PRESSURE POINTS AT AMERICAN STORES

MARK TOSH

Salt Lake City -- American Stores Co. here achieved record results in 1993, but on the eve of its annual meeting here tomorrow it is facing a series of new challenges.

Faced with those challenges, American is keeping to its year-old six-point strategic plan -- which includes moves such as centralizing top management at headquarters and kicking up capital spending to upgrade facilities.

Victor L. Lund, president and chief executive officer, is the architect of the plan, which is generally seen as the impetus for the company's improved financial performance. Lund will address American's shareholders here Tuesday at the annual meeting.

Still, the new competitive and organizational challenges are threatening the company's operating momentum. Among the challenges facing American are:

Price war in Southern California: A significant increase in competitive activity in southern California threatens the low-price leadership position and profitability of American's Lucky Stores unit. The highly successful price-cutting program Lucky launched early last year has finally drawn aggressive response from Vons Cos., Arcadia, Calif., and Ralphs Grocery Co., Compton, Calif.

Dueling with super KMart in Chicago: Kmart, Troy, Mich., has dropped three of its Super Kmart Centers into the Chicago market, where American's Jewel Food Stores unit is the market-share leader. The Super Kmart units are low-cost, nonunion retail supercenters that attempt to draw customer traffic for general-merchandise business with tantalizingly low food prices.

A breakup in the management team: The unexpected departure of two senior managers, Larry Del Santo and Richard Goodspeed, both of whom joined Vons in late April. Del Santo had been hand-picked by Lund to oversee American's supermarket operations and carried the title of senior executive vice president and chief operating officer -- food. Goodspeed was executive vice president -- food.

American is the nation's second-largest grocery retailer, with more than 900 supermarkets. Annual sales total $18.8 billion (about 23% of which was attributable to the company's 787 drug stores).

American operates Lucky Stores in separate divisions in northern and southern California, Jewel Osco in New Mexico, Jewel Food in the Midwest, Acme Markets in the Mid-Atlantic states and Star Market in Massachusetts. According to industry estimates, the company holds leading market shares in Chicago, in Philadelphia and in certain California markets, including Orange county.

Lund declined to be interviewed for this article. However, he has spoken optimistically of American's strategic direction and its prospects for continued growth in recent presentations to securities analysts.

"We are beginning to reap the rewards of the changes that we have announced as part of our long-term strategy for the future," Lund told the New York Society of Security Analysts shortly after American's stock hit a high of $27.13 (adjusted for a two-for-one split) per share in March. An SN reporter attended the presentation.

"[These] strategies will allow us to deliver substantial sales and higher earnings," Lund said at the time. "And we think that will mean increased shareholder value." The "six critical success factors" for American, as outlined in last year's annual report, include reducing costs, focusing on market share, developing new formats, investing in new technology, improving merchandising programs and transforming American from a holding company to an operating company.

As part of his attempt to transform American's management organization, Lund began shifting key operating executives to headquarters here in December 1992. Del Santo, in his position overseeing the food-store operations, was expected to play a major role on that centralized team.

Del Santo, as reported, was named vice chairman and CEO of Vons, which is the leading southern California supermarket operator, with 345 stores. Goodspeed, who is a former president of Lucky Stores and a veteran of 38 years in the industry, was named president and chief operating officer of Vons, succeeding Dennis Eck.

Some observers believe the departure of Del Santo and Goodspeed leaves a hole in American's central management team. Del Santo was one of the architects of and key spokesman on Los Angeles television for Lucky's low-price program, according to Jonathan Ziegler, a securities analyst at Salomon Brothers, New York.

"Mr. Del Santo was largely responsible for curtailing the wholesale clubs' inroads into the supermarket sector by developing the Max Pak sections at Lucky Stores in order to give the customer a reason not to visit the clubs," Ziegler said in a recent industry report. "This program has since been rolled out throughout the industry."

In response to the two executives' departures, Lund named Robert P. Hermanns, a longtime company executive, as American's senior executive vice president -- food. Hermanns has overall responsibility for food-store results. The general managers of the company's six food operations report to him.

Goodspeed was not replaced "given the company's current transition to an operating company structure," American said at the time.

Hermanns was executive vice president and general manager for new business development with responsibility for developing an "alternative-store format" for American. American expects to unveil its new format, with "warehouse-style" racks and lower labor costs than traditional supermarkets, later this year.

On Wall Street, many observers downplay the recent management changes at American.

"I won't say it's not a problem because obviously they're both good men," said Mark Husson, a securities analyst at J.P. Morgan, New York. "But the good thing about American Stores is that it's centralizing and controlling far more of what's going on from the center."

If a company is run at the divisional level, as American had been, then it's important to have good people at the divisional level, Husson said. "If you're a central company it's less important," he added.

The changes on the competitive landscape, however, may have longer-term consequences. American is well versed in fending off traditional competition, but the most recent threats to its operations in southern California and Chicago take a new twist.

In Chicago, Kmart is operating with a nonunion workforce, which helps keep selling costs down and shelf prices low. (Jewel operates about 193 stores in the Midwest and has a high 36% market share, according to estimates.)

According to some observers, the most astonishing facet of Kmart's entry into the Chicago market was the lack of vocal opposition from labor unions. Jewel is a union operator and Chicago is a union town.

