REASON TO CELEBRATE [A LITTLE]

Reported by Jon Springer, Elliot Zwiebach and Mark Hamstra

Don't expect any fireworks in the second half of 2005, according to industry leaders contacted by SN.

That doesn't mean business won't be good -- in fact, most food retailers and wholesalers contacted by SN said they expect sales growth to be strong in the last six months of the year, but ongoing pressure from competition and from operating costs will continue to constrain margin expansion. For many, the gains projected in the months ahead will be more conducive to a sparkler-level celebration than a full-blown Fourth of July spectacle.

"I think you're definitely going to see margin pressures from all competitors in the marketplace," said J.H. "Jay" Campbell, president and chief executive officer, Associated Grocers of Louisiana, Baton Rouge. "It's a slow-growth environment, which you know when Wal-Mart says even they are having same-store sales pressure."

Wal-Mart Stores, Bentonville, Ark., the nation's No. 1 food retailer, last month reported a sluggish start to the summer selling season with same-store sales for the month of May up just 2.5%, at the low end of its projections of 2% to 4%. Much of those gains were driven by its food sales, the company said. Same-store sales for June were projected to grow in the same range.

Some of the food retailers contacted by SN said they expected their sales growth to exceed that level in the second half, despite relatively high gasoline costs and other factors that have inhibited spending, particularly among lower-income shoppers.

Ric Jurgens, president and CEO of Hy-Vee, West Des Moines, Iowa, said his company is expecting same-store sales gains of about 4.5%, similar to the growth he said the chain achieved in the first half.

Although he said some markets where Hy-Vee operates are stronger than others, "Overall, the economy is solid. We're not hearing from our store directors that people are unwilling to spend on better profit items, and we're not hearing reports of dramatic unemployment, except in some communities that have a factory closed or other event that has an adverse impact for a short term."

Some operators said consumers had accepted the high cost of gasoline and did not seem to be as cautious about their spending as they were a year ago, when gas prices soared.

"Gas prices have stabilized," said Mike Proulx, president and chief operating officer, Bashas', Chandler, Ariz. "A year ago they were out of sight, and people were in shock. Prices are about the same now as they were a year ago, but people have accepted it, and that helps the outlook for the grocery business."

According to the Food Institute, Elmwood Park, N.J., supermarkets recorded "real" sales growth of about 1% through the first five months of 2005, after adjusting for inflation. That's slightly better than they performed in the same period of 2004.

Economic indicators have been mixed heading into the third quarter, with the Conference Board, New York, projecting "slower growth setting in." The Board concluded that this is due in part to rising energy prices, but it also cited a "choppy" level of confidence from chief executives and consumers. Unemployment in May remained stable at 5.1%, according to the Department of Labor.

Standard & Poor's, the New York-based debt-ratings firm, had a slightly brighter outlook for the economy overall in the second half in its Industry Report Card for the U.S. retail sector, although it pointed out that consumer spending will be negatively impacted by the lack of a special tax refund, the weak stock market and the deceleration of home-price appreciation. "Consumers will likely keep spending, but ... 2005 is likely to be a somewhat more challenging year for retailers than 2004," the report stated.

RICH PARKINSON

president and chief executive officer, Associated Food Stores, Salt Lake City

Parkinson said he expects second-half sales to climb 2% to 2.5% over the second half of 2004 for two reasons: "First, because we're starting to execute better with our market segmentation program, in which we identify unique opportunities for individual stores so each can focus on the potential of its unique characteristics, based on the demographics it serves, rather than trying to be all things to all customers; and second, because we're getting a sales lift at the wholesale level as our retailers' business grows."

Sales in the first half were "a little softer than we anticipated because we're not quite out of the recession, as we had hoped to be, and the economy remains soft in the Intermountain states."

One way Associated is dealing with margin pressures is to try to reduce its health costs by incentivizing its employees -- trying to reduce smoking, obesity, high blood pressure and other health challenges among employees by promising to rebate part of their insurance premiums if they deal with their health issues. "We're going to a more prescriptive remedy rather than simply reacting," Parkinson said. The incentives started Jan. 1, and Parkinson said he's seeing some progress among a number of employees to become healthier.

JIMMIE GIPSON,

chairman, president and chief executive officer, Houchens Industries, Bowling Green, Ky.

Gipson said Wal-Mart "has been a factor" in his areas of operation, which range from Texas through the Midwest and up as far as New York state, where the company is a licensee of the Save-A-Lot banner.

"When you exclude the influence of any new Wal-Mart locations, it's been pretty steady," he said. "But Wal-Mart has been a factor in our area."

