WILD RIDE

ELLIOT ZWIEBACH

It was a topsy-turvy first half for food stocks.

After outperforming the general market for four years, many food stocks took a nosedive during the first six months of 1999, significantly underperforming the market.

The 38 stocks in the SN Composite Index -- which includes retailers, wholesalers and mass merchandisers -- rose just 6.9% during the half, compared with gains of 19.4% for stocks in the Dow Jones Index and 11.8% for those in the Standard & Poor's 500. In contrast, the first half of 1998 showed the SN Composite up 39.2%, well above the general market gains of 14.4% and 18.4% in the Dow Jones and S&P 500, respectively.

Even more surprising was the fact most of the big gainers were small-cap stocks -- spurred, observers said, by takeover speculation -- while industry leaders like Kroger, Albertson's, Safeway and Ahold all watched their stock prices tumble into the negative range after soaring the year before.

Securities analysts told SN they attributed some of the falloff to the dose of reality that followed the euphoria of the major consolidation deals announced during 1998, including Kroger-Fred Meyer, Albertson's-American Stores Co., Safeway-Dominick's and Ahold-Giant Food.

"It was like investors had attended a wild party and gone home with someone they thought was very attractive, then woke up the next morning and found their partner didn't look so good anymore," Gary Giblen, New York-based managing director for Banc of America Montgomery Securities, San Francisco, told SN.

"Everyone had a good time during the fourth quarter when many of the big-cap stocks were at an all-time high, but clearance from the Federal Trade Commission for the Albertson's and Kroger deals dragged on and all the synergies and benefits investors had been anticipating suddenly became less immediate and more uncertain.

"And because the retailers themselves were busy laying the groundwork to make the mergers work, they had less time to talk to investors, and the resulting vacuum of information made Wall Street sell its food stocks and turn to other types of investments," Giblen said.

He also said the stock market shakeup in October had caused investor flight to more defensive stocks like supermarkets, "but as the world's economies turned around, investors were attracted to more growth-oriented stocks."

Jonathan Ziegler, San Francisco-based analyst with Salomon Smith Barney, New York, said the first-half shift away from food stocks was due to "new uncertainties" about the potential divestitures in the Kroger and Albertson's deals and speculation on whether Safeway would or would not make another major acquisition, combined with the perception by some that the industry has fully consolidated, "which made Wall Street lose interest," he said.

But the shift by investors away from food stocks was also part of a natural cycling process, Ziegler told SN. "Food earnings continued to be strong, but investor interest turned to name stocks with international exposure as the global economy bottomed out and then turned around," he explained.

"And more managements began mentioning the D-word -- deflation -- which impacts on comparable store sales and creates a psychological negative for investors."

Mark Husson, an analyst with Merrill Lynch, New York, said investor excitement over the mergers and acquisitions during the second half of 1998 continued "only as long as there was fresh blood in the water. But with the delays in government approval, investors began selling off those stocks for more cyclical stocks."

Chuck Cerankosky, an analyst with McDonald & Co., Cleveland, said profit-taking by investors in food stocks, combined with the rotation of investments to other sectors, pushed food stock performance down for the first half "as investors rebalanced their portfolios away from the food stocks that had become a large part of their holdings over the last few years."

According to Ted Bernstein, a high-yield analyst with Grantchester Securities, New York, "Investors have become more enamored of sexy go-go sectors like Internet companies and the like, and see no need to retain their positions in defensive holdings like food stocks."

Ed Comeau, an analyst with Donaldson Lufkin & Jenrette, New York, said the group's underperformance had little to do with food stocks themselves and more to do with the market's rotation to more cyclical stocks -- investments that do well in a strong economy, like automotives, steel and oil -- and away from more stable defensive stocks like supermarkets, drug stores and health care.

"Investors had gotten away from the cyclical stocks last year, but with the economy doing so well and interest rates down, they shifted over to other areas," Comeau said. "Additionally, some of the food stocks had increased their valuations beyond their historic levels, but with those levels moving back down, the sell-off should be over during the second half and food stocks should move upward in line with the market -- and they could outperform the market again if investors move back aggressively toward defensive stocks."

Husson said food stocks tend to perform better in the second half of the year than the first "as over-ambitious expectations early in the year fall like the leaves in autumn and investors come back to more stable stocks," and Cerankosky said he expects some recovery in the second half as investors begin to see the payoffs from the big mergers of prior years.

Giblen said he expects the second half will be "considerably better" than the first "because the pendulum of stock prices swung too wide in a positive direction last year and too harshly in a negative direction during the first half."

Ziegler said he's looking for some catalyst in the second half "that will make the group interesting again to investors. That catalyst might come from the Kroger-Fred Meyer integration, which is going gangbusters, or it might evolve from what Safeway tells investors in a meeting at the end of this month about how the chain expects to continue to grow earnings."

He also said he expects the fundamentals for food companies to improve in the second half. "The majority of the acquisitions will be behind the industry, and the news coming out of those companies should be good because the integrations should be proceeding very smoothly," he explained.