With the benefit of few competitive distractions, Kmart has quickly established a low-price image among Chicago shoppers. Salomon Brothers, in a price survey of five grocery stores in Chicago, found Kmart offering

the lowest price ($56.14) for a market basket of 30 items. The same basket at Jewel was priced at $63.18, just below high-end Dominick's at $63.71, according to the Salomon survey.

Lund told the New York analysts that some of Kmart's Chicago locations are very good and that Kmart is going to do "some business" in that market. "We're not ignoring them," he said. "We're taking them very seriously in the marketplace."

Lund said the one advantage American has in Chicago is that all Jewel's union workers are covered by American's health-care and retirement plans.

"We've had a good cooperative situation," he said.

In southern California, where Lucky operates 220 stores, Vons and Ralphs have attempted to reverse declining same-store sales with new pricing programs. Vons, which traditionally has emphasized service and merchandising over price, has been particularly hard hit by the weak southern California economy. In a marketing reversal, Vons has lowered prices four times this year in four separate waves, according to one observer, and Ralphs also has launched its six-point Ralphs Savings Plan.

"You don't have to be a genius to figure out that that is going to increase the pricing pressure for everybody out there," said Jack Russo, a securities analyst at A.G. Edwards, St. Louis. Lucky, Russo said, has always been perceived as "the low-price guy," but Vons executives have indicated in conference calls that Vons is not "all that far away from Lucky" at the moment.

"If that's the case, then I don't think the Albertson's and the Luckys are going to be able to take advantage of Vons much longer," Russo said. (Albertson's, Boise, Idaho, has about 150 stores in California.)

Still, Lucky's sales and profits have been on an upward trend since February 1993's decision to roll back prices on 2,500 items.

In the first quarter ended April 30, Lund said operating profit "was up sharply" at the southern California Lucky operations in spite of basically flat same-store sales. "Our consistent, credible message continues to receive good customer acceptance," he said.

Debra Levin, a securities analyst at Morgan Stanley, New York, said the Lucky Stores in southern California have shown improved gross margins as a result of "cycling past the price reduction program" rolled out last year.

Same-store sales at the southern California stores remain negative, but are better than the 2.37% decline reported for the company's overall Western food operations (Lucky North, Lucky South and Jewel Osco in New Mexico), Levin said in a recent report.

"The negative identicals are in large part due to the continued competitive pressure felt in California," she said. "Management stated that in southern California American has seen some 40 new competitive openings during the past 26 weeks."

American's management, according to Levin, continues to claim Lucky's prices are 4% to 5% lower than competitors.

Husson of J.P. Morgan said Lucky is turning in the best same-store sales results among any of the southern California operators. "Lucky has always had a reputation of being the low-price leader in that market," he said. "The thing Lucky did in the first quarter of last year really cemented that [image] in the consumers' minds and nobody has been able to shake it."

Maintaining market share in growing markets is one of the six points in Lunds strategic plan. He told the New York analysts group it will take three to four years to get the entire six-point plan accomplished.

Another aspect of the strategic plan is upgrading facilities. To this end, American has budgeted $700 million for capital improvements in 1994, about two-thirds of which are earmarked for building and remodeling supermarkets.

The early results of the strategic plan are positive: American reported record earnings of $247.1 million in 1993 and its first-quarter earnings per share of 34 cents exceeded Wall Street's consensus expectations. Selling, general and administrative expenses have declined as a percentage of sales in three of the past four quarters.

American's stock price initially rose with the year-end earnings news, but has since settled a little. It hit an historical high of $27.13 per share in March and was trading in the mid-$20 range last week.

One sign, however, that indicates concern about American's prospects is the increase in short-selling of its stock. In the month ended May 6, the number of American shares sold short more than doubled from 1.39 million shares to slightly more than 3 million.

A short-seller borrows shares, sells them and later buys them back to return to the original owner. If the price drops during that time, the short-seller makes a profit.

The short-selling in April and May, according to some observers, was most likely due to the sudden departure of Del Santo and Goodspeed.

Raising Profit Margins

In spite of relatively flat sales and price-cutting programs, American's operating profit as a percentage of sales rose in all four quarters of 1993 and the first quarter this year.

COMPARISON BY QUARTER OF OPERATING PROFIT AS A % OF SALES

1992 1993 1994

First Qtrs. 2.48% 2.53% 2.88%

Second Qtrs. 3.23% 3.27%

Third Qtrs. 2.94% 3.02%

Fourth Qtrs. 4.54% 4.79%

Lowering Operating Expenses

American had reduced its operating expense margins in the three quarters prior to the first quarter of 1994. First-quarter expenses for 1994 have been adjusted to reflect certain one-time charges.

COMPARISON BY QUARTER OF SELLING, GENERAL ADMINISTRATIVE EXPENSES AS A % OF SALES

1992 1993 1994

First Qtrs. 22.54% 23.21% 23.37%

Second Qtrs. 22.89% 22.81%

Third Qtrs. 23.41% 23.36%

Fourth Qtrs. 22.57% 22.45%

Sales Flatten Out

The sale of more than 250 stores in '91 and '92 initially caused a dramatic drop in revenues. Since then sales have stabilized.

PERCENTAGE CHANGE IN SALES COMPARED TO THE QUARTER 12 MONTHS PREVIOUS

1992 1993 1994

1st Qtr. -9.0% -5.2% -1.3%

2nd Qtr -10.5% -0.2%

3rd Qtr. -7.4% -0.9%