About a year ago Houchens acquired the 90-store Food Giant Supermarkets chain, based in Sikeston, Mo., and with operations in nine states.

He said sales through the first six months of 2005 have been "pretty close to our expectations for the first half of the year."

"We try to anticipate the effect of new competitive openings and factor that in," he said. "It's been steady -- slow or little growth."

As far as pressure on margins, Gipson said, "Margin pressures are always a factor. We don't see anything especially unusual this year."

CALVIN MILLER

president and chief executive officer, Associated Grocers of Florida, Miami

Miller said he's bullish on the second half.

"It's very positive," he said. "We're growing in leaps and bounds. We have a lot of new accounts, and we have some stores that are doing very well. Florida's not like it used to be, when it used to slow down after the winter, because there's so many people moving into Florida today. It used to be a large decrease in sales in the summer, and now it's minimal.

"Florida's booming. Real estate is doing well, and retail is doing well."

He said 2005 so far has been the best year in the history of the company, after the wholesale cooperative picked up a large portion of Fleming's former business a little over a year ago.

"We're adjusting from that growth, and we're adding some new accounts," Miller said.

Among the new initiatives at AG of Florida are new divisions for the distribution of health and beauty care, general merchandise and frozen foods, which previously had been handled on a direct-store-delivery basis.

J.H. 'JAY' CAMPBELL

president and chief executive officer, Associated Grocers of Louisiana, Baton Rouge

Campbell said he thinks the company "is going to do fine in the second half of the year."

"In the first half this year, I thought we did remarkably well for a few reasons. With the price of oil as high as it has been, it kind of surprised me that the consumer was still spending fairly aggressively. I think while people are always going to eat, maybe they took one meal a week out of the restaurant, casual dining or fast food, and ate instead at home. That could be an accentuator in our business. It's hard to measure that, but it's a possibility."

He said he hopes to grow the business in the second half through new-product introductions for AG's retail customers. "Whether we source that ourselves or partner through a cross-dock, it doesn't matter to us -- just so that our retailer has something new and different that the consumer wants."

He expects margin pressure on retailers to continue. "I think you're definitely going to see margin pressures from all competitors in the marketplace -- because it's a slow-growth environment, which you know when Wal-Mart says even they are having same-store sales pressure. That puts pressure on margin because a lot of your operating expense are not within your control: The utility costs, the fleet cost because of the price of fuel, insurance such as group hospitalization and health care -- all those costs continue to increase, and if you're not growing top line to throw more dollars down, you're going to have to do something with your margins.

"I think supermarkets have to be strategic about margins," he added. "I think they know where they can gain a little margin without frightening the consumer. The consumer is astute enough to realize that when certain commodities go up the costs of certain products will go a little higher."

MIKE PROULX

president and chief operating officer, Bashas', Chandler, Ariz.

Proulx said he anticipates "slow, steady sales growth in the second half of 2005, with a better-than-average summer."

He said his optimism is fueled by the problems Arizona's economy suffered last summer from forest fires and a serious drought, "which sent vacationing folks elsewhere where it's cooler.

"Summer vacation time can be feast or famine in Arizona, depending on weather conditions in the northern part of the state," he said. "This year the forests are green, the lakes are full and the campgrounds are open, so we expect a good summer.

"And gas prices have stabilized," he added. A year ago they were out of sight and people were in shock. Prices are about the same now as they were a year ago, but people have accepted it, and that helps the outlook for the grocery business."

To drive sales, Proulx said Bashas' has embarked on a series of summer promotions for beverages, barbecue equipment and patio furniture.

Proulx said the first half "was right on budget. Things started out sluggish because of the rain in January and February, but they picked up in the spring and we're right on track."

He said the biggest margin pressures are coming from rising medical-care costs. Bashas' has formed a task force utilizing consultants that's seeking out local and national expertise "to come up with ways to slow down this escalation in costs," he said.

Other margin pressures are coming from labor costs, energy and utility costs and the cost of goods from suppliers.

ANDREW PARKINSON,

chief executive officer, Peapod, Chicago

Parkinson said the first half of the year "exceeded expectations" for the Internet grocer, which is owned by Ahold USA.

"Our trends have been very positive and we expect that to continue in the second half," he said. "There's more people than ever on the Internet, and broadband is really taking off so that helps us. We've also been expanding into new areas this year.

"We have plans for further expansion in the second half of the year, but I prefer not to say where just yet, because of competitive reasons," he added.

