REBUILDING THE CORE

David Orgel

Ahold USA is now ready to build up after paring down.

Its agreement late last year to sell two chains, Bi-Lo and Bruno's, to a private investment group marked more than the conclusion of a long-awaited divestment process. The transaction also signified the close of a particularly tumultuous year for the global company's U.S. retail operations, which were transformed in preparation for a more streamlined existence.

Now, with four food retail chains left in this country, the Netherlands-based retailer is looking forward to focusing U.S. investments on its smaller number of properties.

"We are now spending our money on our core assets, compared to in the past, when we were dividing it into many places," said Anders Moberg, Ahold president and CEO. Moberg joined Ahold in April 2003, just two months after the accounting scandal that precipitated a management shakeup and period of declining financial health. "We are committed to this approach," he said.

Moberg is steering the global retailer through a critical phase of its three-year "Road to Recovery," the name given to its strategy to bounce back from its crisis. The first year of recovery dealt with crisis management, and the second was one of transition, he said. The goal for 2005 is execution, which includes meeting self-proclaimed financial goals.

"This is a year of delivery, and we must live up to what we promised," he said. "I'm very confident we'll be able to reach our goals."

Specifically for the U.S. retail operations, Ahold hopes to gain the benefits of its difficult restructuring into two "arenas," each of which links together the fortunes of two chains: Stop & Shop, based in Boston, with Giant of Landover, Md.; and Giant of Carlisle, Pa., with Tops Friendly Markets, based in Williamsville, N.Y.

Even as it focuses on retail, Ahold must make some major decisions about the future status of U.S. Foodservice, the unit at the center of the 2003 accounting scandal.

Ahold posted U.S. retail sales of $27.4 billion in the fiscal year ended Jan. 2, which included revenues for Bi-Lo and Bruno's. Comparable-store sales in the retail food segment in the U.S. declined 0.5% for the year; identical store sales fell 1.1% in that period. U.S. retail sales represented about 52% of the company's overall sales in this country, which totaled $46.2 billion. The balance came from U.S. Foodservice.

On a global basis, Ahold posted sales of $68.7 billion last year. In addition to the United States, Ahold operates in areas that include the Netherlands, the Nordic countries and Central Europe.

The company will report fiscal-year earnings in late March. For the first three quarters of last year, the most recent period for which Ahold has outlined earnings, the company reported that U.S. retail operating income fell 28.2% to $766 million.

Targeting Financial Goals

Ahold's stated goals for food retailing are for 5% net sales growth, 5% EBITA margin and 14% return-on-net operating assets. The company plans to achieve those measures during 2005 as it builds performance throughout the year.

However, financial analysts predicted a challenging year for Ahold's U.S. retail performance, noting the company will have to lower pricing in some competitive markets and make bigger capital investments to refresh an aging store base.

"Management focus will now switch from solving financial issues, disposals and restoring operational control. The focus returns to business again," said Patrick Roquas, a financial analyst at Rabo Securities in the Netherlands.

However, Roquas said he forecasts "a continued downward trend in 2005 as price investments and store upgrades are needed. Sales targets for 2005 will have to be postponed."

Jerome Samuel, retail analyst with IXIS Securities, Paris, said he believes Ahold will achieve more focus on the core business now that Bruno's and Bi-Lo are out of the picture. However, he added that "the question is what level of profitability can they achieve in the retail business? They need to cut retail prices, but then margin becomes a problem."

Moberg emphasized that the completion of integrations and a renewed attention to the day-to-day business of retailing will overcome many of these challenges. "There have been a lot of distractions for our management with all they are going through," he said. "That's some of the reason we have slipped a little here and there in our operations. You'll see a more aggressive company going forward compared to 2003 or 2004, and a management more focused on what it will do in 2005 and beyond."

One of the key goals for this year is to achieve payback from the melding of retailers into arenas, which has removed a layer of management. Bill Grize is the outgoing head of Ahold USA; he will be retiring. The CEOs of each arena will now report directly to Moberg.

The integration of Stop & Shop with Giant Landover was a particularly painful process that included relocations of functions, layoffs of about 600 people, and the conversion of about 200 Giant Landover stores to Stop & Shop's information technology platform. The arena's operations, including a perishables procurement function that serves all of Ahold USA, are now mostly run from Massachusetts, with some human resources and public affairs functions based in Virginia and Maryland.

"Stop & Shop has always been a great company, and continues to be," Moberg said. "There are certain weaknesses with Giant Landover. But there are many similarities in the way they go to market. So even though it's not easy, it is best to put them together in one arena."

