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GAINING TRACTION
Increasing fuel prices and volume attrition from Albertsons may help supermarket operators achieve better financial results during the second half of 2005 than they did in the first half, industry analysts told SN.Although the 10 largest publicly traded companies appeared to strengthen sales and profitability during the first six months of the year, some of those improvements were due to weak comparisons
Elliot Zwiebach
October 3, 2005
14 Min Read
Elliot Zwiebach
Increasing fuel prices and volume attrition from Albertsons may help supermarket operators achieve better financial results during the second half of 2005 than they did in the first half, industry analysts told SN.
Although the 10 largest publicly traded companies appeared to strengthen sales and profitability during the first six months of the year, some of those improvements were due to weak comparisons with strike-impacted results in Southern California in the prior year among the Big Three -- Kroger, Albertsons and Safeway -- the analysts pointed out.
A comparison by SN of financial results among the 10 chains showed sales for the group increased 3.2% and operating income rose 14.6% during the first half; however, comparable-store sales on average grew more slowly than they did last year, rising just 1.1% for the first quarter, compared with a gain of 1.8% a year ago, and just 1% for the second quarter, compared with average gains of 2.3% a year ago. (Calculations to determine average comps excluded Winn-Dixie Stores, which did not report same-store sales results for either quarter this year.)
"The first half this year showed a modest recovery over last year, as improvements in the overall economy were reflected in accelerating sales," said Bryan Hunt, a Charlotte, N.C.-based analyst with Wachovia Securities, New York.
Financial results in the half also reflected mild food price inflation, compared with tenuous inflation in poultry and dairy prices a year earlier, he added, "which meant the cost environment was more manageable for retailers. In addition, the major chains benefited from the Southern California labor negotiations in the prior year, which resulted in better comparisons this year and reduced labor rates and health care costs."
Andrew Wolf, an analyst with BB&T Capital Markets, Richmond, Va., said financial results improved in the first half for several reasons. "The Big Three chains as a group started to get traction as they recovered from the Southern California strike, which helped their comps," he said. "In addition, the macroeconomic environment improved, and the moderation in inflation in food and product costs, particularly in the first quarter, was good for gross margins."
Jonathan Ziegler, an analyst with J.M. Dutton & Associates, El Dorado, Calif., was less enthusiastic, characterizing first-half growth as modest. "The numbers held up OK in the first half, though they certainly weren't very exciting," he said. "But the gradual recovery in the economy helped propel results, and the comparison with strike-impacted numbers certainly had a positive effect on results for the Big Three, which may have disguised some underlying issues."
Gary Giblen, senior vice president and director of research for Brean Murray & Co., New York, had a more negative opinion, noting that first-half results were mediocre, "as they have been for several years, with no clear indication of improvement." He said the major chains were still feeling the effects of the strike-lockout, "and they're still being hurt by alternate formats and the impact of gas-price shock on customers."
That shock is likely to continue into the second half, with gas prices hovering in the $3-a-gallon range, analysts said -- though that could prove a positive for supermarket operators, they added.
HIGHER FUEL PRICES
Ziegler said he believes higher fuel prices will translate into higher sales and, for companies selling gas, higher profits as well. "The fundamentals look healthy for the second half," he explained. "Higher prices will mean fewer meals away from home and more meals eaten at home with food purchased from supermarkets," he explained, "and that will be good for traffic and basket sizes. Furthermore, when people are financially strapped, they are likely to trade down to private brands, and while that's a negative on sales growth, it should boost margins."
Hunt said higher fuel and energy costs are likely to impact consumer pocketbooks to the tune of $1,000 to $1,100 per household, "and that strain will lead consumers to trade down from premium items to private label and to do more cherry-picking as well."
Wolf said he expects the second half to be "a little more challenging, primarily because of a slowdown in the consumer sector as gas prices rise, which means consumers will have less liquidity. But for the first time in years, I think supermarkets will make out better than some other sectors of the economy.
"On the earnings side, the continuing recovery from the Southern California strike will provide a modest boost for the major chains, and the fact consumer prices are rising at a greater rate than product costs should push profitability upward. So it should be a good time for the industry."
Giblen said he has little expectation for much change "because, although companies are investing more, they are not yet succeeding more," he said.
With Albertsons on the market, Giblen said he sees volume fallout from the Boise, Idaho-based company as a positive possibility for the second half -- perhaps the only positive. "With the transition at Albertsons having a deleterious effect on store productivity and employee morale, the prospects for Kroger and Safeway to take advantage of the situation look good," he explained.
Perry Caicco, an analyst for CIBC World Markets, Toronto, said the anticipated sale or breakup of Albertsons could potentially add more than $1 billion to the top lines at both Safeway and Kroger over the next year -- gains that can be achieved with little effort on their part, he added, because they will come from "benign bleeding" rather than from "active attempts by Safeway and Kroger to entice Albertsons' customers to switch stores. As such, the sales boosts can head right to the bottom line without lowering gross margins and without increasing spending."
