TIGHT CONSUMER SPENDING HOLDS SALES PERFORMANCE BACK

Elliot Zwiebach

For supermarket retailers, it was an ugly second half of 2002, and the first half of 2003 isn't looking much better, industry analysts told SN.

Overall sales gains were modest for most of the Top 10 publicly traded companies, with six of them experiencing negative same-store sales results and four suffering lower operating income, including one -- A&P -- that had an operating loss.

Total sales for the 10 companies declined an average of 16.3% from the second half of 2001; same-store sales for the third quarter or its calendar equivalent were flat, compared with a 1.7% gain a year earlier; fourth-quarter comps fell 0.7%, compared to a 2.9% gain; and operating income dropped an average of 24.3% from the year-ago results.

"Industry sales slowed down pretty dramatically starting last summer, and I don't think we saw any real improvement during the holiday season," said Meredith Adler, an analyst with Lehman Brothers, New York. "Sales were weak and the environment got heavily promotional during the second half, and the first half of this year is providing more of the same."

Adler said it's difficult to pinpoint any specific reasons for the malaise. "Consumers just got very cautious, and the shocking thing is seeing how much of sales is really discretionary. For most people, it's not a matter of not having the money to spend -- it's just been a matter of not wanting to spend it."

If anything has changed in the first half of this year, Adler said, "it may be that we're seeing less promotions and stronger margins than we did three or four months ago. In addition, with less deflation, there's a little less pressure on sales. But it's hard to say there's any kind of positive trend evident."

Jonathan Ziegler, principal in PUPS Investment Management, Santa Barbara, Calif., said the second half of last year was negatively impacted by a host of factors, including cannibalization from existing stores as the chains cut back on new-store growth; growing competition from supercenters, clubs and dollar stores; escalating deflation; the loss of share-of-stomach to the food-away-from-home segment; "and the pervasive inefficiencies inherent in the industry, as exemplified by the flap over vendor allowances."

All those trends will continue to hamper first-half results, Ziegler said, "though I'm a little more optimistic that, with the end of the war and if President Bush is serious about pumping up the economy with tax cuts, there could be some positive spin-off for supermarkets, though none of that will happen until the second half of the year."

Gary Giblen, senior vice president and director of research for C L King Associates, New York, said what he termed "disastrous" second-half results stemmed from a confluence of declining consumer confidence, intensified price wars in some markets, ongoing deflation and continued acquisition indigestion, "and the first half of this year is really more of the same. But I believe things have bottomed out, and we should begin to see results getting a little better by the second half of the year."

Edouard Aubin, an analyst with Deutsche Bank Securities, New York, said the margin squeezes that impacted the second half of last year could continue through the first half of this year. "Given the negative inflation differential, it's difficult to see how food retailers could surprise us on the upside," he told SN.

Looking at second-half results at each chain, analysts had the following observations:

KROGER CO., Cincinnati, with overall sales up 3%, comparable-store sales down 1.3% in the third quarter and 1.2% in the fourth quarter, and operating income down 3.4%.

Kroger had some difficulties during the half finding the right mix of promotions and profitability, Giblen said. "It overdid it on promotions in the third quarter to build profits, then rectified the balance in the fourth quarter," he pointed out.

Adler said Kroger's sales increases were attributable to increased square footage, while comps were off less than they were at the other major chains. "Kroger seems to be outperforming the industry, though not by as much as it once did," she noted.

SAFEWAY, Pleasanton, Calif., whose overall sales rose 1.1% while comps fell 0.7% and 1.3% in the third and fourth quarters, respectively, and operating income dropped 63.2%.

Square footage growth helped Safeway's top line, Adler said, but comps were negatively impacted by the chain's performance at two of its acquired divisions: Dominick's in Chicago and Randall's in Texas. An inability to reach an accord with the United Food and Commercial Workers Union prompted Safeway to announce plans to sell Dominick's.

Safeway's operating income was impacted by writedowns of asset values at Dominick's and Randall's in last year's fourth quarter, Adler added.

According to Giblen, "Every quarter for Safeway seems to get worse than the one before after years of being the best-managed company in the industry."

ALBERTSONS, Boise, Idaho, with overall sales down 3.3% in the half, comps down 0.8% and 1.5% in the third and fourth quarters, respectively, and operating income down 19%.

Analysts agreed that the drop in overall sales was due largely to the shutdown of 8% of Albertsons' retail base during the past two years, including a complete pullout during the first half of 2002 from Memphis and Nashville, Tenn., and from Houston and San Antonio, plus the closing of more than 300 underperforming stores around the country.

