolling out aggressive marketing and merchandising programs.

"We're still a promotional retailer," he said. "We are continuing to do things that attract the attention of our customers who look for the kind of values we offer.

"Our stores have gotten bigger and better merchandised in providing a wide variety of perishables, which is one of our strengths," Golub said.

According to Tres Lund, president and CEO, Lunds Food Holdings, Minneapolis, the increasing competition from alternative channels is challenging his business. "We're seeing supercenters, limited-assortment formats coming, specialty formats growing and coming, and warehouse clubs," he noted.

"This market is developing pretty dynamically. Within five years, you're probably going to see 20% to 30% of market share held by non-union operators."

Despite a strong first half, with same-store sales approaching 4%, Ron Pearson, chairman and CEO, Hy-Vee, West Des Moines, Iowa, said he worries about the competition. "The competitive activity continues to be strong, even continuing to get stronger. We're having more supercenters open up against us all the time.

"We've managed that to date, but we have to continue to do a very good job because we have about 70% of our stores affected by supercenter openings in the last five years, with more openings on the way."

However, Pearson said Hy-Vee does not have to change direction to meet this growing challenge. "We feel very comfortable with our plan, and we'll continue what we're doing," which he described as giving stores "local autonomy to do what the customer needs and wants."

Costs on Rise

Rising costs also dampened some executives' projections for a robust end of year. According to Norman Mayne, president and CEO of Dorothy Lane Markets, Dayton, Ohio, "just watching costs," especially health care, will be a big challenge. "The fundamental costs of the business -- you can't let them get away from you," he said.

For Golub of Price Chopper, it's the rising labor costs. "I think everybody faces the challenge of added expenses, particularly in health care, pension and workers' comp," he said. "Those sort of things continue to move upward, and yet the economy is not as robust as it was. Inflation has really flattened out."

The economy and states such as California facing fiscal crisis are putting businesses under extra burden.

Al Plamann, president and CEO of Unified Western Grocers, Los Angeles, said, "We haven't owned up to the fiscal challenges in the state, including the need to attack workers' comp and insurance in general. In addition, the state's budget crisis will put a burden on taxpayers and businesses, and the cost structure is particularly difficult in the state because of its heavy reliance on small businesses now that many companies have moved their corporate headquarters elsewhere, along with higher-paying jobs, so the recovery here will take longer."

In the New York metropolitan area, D'Agostino's, based in Larchmont, N.Y., was hurt during the first half by the weak economy, particularly in New York City, where the fortunes of consumers are tied closely to the stock market, said Nicholas D'Agostino Jr., chairman and CEO. "The general stock market decline impacts us pretty heavily."

He said the company is trying to decipher the fickle mood of the Gotham consumer.

"The economics are so difficult because on the one hand, the customer is shopping in specialty stores, whether it be Citarella or Fairway, for unique items, and shopping in what they consider to be inexpensive 'other' stores for center-of-plate items and shopping at Whole Foods," he said. "It's a very difficult marketplace, so what we are trying to do is try and figure out how to find our own niche in that marketplace."

In the second half, he said he expects consumer confidence to play a big role in how the industry and his company in particular perform.

"The confidence that the consumer has in their spending and the way they lead their lives is going to influence us tremendously," he said. "We are making every effort to re-examine the way we go to market, and to see how we can better satisfy our customer. We're basically a New York City-based operation, and we're focused on, 'How can we satisfy that customer?"'

Consumer Spending

Jack Brown, chairman, president and CEO of Stater Bros. Markets, Colton, Calif., said, "Nationally, the tax rebate for each child will put $400 to $600 of real cash in many people's hands, and that will be positive for the industry. But the state of California has asked for a tripling of the automobile registration fee, and that could take some of that cash away."

Other executives, however, did not expect the larger tax rebates to result in a significant boost in their sales. Many viewed consumers as still remaining cautious and feeling uncertain regarding their jobs, the economy and world stability.