Hunt, however, said the pending sale of Albertsons is unlikely to have much impact this year. "That's probably more of a 2006 issue," he noted.
The analysts discussed results separately for the first half of the calendar year for each of the top 10 companies. Their observations follow:
KROGER CO., Cincinnati, which saw sales for the half rise 6.5%, operating income climb 8.5% and comparable-store sales (excluding fuel) move up 2.8% in the first quarter and 3.8% in the second.
Kroger benefited during the half from its decision a year ago to implement lower prices, Giblen said, "and now it's arrived at a good balance of sales and profitability -- a balance neither Safeway nor Albertsons has attained -- that results from good execution on basic blocking and tackling every day rather than trying to do anything fancy."
According to Wolf, "Kroger's sales strengthened as the half progressed, because of the economy in general, and the traction it gained from its pricing and marketing programs in particular, as evidenced by increases in customer counts in both quarters. And to have customer counts up for two quarters in a row is something we haven't seen at any company since the 1990s."
While results in Southern California showed improvements, "Southern California was actually a drag on results," Wolf pointed out. "The recovery there has been moderate, while Kroger's core business has been improving at a better rate."
Kroger's operating profits were also up year-over-year "for the first time in a long time, with or without the strike's impact," Wolf added.
Caicco said Kroger has succeeded "in driving its price position to a level below most of its conventional competitors and closer to that of alternative discounters." He said the chain has "the best set of assets in the industry," with a wide variety of formats, and its price position and margin stability "put [Kroger] in prime position to pick up sales from the faltering Albertsons."
According to Ziegler, "Kroger has done a phenomenal job, and it seems to be hitting on all cylinders, even though it goes up against Wal-Mart in more locations than either of its top rivals. It has its merchandising and pricing right, and it's done a good job with store segmentation, with formats to fit all kinds of situations."
ALBERTSONS, Boise, Idaho, whose first-half sales were up 7.5%, operating income up 13% and comps up 1.8% in the first quarter and down 0.6% in the second.
Wolf said Albertsons' first-half results benefited greatly from the inclusion of Shaw's Supermarkets, which it acquired in March 2004, "but when that acquisition anniversaried in the first quarter, it left second-quarter sales weak." Wolf also said Albertsons' fundamentals "remain seriously challenged."
Caicco said Albertsons has suffered from "consistently substandard store conditions and poor marketing execution."
SAFEWAY, Pleasanton, Calif., which saw first-half sales increase 8.3%, operating income rise 26.6% and comps go up 3.2% in the first quarter (excluding fuel and Vons stores affected by the strike) and 1.9% in the second (excluding fuel only).
"Safeway got sales going during the first half, and it benefited in the first quarter from comparisons with the strike, but operating profits were down 6.4% in the second quarter, so it improved sales productivity, but at a sizable cost to earnings," Wolf said.
According to Giblen, because Safeway was the target of the Southern California strike, it was the hardest hit, "so it has had the easiest bounce, and its improved financial results are coming mostly from that, not from any genuine improvements. It's still not getting any traction at Randalls [in Texas] or Dominick's [in Chicago], and it seems more intent on cutting costs than on building volume."
He acknowledged that the chain's fresh-oriented lifestyle stores may improve financial results, "but that will take time."
Ziegler offered a similar opinion. "Safeway is improving its results by inches" as it converts stores to its lifestyle approach, he said, "but with only about 20% of the stores converted, it still has a ways to go for those stores to have a real impact on financial results."
According to Caicco, "It's difficult to initially lever 'lifestyle'-driven sales growth into earnings growth because of the higher operating costs, particularly labor, associated with these remodeled stores. That will take one or two years."
AHOLD USA RETAIL, Chantilly, Va., which had a sales increase of 0.4% in the half, a drop of 8.6% in operating income and negative comps of 2.8% in both the first and second quarters (though comps were up 0.2% and 2.3%, respectively, at the chain's Stop & Shop division while falling 3% and 4.1%, respectively, at its Giant of Carlisle, Pa., division).
Wolf said most of Ahold's problems in achieving better results stemmed from disruptions caused by the company's attempt to combine Stop & Shop and Giant of Landover, Md., into a single operating platform, plus a drag on results from Tops in the second quarter.
Giblen offered a similar opinion. "Ahold has been penny-wise and pound-foolish," he said. "Because in its efforts to reduce costs by combining operations, it's had disappointing results at Giant and lost more than it's gained, and that has impacted same-store sales, because it's been distracted by the integration and thereby lost momentum."
DELHAIZE AMERICA, Salisbury, N.C., whose sales jumped 3.8% for the half, while operating income dropped 1.8%; comps rose 0.3% in the first quarter and fell 0.4% in the second.
