FLEMING AND KMART SIGN EXTENSIVE SUPPLY DEAL

DAVID GHITELMAN

DALLAS -- Fleming here said last week it has signed an agreement with Kmart, Troy, Mich., to provide substantially all the food and consumable products in all current and future Kmart and Kmart supercenter stores.

The 10-year agreement will produce $4.5 billion worth of business in its first year, which begins July 1, a Fleming spokesman told SN.

Fleming said the arrangement includes grocery, meat, produce, frozen foods and dairy, among other items. The company added the agreement may be expanded to include health and beauty products.

In a related development, Fleming said last week the Yucaipa Cos., Los Angeles, will make a $50 million dollar investment in Fleming, which will give Yucaipa control of approximately 8.7% control of Fleming's outstanding stock, the same entity that's obtaining an interest in Kmart .

On the day news of the Kmart agreement and Yucaipa investment was released, Fleming shares rose 45.4% on the New York Stock Exchange.

Last month, Ronald W. Burkle, Yucaipa president and chief executive officer, revealed that Yucaipa and a business associate had accumulated a total of 6% of Kmart stock since September.

Industry analysts offered SN diverging opinions of the Kmart-Fleming deal.

Some said the agreement was the fruit of steady cost-cutting and business-building efforts at Fleming over the past two years.

Others, however, said Fleming could be overextending itself in an effort to gain a large but possibly unprofitable piece of business.

Among the chorus of skeptics was Jeff Noddle, president and chief operating officer, Supervalu, Minneapolis. Supervalu, which by its own estimate currently supplies roughly two-thirds of Kmart's groceries, had been Fleming's principal competitor to become the sole grocery supplier to the mass merchandiser until last month when Supervalu dropped out of the bidding process. The company said at the time the terms Kmart was demanding would not permit Supervalu to earn a profit.

Speaking last week at the Credit Suisse First Boston Food & Drug Retailing Conference in New York just after the Kmart-Fleming agreement had been announced, Noddle repeatedly emphasized the amount of work ahead for Fleming.

"This is an enormous task for Fleming and Kmart," he said. One reason Supervalu bowed out of its bid for the business was, he noted, "We didn't want to we didn't want to place our basic customer base at maximum risk.

"I don't want to comment on what Fleming's situation might be on this, but it's an enormous undertaking."

Fleming appears to have little doubt about its ability to profit from the Kmart arrangement. The company said it anticipated earnings per share will be $1.90 in 2001, $2.50 in 2002 and $3.30 in 2003, up from a previously announced estimate of $3. Fleming is scheduled Wednesday to report fourth-quarter and full-year earnings for 2000.

The company also said it is fully prepared to take on the task of supplying Kmart.

"We have a meticulous plan in place," Shane Boyd, Fleming vice president, communications, told SN.

Boyd said that Fleming will need three additional distribution centers to handle the Kmart deal. "I wouldn't expect them to be new-built," he said. "We are negotiating with other parties [to obtain existing facilities] in the Northeast, Ohio Valley area and Pacific Northwest, three geographies where we don't have the coverage."

The new warehouses would give Fleming the ability to service accounts in all 50 states, the only company with that capability, noted observers. "Having a national distribution network opens doors to some other business opportunities," said Boyd.

Some of those opportunities began approaching the company on their own last week, he added. "I can't tell you how many call we've received today from independent and chain retailers."

The reason Fleming can handle the business, according to Boyd, is it has a centralized procurement system. "Fleming has spent the last two years reducing its cost structure," he explained. "That's key. That's why the deal is profitable for us. And it is making people aware that we can now do what we were not able to do two years ago."

Several analysts also expressed confidence in Fleming's ability to handle and profit from its new arrangement with Kmart. Meredith Adler, equities analyst, Lehman Brothers, New York, told SN, "I don't think there's any doubt this is a good deal for Fleming. It's a win-win.

"This is a unique partnership. That Kmart would source general merchandise on behalf of Fleming is awesome. If Fleming wins Kmart's health and beauty business, that makes them much more valuable a partner for other people."

Adler said she believed Supervalu may have dropped its bid because it saw potential conflicts between servicing Kmart and its other customers. "Supervalu has larger customers with more overlap with Kmart. Its geography is closer to Kmart's core market," she noted.

Gary Giblen, director of research and senior vice president, C L King Associates, New York, took a more skeptical view of the Fleming-Kmart deal. "The big question is unanswered," he told SN. "Why would anybody presume that Fleming could make money when Supervalu says it can't?

"Last year, when Kmart divided up its distribution business, it awarded every possible piece of business to Supervalu. Supervalu is the preferred buyer and more efficient company. It's hard to see how Fleming can get any profitability, let alone acceptable profitability, from this."