"And if the economy slows down, investors will want to come back to more stable consumer stocks like food companies, although there's been talk of an economic slowdown for 18 months and nothing has come of it. But if the economy keeps rolling along and food stocks have to fight a headwind, then the group is likely to experience a further slowdown," Ziegler said.

Analysts talked to SN about some of the gainers and losers. Their comments follow:

BJ'S WHOLESALE CLUBS, Natick, Mass., up 33.6%, due to solid earnings-per-share growth and management's ability to talk to more investors two years after the company went public, Cerankosky said. "BJ's does a good job on the food side of the stores, and all the news is good as it gets overdue notice from investors and as it moves beyond its New England territory into the Midwest, the Mid-Atlantic region and Florida."

INGLES MARKETS, Black Mountain, N.C., up 29.8%, "because investors are focusing on it as one of the industry's takeover candidates," Giblen said.

SEAWAY FOOD TOWN, Maumee, Ohio, up 22.7%, "because of the good job it does protecting its market share," Cerankosky said. "It's a classic single-market operator, with all its stores in northwest Ohio, but it's showing positive comps, delivering earnings and making a few small acquisitions that help boost earnings. And there's some speculative takeover buying that's helping to keep the stock price up."

WAL-MART CORP., Bentonville, Ark., up 19.7%, "because it is delivering superior numbers that are better than expected," Ziegler said, "and making acquisitions and proving it is still a real growth story."

According to Giblen, "Wal-Mart's consumer confidence numbers are strong, and its acquisitions have sparked investor interest because it shows the company is willing to accelerate its growth rate."

A&P, Montvale, N.J., up 13.9%, which Ziegler said reflects investor confidence in what Christian Haub, president and chief executive officer, is doing. "He's taken control and introduced programs to revitalize the chain, and the result has been four consecutive quarters of positive comparable store sales."

Comeau said A&P stock is coming off a low base, "and investors are coming back in as they feel positive about the change in management and the company's new strategy."

FOOD LION, Salisbury, N.C., up 12.1%, "because of a dawning realization by investors that things are moving along better with the change in management earlier this year and the more active role being taken by (Belgium-based parent company) Delhaize," Giblen said.

Also raising investor confidence, he added, is the company's stock buyback program and the willingness by Delhaize to buy additional shares of Food Lion on the open market, "which demonstrates that management views the stock as undervalued and it's willing to spend money to repurchase it, which could be additive to earnings."

According to Ziegler, Food Lion is delivering good financial results "and running the best comps in the business."

Husson said Food Lion stock benefited this year from investors' poor perceptions in the past. "It started the year as one of the least loved stocks and slowly attracted people to it -- partly due to speculation that Wal-Mart, with its 'small mart' Neighborhood Stores that are so similar to Food Lion's stores, could acquire the company."

Comeau said investors are impressed by Food Lion's stock repurchase program "and the clear anticipation that the company will make acquisitions or ultimately will be purchased entirely by Delhaize, either of which would be accretive to earnings and would pay off investors."

COSTCO COS., Issaquah, Wash., up 12%, because of investor recognition of its above-the-club-industry sales growth -- on top of strong comps -- and its better-than-expected earnings, Ziegler said. "Costco management is never satisfied with what it has, so it's always striving to deliver more to customers."

FLEMING COS., Oklahoma City, up 8.8%, "because of investor excitement about the possibility that new management under (chairman and CEO) Mark Hansen has put strategies in place to turn the company around," Bernstein said. "They're encouraged that something is finally being done after years of inaction and that the company is responding to challenges."

KMART CORP., Troy, Mich., up 5.2%, primarily on takeover rumors, which Giblen said are exaggerated.

SMART & FINAL, Vernon, Calif., up 5%, "due to management changes and the attempt to build confidence, and the numbers are starting to come back a bit," Ziegler said.

According to Cerankosky, "The market is looking at Smart & Final and trying to ascertain when the turnaround will begin. New management is in place, but the problems have been growing for the past couple of years so investors are taking a wait-and-see attitude because no one expects a sudden turnaround."

WHOLE FOODS MARKET, Austin, Texas, up 4.5%, reflecting a rise in the stock's value "after it bottomed out early in the year when expenses got out of control," Giblen said.

WILD OATS MARKET, Boulder, Colo., up 2.9%, due in part to strong comparable store sales trends, Giblen said.

HANNAFORD BROS., Scarborough, Maine, up 1.7%, because of takeover speculation and anticipation of what the company plans to do with its home-delivery program, analysts said.

According to Husson, the boost in the stock price was due "not to the company's fundamentals but to strategic evaluations" stemming from the decision by Canada's Sobey family not to renew its standstill agreement, "which convinced many observers that it is prepared to sell its 26% stake and that whoever buys those shares might want to gain majority control of the stock."

Giblen said the stock was also strengthened by the expectation that Hannaford will do something with its Internet-based HomeRuns home delivery business -- "either sell it or find a partner," he noted -- "so to the extent Internet stocks go up or down, that helps or hurts Hannaford."

Comeau also said investors anticipate realizing some value from the company's stated intention to seek a partner for its HomeRuns program.