Seeking Benefits From Chain Integrations

"This year, we should get the results of putting Stop & Shop together with Giant of Landover. We are taking out costs. There's an opportunity to lower prices, if needed, and react in a more proactive way to what's going on in the market, if needed, for competitive reasons. Everything we have done is meant to make us prepared for the competition."

Stop & Shop has experienced an unusually high level of competitive openings in the last two years and some intense price competition, particularly from Shaw's, Roquas said in a recent research report. The analyst said "substantial price cuts are needed," and are likely to lead to "margin pressure and lower sales in the short term."

Moberg, while conceding that price cuts may be necessary, said Stop & Shop is well prepared for making adjustments because of its knowledge of local markets. "I'm very impressed with how Stop & Shop has developed its skills as a local player when it comes to pricing, assortment and other things. In everything from the selection of stores to pricing, they are excellent. I'm impressed with their systematic approach."

Perhaps a bigger challenge in this retail arena will be to upgrade the Giant-Landover store base. The average age of Giant-Landover stores is 8.7 years, vs. 6.4 years for Stop & Shop and 4.9 years for Giant Carlisle, according to Ahold.

"We need to invest to get some of the Landover stores up to speed," Moberg said. "It will take some time to lower the age of the store portfolio."

In a presentation late last year at an analysts' conference in Philadelphia, Marc Smith, president and CEO of Stop & Shop/Giant-Landover, said Ahold has an ambitious agenda of near-term improvement steps for Giant-Landover. These include improving the supply chain, enhancing management staffing and training, upgrading perishables, and refreshing the store base in the northern Virginia and Maryland markets.

He stressed the need to take advantage of procurement opportunities for the two chains, which together post sales of more than $16 billion.

Smith emphasized that each chain stands to learn from the other in the merchandising and operations realm. For instance, Stop & Shop can help Giant with store operations, product variety, produce, meat and floral. Giant has an expertise in pharmacy, bakery, seafood and community services.

Other opportunities for the two chains include a new natural and organic private label called Nature's Promise, which is showing encouraging early results, and an initiative to expand the variety of general merchandise items, Smith said.

Ahold's other U.S. retail arena, Giant of Carlisle/Tops, has its own set of challenges and goals. The brightest spot is the performance of Giant-Carlisle, an everyday-low-price operator, in its competitive market, which is flush with supercenters. Ahold's other three U.S. chains are hi-low operators.

"I am very excited about Giant-Carlisle's ability to compete with Wal-Mart," Moberg said, noting Giant competes with the Bentonville, Ark., giant in about 70% of its market area. "Giant has taken a very systematic approach to that competition. I am impressed and have spent a lot of time trying to understand how they have done this," Moberg said.

The most problematic part of this Ahold arena, and indeed of the entire U.S. retail business, is Tops, which has suffered through a long string of missteps and lagging performance.

"Over the past 10 years, Tops has changed managements and strategies a little too much," Moberg said. "I think we've confused not only the customers, but our own people."

Ahold's goal now is to bring a consistent approach to the chain. "Tops will come in line more with what we are doing with Giant-Carlisle, and Carlisle will drive that concept into Tops," Moberg said.

New Strategies for Tops

The remaking of Tops' business is already under way. Ahold has cited good results from a test of a remodel and rebannering of an underperforming Tops store in Rochester, N.Y. The 92,000-square-foot store was converted to Martin's Super Food store, a variation on the Martin's Food Markets stores already in use by Giant-Carlisle. The Rochester Martin's has specialty departments that include upgraded perishables, organic foods, health and beauty care, and expanded general merchandise.

"The goal with the Martin's store was to full-scale go and present it at our best. So we took all our best people and really did it the way we know how. We're very happy with the store. This is how we'll continue to go forward with Tops and address the difficulties."

Asked if more Tops stores will be rebranded, Moberg said, "I definitely see converting more of the Tops stores to Martin's. We want to give customers the best value, prices and performance. Martin's will help raise the bar on how we behave in the market."

However, the solution for Tops isn't as simple as wholesale conversions to Martin's. The Tops store base is the oldest in Ahold's U.S. portfolio, with the typical store being more than 10 years old, the company said. Tops faces intense competition, including from Wegmans and discounters. So the picture for Tops changes depending on the specific market.

"We could end up leaving one or another market in order to concentrate on other areas," Moberg said.

The most difficult Tops region is northeastern Ohio, where Tops has suffered against the force of the competition. "The problems there partly relate to what's going on in that rust belt region," Moberg said. "As a company, we haven't taken action on those problems for many years. Also, perhaps we hadn't taken the right action in the past. We can't change the past. But we must address the issues now, taking decisions one by one."