The company's results benefited from strong remodeling activity across the Food Lion chain in the Southeast and the conversion of Kash n' Karry stores in Florida to the Sweetbay banner, Hunt said, while Hannaford did well in New England with strong marketing initiatives and a focus on fresh formats. "But those gains were offset by strong competitive pressures in the Southeast, particularly in the second quarter, as Winn-Dixie announced it would exit 200 stores that overlap heavily with Food Lion and launched going-out-of-business sales that detracted from Food Lion's comp-sales results," he explained.
Giblen said Food Lion, Delhaize America's largest division, was also hurt during the half, "as lower-income customers, who make up a large portion of its sales base, were affected by the economy and rising gas prices."
A&P, Montvale, N.J., which saw sales fall 1% for the first half of the calendar year (the chain's fourth and first fiscal quarters), operating cash flow increase 39.1% and comps remain flat in the fourth quarter and drop 0.3% in the first.
Sales fell because of an extra week in the prior year and comps remained flat because of heavy competitive activity in the Detroit market and in the Northeast, Hunt noted. However, operating profits rebounded as a result of the chain's cost-saving initiatives in its U.S. divisions, he added, including a head-count reduction, the closure of several money-losing Farmer Jack stores in Detroit and productivity gains in Canada.
Giblen said A&P continued to operate mediocre stores, "and its focus on selling Farmer Jack and its Canadian division resulted in flat trends across the company."
WINN-DIXIE STORES, Jacksonville, Fla., with sales down 13.3% for the half (its third and fourth fiscal quarters) and negative operating cash flow of $102.1 million. Winn-Dixie has been operating under Chapter 11 since February and did not issue comparable-store sales results for the third and fourth quarters.
Winn-Dixie's activity during the half was focused on closing stores, prompting it to promote going-out-of-business sales during the April-to-June quarter, which drove volume downward, Hunt said. "The chain was running markdowns of 20%, 30%, up to 50% as it sought to liquidate inventories during the quarter," he explained, although it did not begin closing stores until after the quarter ended.
Giblen characterized the declines at Winn-Dixie as "a meltdown."
WHOLE FOODS MARKET, Austin, Texas, which saw sales jump 21.9% for the half (the chain's second and third fiscal quarters), operating income rise 22.6%, and comps climb 11.6% in the second quarter and 15.2% in the third.
"This is Whole Foods' time in the sun," Wolf said. "It is an excellent food retailer whose focus is on the biggest growth segment in food retailing -- natural, organic and healthy foods, plus gourmet, which is a unique combination. Whole Foods is the leader in a $40 billion business that's growing at a rate of 10% a year, and it executes extraordinarily well.
"In addition, it has a high percentage of full-time employees and low turnover, plus a culture of excellence, and it invests heavily in training that leaves its people with a feeling of pride in merchandising."
Giblen said Whole Foods is "the industry's star performer. With its emphasis on natural and organic foods, it shows you can be high-priced but still grow because of an excellent merchandising program."
PATHMARK STORES, Carteret, N.J., which saw sales drop 0.07% in the half, operating income drop 24.5%, and comps fall 0.1% in the first quarter and 2% in the second.
Pathmark's financial results reflect "its inability to get its promotional and merchandising programs across, which is due in part to the relentless pricing efforts at Wakefern's ShopRite stores," Ziegler said. "Pathmark has phenomenal store locations, but it hasn't done a good job with perishables, and that's where a store can differentiate itself for a competitive advantage over lower center-store pricing elsewhere."
Hunt said Pathmark's results were hurt by the competitive environment in the metropolitan New York area, "where there's no real population growth and where there's been no significant improvement in the manufacturing economy early in the year." Financial results were also negatively impacted by merchandising changes -- primarily a move to everyday low pricing in its health and beauty care categories. "It did not see any elasticity of demand from those price investments, and its recent remerchandising initiatives proved disruptive to store operations," Hunt explained.
STATER BROS. MARKETS, Colton, Calif., whose sales fell 8.4% in the half (the company's second and third fiscal quarters), operating income fell 56% and comps dropped 18.4% in the second quarter and 1.9% in the third.
Stater suffered from comparisons with the big sales and earnings lift it got during the Southern California strike-lockout, when it was the only major supermarket retailer operating stores with no business disruptions -- a situation that resulted in a sales lift of 34.5% in the first half of 2004, with a 200% boost to profits and comp-store sales increases of 42.2% in the first three months of the year (as the strike ended) and 17.1% in the subsequent quarter.
Hunt said Stater Bros. is continuing to get strong returns from expanding its produce offerings and the number of in-store pharmacies and bakeries it operates, from adding unique items to its product assortment from the dairy it owns, and from joining Topco, "which has enhanced its private-label assortment and lowered its cost position."
2005 First-Half Financial Results
Below are financial results for the 10 largest supermarket chains with public equity or public debt. Although reporting periods vary, the chart represents sales, operating income and same-store sales for the two quarters most closely paralleling the first half of calendar year 2005.
Name: Sales (in billions); % Change; Operating Income (in millions); % Change; 1Q Comps; 2Q Comps; Dates