According to Adler, the chain's comps would have been down as much as 4.5% if pharmacy sales were removed from the comparison; however, Albertsons does not separate comps by retail segment. She said operating income was impacted by Albertsons' decision in the fourth quarter to invest in price and promotions, which pressured gross margins.

AHOLD USA RETAIL, Chantilly, Va., whose second-half sales rose an estimated 9.2%, with third-quarter comps up 1.6%. Other figures were not available because the company has delayed releasing fourth-quarter results while it attempts to deal with investigations of vendor allowance policies in its U.S. Foodservice division.

According to Giblen, Ahold USA Retail did well during the second half. "The bottom didn't fall out for Ahold as it did for others in the second half, because Giant Food and Stop & Shop pretty much owned their respective markets against generally benign competition in Maryland and Massachusetts, respectively."

DELHAIZE AMERICA, Salisbury, N.C., a division of Belgium-based Delhaize Group, whose sales fell 2.6% in the half, with comps off 2% and 1% in the third and fourth quarters, and operating income up 4.6%.

The company saw some erosion in its results during the half, Giblen said, "but not the kinds of downticks Kroger and Safeway experienced," with Food Lion in the Southeast benefiting from population growth and ongoing investments in gross margins to keep sales up at a time Hannaford and Kash 'n Karry were seeing economic pullbacks.

WINN-DIXIE STORES, Jacksonville, Fla., whose sales

rose 0.7%, with comps up 2.1% and 1.3%, respectively, and with operating income dropping 2.1% for the half.

Giblen said Winn-Dixie's second-half results "constituted a stellar performance against the group and reflects the results of a series of turnaround moves that were effective in driving results, including reformatting about 20% of the store base to the SaveRite warehouse format and becoming the first in its market area to offer a frequent shopper card. While it's still uncertain whether those results are sustainable, they were successful in driving short-term improvements."

Ziegler said Winn-Dixie was going up against easy comparisons in the second half. "But the management there has really revitalized the chain by remerchandising the stores, making them more user-friendly and delivering customer service, all of which has resulted in positive same-store sales," he said.

According to Adler, any significant boost to Winn-Dixie's topline sales was offset by the ongoing shutdown of underperforming stores, including exits from the Texas and Oklahoma marketplaces, she pointed out. "Winn-Dixie management did a good job boosting income," she added, though several onetime costs affected those results, she noted, including charges for rolling out the frequent shopper program, store closures and implementation of a new management bonus plan.

A&P, Montvale, N.J., whose sales rose 1%, with comps up 2.7% and 1% in the second and third quarters, respectively, and with an operating loss of $20.6 million.

A&P sales were hurt by "extremely competitive environments in virtually every market they operate in," Adler said.

According to Giblen, "A&P is caught in a vortex, with everything spiraling downward. It hasn't been able to execute Great Renewal 2, and it's being targeted in metropolitan New York and Michigan by other operators who perceive A&P to be weak and wounded, and are going for blood."

PATHMARK STORES, Carteret, N.J., where sales fell 0.7%, comps dropped 1.6% and 2.6% in the third and fourth quarters, and operating income rose 167.3%.

After suffering a bad third quarter, Pathmark stabilized itself in the fourth, Giblen said, as Eileen Scott succeeded Jim Donald as chairman and chief executive officer, and oversaw a strong fourth-quarter turnaround. "Pathmark became more aggressive in responding to ShopRite's price promotions and initiatives, and forcing ShopRite to retreat somewhat. In addition, Pathmark found more opportunities to improve its buying, and the decision to switch its ads from Sunday to Friday was a simple stroke of genius that worked better from the standpoint of consumers and store labor."

WHOLE FOODS MARKET, Austin, Texas, which saw sales rise 15.8%, comps rise 10.5% and 10.1%, respectively, and operating income climb 42.9%.

"Whole Foods continues to shine with strong execution and leadership," Ziegler told SN. "Like Costco, Whole Foods creates excitement at store level, and it takes market share because management is never happy with what it's doing and is constantly revitalizing the stores."

According to Giblen, "Natural foods have held up well during the recession, and Whole Foods has found the sweet spot for exciting execution and well-chosen real estate for new stores."

HARRIS TEETER, Matthews, N.C., a division of Ruddick Corp., Charlotte, N.C., which saw sales jump 4.8%, comps remain flat in the third quarter and fall 0.5% in the fourth, and operating income jump 8.8%.