The company currently serves Chicago and several markets in the Northeast where it partners with the Giant-Landover and Stop & Shop chains, also owned by Ahold. Peapod also recently began offering products from natural-and-organics specialist Wild Oats, Boulder, Colo.

RIC JURGENS

president and chief executive officer, Hy-Vee, West Des Moines, Iowa

Jurgens said he's "very optimistic about sales" in the second half.

"We operate across a seven-state area, and we certainly see some areas stronger than others, but overall the economy is solid," he said. "We're not hearing from our store directors that people are unwilling to spend on better profit items, and we're not hearing reports of dramatic unemployment except in some communities that have a factory closed or other event that has an adverse impact for a short term."

Jurgens said the company had comparable-store sales gains of about 4.5% in the first half, and he anticipates similar results in the second half. "Total store sales are up over 7.5%," he said. "There are a lot of growth areas for us: We've been strong in pharmacy, the fuel business, organics, wine and spirits, and general merchandise. We've also run a 3% increase in center store this year."

Among the initiatives he said Hy-Vee is testing to drive sales is the installation of Starbucks cafes in the stores. He said the chain has 15 such outlets now and plans to add more throughout the year.

He described margins as "stable."

"I've been in the business 35 years, and I'm trying to think of a year when I didn't feel there were margin pressures: It seems as though that's a constantly mounting pressure in the food industry. Those of us who figure out ways to creatively raise margins, or maintain them, survive."

JIM BUCHANAN

president and chief operating officer, Laurel Grocery Co., London, Ky.

Buchanan said he expects most of his company's growth in the second half to come from new customers.

"We've seen double-digit growth every year for the last five years so we think that's going to continue on in the second half of this year," he said. "We have a number of customers lined up to come over during the second half of this year, and I think we'll pick up some additional ones that we don't know about yet."

He said the company is set to begin testing an initiative in four stores involving loyalty cards to help Laurel's independent customers "compete against the Wal-Marts popping up everywhere in Ohio and Indiana."

"We have a strong base there we need to protect, and we have customers in areas where Wal-Mart has already saturated," he said. "It will involve a loyalty card and emphasize not getting into a price war with Wal-Mart, but keeping the pricing close enough so that the consumer can't justify going to a Wal-Mart store just because of the price. It involves everything from product selection to marketing and merchandising and a special ad. It's a controlled program that independents really need, so we're investing behind it."

He described margins as "tough."

RICHARD NIEMANN JR.

president and chief executive officer, Niemann Foods, Quincy, Ill.

Niemann told SN that he is optimistic for a strong summer, although some comparisons will be difficult in the second half.

"We're pretty bullish on our ability to bring sales home," he said. "Beef was very hot last year and drove a lot of our sales, and now we're competing with those numbers this year. There was a lot of price inflation at that time."

He said produce sales have been up over last year, however, "picking up the slack" for the beef-sales comparisons.

The company, which operates 64 stores in four states, faces a variety of different economic conditions in its markets.

"In some towns, it's a disaster if a major employer has left, but in other areas it's booming," he said.

He said said he thinks consumers have grown accustomed to the high price of gas, and it's not as much of a factor in their spending any more.

"People got used to the sticker shock," he said. "It's still having an effect on disposable income, but it's not as acute as it once was."

BOB HERMANNS

president and chief executive officer, Associated Grocers of Seattle

Hermanns said he's anticipating "modest sales growth" in the second half. "The economy in the Pacific Northwest is better than it was last year, though it's still not robust," he noted.

"Boeing has a big influence on the economy here, but it's not growing jobs significantly in the marketplace and it's been outsourcing components as it develops the 787. And although there are new jobs in the marketplace, the increase is not as dramatic as in years past when the company used more subcontractors in the area."

Hermanns said the first half met expectations thanks to a late upsurge in sales. "The Pacific Northwest had a great Memorial Day weekend, and weather didn't have a negative impact here as it had elsewhere in the country, so we ended the half with a surprisingly strong finish," he explained.

To drive sales in the second half, "we are continuing to work with retailers to help them effect differentiation strategies to strengthen their market presence and defend against the growth of Wal-Mart and Winco and the heavy spending on remodeling by Safeway and Fred Meyer."

Most margin pressures are coming from transportation costs, Hermanns said, "because of fuel price increases, which affects our shipping costs, and because of a lack of trucking alternatives. Outbound freight costs are under extra pressure because of rising fuel rates, and a lot of independent truckers are leaving the business, so the supply of independent truckers continues to shrink, and being in the corner of the U.S. as we are, freight rates often are dependent on whether shippers can get backhauls here."