SAFEWAY DECIDES TO KEEP AILING DOMINICK'S AFTER ALL

ELLIOT ZWIEBACH

PLEASANTON, Calif. -- Safeway here has decided Chicago is its kind of town after all.

After trying to sell Dominick's Finer Foods for 11 months, Safeway said last week it has taken the 113-unit Chicago-area chain off the market and installed as president Randall Onstead, the former chairman and chief executive officer of Randalls Food Markets, Houston, which Safeway acquired in 1998.

Industry analysts told SN that Onstead faces some serious challenges at the beleaguered chain, including negotiating a new labor contract and restoring Dominick's merchandising prowess to regain lost market share.

Safeway said the decision to hold onto Dominick's was prompted by the inability of the buyer it selected -- reportedly Supervalu, Minneapolis -- to reach an agreement with the United Food and Commercial Workers Union. "As a result, it makes more sense for us to stop marketing the chain and focus instead on improving the Dominick's operation," Steve Burd, chairman, president and chief executive officer, said. "Safeway shareholders will be better served by having us operate the stores instead of selling them for an unacceptably low price."

Onstead, the son of the co-founder of Randalls, has been working on "a range of retail projects" since joining Safeway in September, the company said. At Dominick's he will succeed Scott Grimmett, who will become president of Safeway's Denver division, with Paul McTavish, the acting president of that division, moving on to another position, the company told SN.

Burd said Onstead "is a person with CEO-caliber credentials and an undisputed track record running a very successful regional supermarket chain with the same 'family-owned' identity as Dominick's." He also called Onstead "a great merchant and a consumer-focused operator."

Safeway disclosed plans last December to sell Dominick's when it was unable to reach agreement with two UFCW locals on new contracts. The unions agreed to extend the expired contract after Safeway said it would try to sell the company and subsequently have extended the agreement on a day-to-day basis.

Representatives of the two UFCW locals told SN they are cautiously optimistic they will be able to work with Onstead.

"We're willing to give the new CEO a chance, especially if Safeway gives him the autonomy and authority to do what's necessary to restore the good employee relations, superior service and unique product offerings that characterized the old Dominick's," said S.J. Peters, communications director for UFCW Local 1546.

Elizabeth Drae, communications director for Local 881, offered similar comments. "We told Safeway that, if it decided not to sell Dominick's, we wanted it to appoint a new president who would hopefully work with the union to move forward on revitalizing Dominick's, so we're cautiously optimistic Safeway is truly interested in bringing back the value of this company and that we can work together to do so."

Industry analysts told SN they believe negotiations with the unions are likely to be contentious, given the historical strains on Safeway's relationship with organized labor.

Mark Wiltamuth, an analyst with Morgan Stanley, New York, said he doesn't rule out "some form of labor-related earnings disruption in the near term, [since] the original dispute over wages and benefits remains unresolved. Accordingly, there is some risk of a labor strike at Dominick's in the near future."

Andrew Wolf, an analyst with BB&T Capital Markets, Richmond, Va., said Onstead "has got to go in there and make nice to the union. That's mission critical."

Chuck Cerankosky, an analyst with McDonald Investments, Cleveland, also said it's imperative for Safeway to resolve the union issue. "Dominick's has an uncompetitive labor contract, and at the end of the day, the UFCW must recognize that. Union members are best served by having a viable contract so Safeway can grow its business."

Gary Giblen, senior vice president and director of research for C L King Associates, New York, said Safeway's moves carry mostly negative implications.

"Dominick's comps are running around negative 11%, and Safeway has been starving those stores in terms of investments, staffing and maintenance, so it will have to invest heavily to bring those aspects back up," Giblen said. "And Randall Onstead is an inappropriate choice because he has no turnaround experience, no experience with urban stores, no experience with unions and little experience in day-to-day operations."

Lisa Cartwright, an analyst with Citigroup Smith Barney, New York, offered similar comments. "Dominick's is a chain with a declining customer base, structurally higher labor costs, demoralized employees and a tired store base, so turning it around could take years and result in further management distraction," she said.

"The deteriorating state of the Dominick's business will make it tougher for Safeway to regain lost customers without a significant ramp-up in advertising, overtime pay and a new merchandising strategy."

Wiltamuth said the decision to take Dominick's off the market "is a disappointment for Safeway, as it puts an underperforming store base with an unresolved labor dispute back in management's lap."

He said Dominick's has been running near break-even levels through the first nine months of the year, so switching it from a discontinued operation to a continuing operation is unlikely to have significant impact on earnings per share. "However, on the sales line, market-share loss and negative same-store sales trends at Dominick's [could] put some downward pressure on Safeway's comp performance in the fourth quarter and beyond," Wiltamuth pointed out.

Jonathan Ziegler, principal at PUPS Investment Management, Santa Barbara, Calif., said the union issue will be a major challenge for Onstead, but if he can resolve that, then his merchandising abilities could return Dominick's to its former glory and provide a blueprint for the rest of Safeway's operations.

"If Onstead succeeds in improving the merchandising at the stores and winning back market share, then it's natural to assume he could do the same at Safeway's Randalls and Genuardi's divisions and hopefully at the core Safeway stores," Ziegler said. "It could take a couple of months to figure out what needs to be done, and then maybe six to nine months to see if the merchandising plan works."

If Onstead is successful at reversing what Ziegler termed Safeway's "uninspired merchandising," then it's possible he could be designated as Burd's successor as Safeway CEO, Ziegler said.

Safeway paid $1.85 billion for Dominick's when it acquired the chain from Yucaipa Cos., Los Angeles, in 1998. The company acknowledged last month the value of the division had fallen to $315 million.

Safeway will revert back to reporting Dominick's financial results as a continuing operation beginning with the current quarter.

Safeway has listed Dominick's as a discontinued operation for three quarters, and it was unclear last week whether it would have to restate financial results to reflect the division's new status.