HEIGHTENED INTEREST

LISA A. TIBBITTS

Interest rates will play a key role in supermarkets' expansion abilities over the next few years as competition heats up.

The Federal Reserve Bank's round of interest rate hikes over the past year alarmed some in the supermarket industry who claimed that operators will be squeezed out of growth opportunities.

However, the blows haven't yet been as hurtful as some feared, according to a number of analysts, operators and other observers. Many retailers said they believe rates have stabilized just in time and may not reach dangerous levels any time soon. Analysts noted that a number of operators won't be hit by higher rates because they refinanced debt at lower rates several years ago. In addition, executives said that the cost-cutting benefits of Efficient Consumer Response are more helpful in a climate where borrowing is more expensive. Some even said higher rates could fuel more efficiency initiatives.

Still, most cautioned that continued jumps in rates could be highly detrimental, and could even encourage industry forward buying as a means of reducing cash crunches.

Timothy Hammonds, president and chief executive officer of the Food Marketing Institute, said in a recent interview that the Fed needs to hold the line. "What we need to do is to give last year's increases time to work their way through the economy and refrain from tightening things further," he said. "If the Fed wants to continue to [raise] interest rates through the middle of the year, then it runs the substantial risk of pushing the economy back into recession."

Roger Stangeland, retired chairman of Vons Cos., Arcadia, Calif., said he expects rising interest rates to stimulate increased interest in the Efficient Consumer Response movement.

"[Through ECR,] people are able to employ cross-docking and just-in-time deliveries and all the other things, which removes inventory from the system and lowers the need for short-term debt," he said. "Also, I would think long-term capital costs such as warehousing would decline."

Nevertheless, he noted, "Whenever interest rates rise and inflation is low, it creates a profit challenge for everybody in the free-enterprise system."

Roger Hughes, chairman and chief executive officer of Hughes Family Markets, Irwindale, Calif., said as long as interest rates stay below 10%, southern California should bounce back from the recession it is still feeling. "As far as our company, we're not presently planning on borrowing money over the next year, so the interest rates wouldn't affect us in that way. Our debt now is old debt at good rates," he said.

Doug Nidiffer, vice president of C&K Markets, Brookings, Ore., said he is optimistic about the economy. "I think highly fluctuating interest rates are [what] scare us the most. We can live with interest rates that are stable."

Brian Suher, vice president of Piper Jaffray, who is based in Portland, Ore., said higher rates will hurt highly leveraged retailers.

"They'll spend less because they are having to put more of the dollars they take into debt payment," he said, so they are funneling less money to capital expenditures.

However, Suher, who said he believes rates will remain steady for the rest of the year, also sees a benefit in higher rates. In his view, they could lead to increased consumer spending on high-end items. Although higher rates keep consumers from buying big-ticket items, such as household appliances, vehicles and houses, they will still have disposable income, he said.

"The American public has been sold on rewards," he said. "The grocer, in times of higher interest rates, is very well positioned to be able to provide more modest awards. In other words, they are more likely than they would have been before to buy a loaf of premium baked Italian bread instead of the store brand because it is considered a reward."

Gary Giblen, managing director of Smith Barney, New York, said most supermarket companies will not be greatly affected by rising interest rates because the "savvy" ones, such as American Stores, Salt Lake City, refinanced their debt at lower rates several years ago.

And he noted that, historically speaking, interest rates are below average and supermarket stocks seem to be doing well.

"If interest rates go up, that causes stock values to go down so therefore you would think that the ability to raise money in public offerings with stock would be decreased. But the market is at a record level so even that seems not to be a problem." If stock values did go down it would be a problem, but we're a long way from that, he said. He acknowledged, however, that rising rates will have an effect on store expansion. "It makes an attractive return on investment more challenging for a supermarket chain," he said.

Steven Ruggiero, managing director of high-yield research at Donaldson Lufkin Jenrette Securities, N.Y., said the interest rate issue isn't a crisis for operators right now.

"I do not see it [the rising of interest rates] being significant enough of an issue that it impacts free cash flow," he said. "Safeway stock is climbing and Kroger stock is doing well. These stocks have been doing well despite these interest rate increases."

Although earnings per share

could be affected by a few cents, he cautioned that retailers should be more concerned with the impact of other factors, such as Wal-Mart, Bentonville, Ark., building more supercenters and Hannaford Bros., Scarborough, Maine, expanding into new markets.

Bob Lupo, managing director of high yield research for PaineWebber, N.Y., stressed that firms have ways of protecting themselves from rate gyrations. He pointed to the common practice of arranging an interest rate protection agreement with banks. Using this technique, highly leveraged companies like Kroger don't need to be caught off guard by rising rates, he said. "You don't know what's going to happen to interest rates tomorrow, so in order to lock in that risk, you enter into these agreements to hedge your floating rate risk," he said. "For however long these agreements are in place -- typically five to seven years out -- the company knows the highest average [interest] rate it will be paying on its floating debt."

Indebted businesses should not need to worry about hikes until their "swap agreements" expire, he added.

Lupo referred to Kroger's Securities and Exchange Commission 10-K form, which said, "The Company uses interest rate swaps and caps to hedge a portion of its variable rate borrowings against increases in interest rates."

Lupo said those looking to borrow would be sensitive to rate changes but should not be dramatically affected. "If it's managed correctly, the interest rate part of the risk is capped," he said.

Irwin Kellner, chief economist at Chemical Bank, N.Y., was among those who said rate rises are fueling efficiencies.

"Higher interest rates are forcing supermarkets and other outlets to manage their inventory better -- to look closely at the rate of turns and be careful not to stock too many units of slow-moving items," he said.

Because the housing industry has been stimulated, he said there is a good chance the Fed will raise short-term rates -- a factor that will have little impact on supermarkets.

And if they are boosted, they will only slightly affect consumer spending, he added. People will be shopping more carefully but, because they pay for their groceries with cash, this may not be as obvious.

Don Stuart, a partner and certified financial planner at Cannondale Associates, Wilton, Conn., said trade relations could suffer in a climate of higher rates, and a new round of forward buying and diverting could result.

"While management may be talking category management, if cash pressures are tight, the buyers are going to go for the short-term benefit even though that may not be consistent with a long-term business goal," he said. "When things get tight, you're going to see smart buying take precedence over good selling."

And when margins are squeezed, retailers begin looking for other sources of income, he added. "You're going to see continued acceptance of in-and-out-type products just to take advantage of slotting allowances," he told SN.

Prime Concern

The upward movement of interest rates over the past year has raised some alarms in the supermarket industry. Shown is the movement of the prime rate.

YEARS

MONTHS Nov.'93-Mar.'94 Apr.'94 May'94 Jun.'94-Aug.'94

RATE %'s 6.00% 6.25% 6.75% 7.25%

YEARS

MONTHS Dec.'94-Jan.'95 Feb.'95-Apr.'95

RATE %'s 8.50% 9.00%