Plamann of Unified Western Grocers said the tax cut will have only a nominal impact. "We might see some people spending a little more, but people are not going to go back to buying expensive frozen entrees," he said.

According to Lund, "Shopper sentiment was still far from buoyant." He asked, "Are the emotions of the consuming public going to turn around because the war is over? I think people are still watching very closely. Are we doing the right thing in Afghanistan? Is the peace process going to continue? Are we at risk for problems in the U.S. and abroad? There are still a lot of emotional things we can't control."

Dorothy Lane's Mayne said he does not expect to see shoppers arriving at his stores eager to spend their tax cut money on food. "I don't see the tax cut doing a lot about how people are going to buy their groceries," he observed. "It will probably be more positive for the furniture and finance businesses."

Marshall of Nash Finch noted consumers have gotten used to paying little or no interest on major purchases, so spending could slow if interest rates rise. "Interest has been cut so much that businesses are going to find that they can't sell anything if it isn't free." However, retailers also will benefit from the tax reform changes. Golub pointed out the added benefit from depreciation. "Certainly, that will have some impact on [earning before interest, taxes, depreciation and amortization], and that will be good for us," he said.

Lund estimated the recently enacted cuts will lower Lunds' tax burden 8% to 10%. "Pretty significant," he commented.

New Business and Programs

What will really impact second-half results are the programs and new business initiated by the executives.

Robert Piccinini, chairman, president and CEO of Save Mart Supermarkets, Modesto, Calif., said second-quarter results were skewed somewhat by the addition of 25 Food 4 Less stores it acquired from Fleming, 19 of which have already reopened under Save Mart management.

The biggest challenge in the second half will involve trying to absorb 25 new stores, he added. "We've got most of them up and running, and now we're starting to tweak them to perform better," he explained.

Plamann said he also expects a boost in business based on Unified's ability to pick up new members in Northern and Southern California that had previously been buying from Fleming, "and we're also seeing some consumers buying a little bit more."

Stater Bros. is pinning some of its hopes for second-half improvements to changes at store level, including the conversion of all frozen food cases to reach-in door fixtures over the last eight months. This has enabled the company to increase item count by 600. Brown said the upright cases show the product off better and keep the aisles warmer, "and frozen foods is a good grossing item for us. Every time we've converted a store to doors, we've seen a sales boost in the frozen category within six weeks."

The company also expects to benefit from the ongoing expansion of florals, delis and bakeries, including the addition of the LaBrea Bakery artisan bread line in six-foot sections.

Cole of Brown & Cole said he's optimistic about the second half of the year because of a new marketing campaign the company has adopted and because of cap-ex spending. The new marketing program is the S&H loyalty program, which offers customers the opportunity to get price discounts on store merchandise (like loyalty card programs), or to earn points that can be used for even lower-priced items or for items from an S&H premium catalogue. Brown & Cole introduced the S&H program June 10 at about two-thirds of its 35 stores, with a rollout planned later this month to the other stores.

He also said he expects a sales lift from an ongoing remodeling program, in which the company is remodeling one store every three months.

Golub said he expects Price Chopper to perform well during the rest of the year. The company has opened one store so far this year, but has another seven or eight expected to open by the end of the year, including some that will be converted from former Kmart and Ames locations.

"That will certainly help us," he said. "We have many opportunities to improve margins and mix, and we're going to continue to do that, so we're optimistic."

As far as the second half, Affiliated Foods Southwest's Davis said he expects to be fully focused on absorbing the new retailers that have joined the co-op in the wake of Fleming's closure of its warehouses in Lafayette, La., and Geneva, Ala.

"Getting good, properly trained help will be our big challenge in the next six months," he said. "Getting geared to handle this big influx in business and efficiently handling it -- that's the other side of it. We've got to do it, and we've got to do it efficiently, too."

Lund's secret weapon for the second half is simple: hard work. "We work very hard for every incremental sale that we've gained," he said. "It's been tough going, and we've worked hard at not only hitting our goal, but pushing beyond it."