WEIS MARKETS, Sunbury, Pa., down 1.7%. "Weis is like a blade of grass that blows up or down based on takeover sentiment," Giblen said. "That sentiment was strong at the end of 1998 but it's weakened since."

KROGER CO., Cincinnati, down 3.7%, "following the euphoria when the Fred Meyer deal was still pending," Giblen said. "Now investors are facing the more mundane reality that the company has to do the spade work to get the integration going, and in these early stages, there's been no real earnings accretion yet."

Cerankosky said the company's stock has suffered from profit-taking ventures and the lack of real news about combining the two companies and what combined earnings would be like.

According to Ziegler, investors may also be concerned that Fred Meyer had integration issues of its own to resolve -- stemming from its 1998 purchase of Ralphs Grocery Co. and Quality Food Centers -- "and combining those concerns with concerns over integration issues between Kroger and Fred Meyer may have hurt the stock price."

RICHFOOD HOLDINGS, Glen Allen, Va., down 8.1%, due to the loss of business of Giant Food of Carlisle, Pa., analysts indicated. Richfood said in June it has agreed to be acquired by Supervalu, Minneapolis.

SUPERVALU, Minneapolis, down 6.3%, which Cerankosky said he attributed to "guilt by association with the problems of other food wholesalers, and the stock paid the price, even though Supervalu is the only star performer among wholesalers."

Giblen said he attributed the price drop to "investor boredom with the company's consistent, steady but non-inspirational growth in its wholesale division and the stronger growth in the smaller retail division."

EAGLE FOOD CENTERS, Milan, Ill, down 4.8%, due to an extremely competitive situation that pits the chain against Wal-Mart, Dominick's, Jewel and Hy-Vee, Bernstein told SN. "The stock came back slightly because of speculation about the possibility of Safeway's interest in acquiring Eagle, but even as Eagle continues to invest in its store base, the competition is really hurting."

Also fueling investor concerns, Bernstein said, is a $100 million bond payment due next April 15. "Looking ahead, investors believe the company must do something ahead of that date -- either selling or improving results -- so it can refinance the bonds," he said.

AHOLD USA, Atlanta, down 11.2%. "Ahold's stock is driven by a lot of foreign investors and their perceptions of the European economy," Giblen said. "And while Ahold's U.S. results have been strong, with the integration of Giant Food (Landover, Md.) way ahead of plan, investors are less enthusiastic about Ahold's pending acquisition of Pathmark because that's a weaker company than some of its other divisions."

GRAND UNION CO., Wayne, N.J., down 13.5%, which Giblen said was due to the fact the company's post-Chapter 11 turnaround is taking longer than anticipated. "The stock had been depressed right after the bankruptcy, and despite some excitement generated late in 1998 when the company spelled out its strategic plan, the numbers were a tad soft in the first quarter, so investors retreated to higher ground to take a wait-and-see attitude."

HOMELAND STORES, Oklahoma City, down 14.3%, because of the tough competitive challenges the company faces, Bernstein said. "In its two primary marketing areas of Tulsa and Oklahoma City, Homeland is going up against Albertson's, a formidable prospect that's reflected in the chain's relatively flat to down results," he explained.

On the plus side, however, he noted that Homeland has been making strides in same-store sales by becoming more promotional, albeit at the expense of cash flow, while making strategic changes by expanding its store base through small acquisitions.

MARSH SUPERMARKETS, Indianapolis, down 15.9%. According to Bernstein, "Marsh is an incredibly solid operation, but (chairman and CEO) Don Marsh has made it clear he has no interest in selling, and that's weighed negatively on the stock price because of investor concerns that Marsh will miss the consolidation wave."

WINN-DIXIE STORES, Jacksonville, Fla., down 16.5%, "due to inconsistent financial results in the wake of promises to Wall Street to do better," Husson said.

ALBERTSON'S, Boise, Idaho, down 17.6%, "which may be due to nervousness by some investors with the challenges of integrating American Stores," Ziegler said.

According to Cerankosky, the biggest problem with the stock "was the fact the FTC took 10 months to approve the American Stores transaction and required 145 divestitures, which was more than people had expected. At the same time the marketplace was worried about erosion in the business of the American Stores companies during that long period."

Comeau said investors are concerned that the effect of the delay and the divestitures will combine to impact earnings by 5-10 cents per share, "and there's also concern about the company's sales, which continue to be lackluster."

SAFEWAY, Pleasanton, Calif., down 18.6%, "which is the most mysterious decline of all," Giblen noted. "Perhaps Safeway was caught in the down-draft of investor boredom waiting for the Albertson's and Kroger deals to be approved and the fact Safeway did not make any acquisitions during the year, which made some Wall Street observers feel Safeway was outmaneuvered by Ahold in going after Pathmark.

"In addition, the Street is focusing excessively on acquisitions as a source of Safeway growth while grossly underestimating the internal growth potential Safeway still has," Giblen added.

According to Ziegler, Safeway stock hit an all-time high in 1998, "and perhaps some people thought that was as good as it gets and Safeway couldn't possibly do that well again."