Ahold has a few options with the Tops chain, according to Roquas. One scenario could involve divesting a number of stores or exiting from a number of regions, and converting the remaining units to Martin's, the analyst said. Another choice is to dispose of the entire chain and refocus all capital expenditures on the remaining portfolio, he added.

Moberg isn't forecasting what moves Ahold will make, but he did concede the company is carefully analyzing all aspects of the Tops franchise.

"When the Martin's opportunity was first raised, I challenged our people to consider if the Tops name was positive as a banner, or if we had destroyed it over time," he said. "I asked this coming in as an outsider.

"We haven't been very clear with the Tops banner over time. This all involves the question of what's left of our franchise in relation to our customers. We haven't answered the question yet."

Tony Schiano, president and CEO of Giant-Carlisle/Tops, outlined improvement steps for Tops at the Philadelphia analysts' conference late last year. These include a renewed focus on customer relationship marketing and category management, enhancing existing facilities, and building price competitiveness.

Leveraging Peapod for Differentiation

Any discussion of Ahold's view of key long-term opportunities cannot exclude its Peapod home-shopping service. The company views this initiative as an activity that can set it apart from competitors.

"Since most companies have left this sector, I see Peapod as a real opportunity for differentiation," Moberg said. "I'm happy with it. I see continuing to grow it. It will play to our advantage going forward."

Andrew Parkinson, Peapod president, said in an interview that the home-shopping service continues to expand the markets in which it supports Ahold's chains. Currently, it works with Stop & Shop and Giant-Landover in areas that encompass Massachusetts, Rhode Island, Connecticut, Westchester and Long Island in New York, plus New Jersey, Washington, Maryland and Virginia.

Peapod also operates a stand-alone business in the Chicago area, its original base, where it's added a distribution agreement for Wild Oats brand products. However, all of Peapod's expansion will be on the East Coast, Parkinson said.

"Our strategy is to serve the Ahold chain customer," he said. "Eventually, we plan to expand into the other Ahold markets."

Parkinson said Peapod is profitable in almost all of its markets and gets closer to overall profitability as it expands.

One of the biggest question marks for the American business is the future of U.S. Foodservice. Moberg said Ahold has not yet made a decision on whether to retain this operation. Indeed, Moberg is insistent on avoiding a rushed decision. In the fall of 2003, he said he needed 18 to 24 months to get it back on track toward stated financial goals. After that period, he will assess its value to Ahold and make a decision.

Moberg said he is "very happy with what the new management has done" and called it a good asset, noting that there are sourcing synergies between food service and retail.

"The strategy to buy U.S. Foodservice was not wrong," he said. "The execution was poor. The integration never took place. So we've made a big effort to integrate the company. There's been more to do than I would have thought. But we will do it."

Financial analyst Roquas outlined some key options for Ahold regarding U.S. Foodservice. These include holding onto the entire asset, bringing it to the market in an initial public offering with a new listing, or selling part or all of it to a financial player.

Analyst Samuel said he believes decisions about U.S. Foodservice will be based on the level of margin achieved by 2006, although he said that at the moment, the margin target isn't too ambitious.

"We are considering what should be the next step for U.S. Foodservice," Moberg said. "We are thinking about which opportunities we should be aggressive with, and we'll look at the different scenarios going forward. We will come back to the question of 'Should we keep it?"'

Moberg warned that a decision will not likely be reached this year. "Sometime early next year, we'll come to a decision on what to do."

Looking Beyond Legal Impact

While the future of U.S. Foodservice is still in question, the legal impact of its accounting scandal on Ahold is lessening.

"As a company, we have more or less dealt with everything," said Moberg, noting that an investor class-action suit is expected to proceed in the United States this year.

"We decided from the early stages to cooperate with all authorities in the United States and Europe, and that has paid off above all expectations I had," he said. "We worked very hard to get to that point. You have to put the past behind you, draw a line, and then move forward."

Moberg conceded that upcoming Dutch legal cases involving members of former management will attract a lot of press attention, but he stressed that those proceedings don't involve Ahold as a company.

"From the company's point of view, we have distanced ourselves from that," he said.

Ahold's future, as with its past, will play out in multiple countries and continents. How does the company hope to balance its operations among various parts of the world?

Moberg asserted that more important than the relative breakdown by world region is the local clout of each of its operations.

"What's most important for us is that within the geographic areas of concentration, we are positioned to become No. 1 or No. 2," he stressed. "We want to grow organically within those areas."