RETAILERS STUNG BY WAL-MART, ECONOMY

CHRISTINA VEIDERS

The confluence of extremely challenging events that occurred in the second half of fiscal 2001, which stalled most of the Top 10 publicly traded supermarket companies in their tracks, provided additional momentum to a much bigger factor in food retailing -- Wal-Mart's growth.

According to second-half company performance figures compiled by SN, the Top 10 chains showed hardly any growth in same-store sales. They averaged 0.1% during the period, compared to 1.1% in 2000. The 10 chains included in the comparison were identical to the previous year. (See second-half financial breakout chart for Top 10 companies, Page 96.) In comparison, Wal-Mart Stores -- including supercenters -- saw a 7% increase in comparable-store sales during the second half.

Analysts interviewed by SN predicted Wal-Mart supercenters would continue to penetrate the country as they rolled out more food formats and thus cut away at traditional food retailers' sales and market share.

The three leaders behind Wal-Mart in food retailing -- Kroger, Albertson's and Safeway -- all have experienced some disruptions to various degrees in their respective markets due to the Wal-Mart factor, said analysts.

Neil Currie, equity analyst, UBS Warburg, New York, noted the domino effect. While Safeway has been the least impacted by Wal-Mart to date, especially on the West Coast, Kroger's ramping up of its cost structure to bring its pricing down to compete with supercenters will make it tougher for Safeway stores on the West Coast even without Wal-Mart supercenters, Currie said.

"If Wal-Mart is the cause of Kroger's issues, then the domino impact for Safeway is that it has -- if you exclude Canada -- 58% of its stores within five miles of Kroger," he said.

The pressure from alternative formats only became heightened during the second half of last year following the Sept. 11 terrorist attacks, massive layoffs and the country plunging into a recession. This caused consumers to be even more price-conscious as they traded down on food as well as flocked to the discounters. This was coupled with an overcapacity of retailing space, particularly in the discount sector, fierce price competition and a slow growth market, which all resulted in a dismal second half for many of the top food retail companies.

"The slowdown came to a standstill in the fourth quarter," said Mark Husson, equity analyst, Merrill Lynch, New York. This was caused by a combination of events, said Husson, "the size and the [slow] growth of the market, the increase in store capacity that came onto the market just as it was slowing down, the increased price competition, in particular the price competition by Wal-Mart and Kmart in the same market. They were knocking seven bells out of each other during the quarter, and a number of retailers got caught in the crossfire."

Besides the economic slowdown, there was no inflation, noted Husson, and a significant amount of trading down by consumers and increases in private-label sales. "All of this really served to dump on the top line," he said.

"It's hard to isolate the impact of Sept. 11 and the general slowdown of the economy," said Jack Murphy, vice president, Credit Suisse First Boston, New York.

"The sales environment turned out to be a lot more cyclical than expected. There were already other factors like a tougher competitive environment, which is more important," he added.

"If it was just a single negative, it would be manageable," said Gary Giblen, vice president and director of research, C L King & Associates, New York. "But a lot of negatives taken together were pretty challenging for even the best and the brightest." While total sales actually increased 4% over the previous year from $97.9 billion in 2000 to $101.9 billion in 2001, those numbers don't clearly reflect the shifts taking place in individual markets. During the period, Kroger announced it would further leverage its size to achieve greater economies of scale and reinvest in its core business to increase sales and market share, and Albertson's began to exit underperforming markets in Houston, San Antonio, Memphis and Nashville. Others of the Top 10 simply reassessed their positions in their respective markets and acted accordingly by pulling out, selling stores, cutting costs and pursuing other, internal cost-cutting measures for survival.

Safeway struggled with its integration of Genuardi's Family Markets, Norristown, Pa., said some analysts, as it has with acquisitions in other markets. The purchase of Genuardi's in February 2001 impacted Safeway's third and fourth quarters.

Meanwhile, operating income for the Top 10 companies rose 17.1% to $5.7 billion, up from $4.7 billion in the previous year.

But flat comparable-store sales remain a big challenge for supermarkets. "Same-store sales growth softened fairly substantially in the third and especially fourth quarters for all companies," noted Jonathan Ziegler, San Francisco-based managing director, Deutsche Banc Alex. Brown, New York.

"The real issue out there was too much square footage and too much consumer products. That combination of oversupply drives prices down," he noted.

Forecasting into the first half of 2002, analysts did not expect much improvement in growth in spite of an improved economy.

David Shriver, food retail analyst for Credit Suisse First Boston in London, who follows Ahold and the Delhaize Group, said, "The whole industry has to think through how to differentiate themselves from supercenters with the realization that competition has got fiercer. The industry has to rethink what they are doing to add value for the customer." The analysts offered their observations on the performances of the Top 10 chains:

KROGER CO., Cincinnati, whose sales were off by 0.6% while operating income rose 3%. Comparable-store sales in the third quarter rose 1.4% but fell to 0.3% in the fourth. "We are operating in the most challenging economic and competitive environment of the past 20 years," said Joseph A. Pichler, Kroger's chairman and chief executive officer during the period.

Pichler's statement was probably the best indication on how tough the environment was out there, said Murphy. The company changed its business strategy and announced it would institute promotions funded through $500 million in cost savings, which included company layoffs, Murphy noted. "Being sharper on promotions is the right strategy," said Murphy. "The only issue is that Kroger set an aggressive goal for getting its identical sales up. It's very tough for any supermarket to get sustainable sales growth much above a flat 1%."

Ziegler said that what is impacting Kroger the most "is the awareness that Wal-Mart ain't going away."

While many agreed Kroger's strategy is positive, Currie questioned whether Kroger's re-engineering efforts were coming too late in the game. "Wal-Mart is bigger than Kroger. Is it going to be enough?"

ALBERTSON'S, Boise, Idaho, whose sales grew by 3.2% and operating income dipped 0.3%. Comps rose 2.3% in the third and were flat, 0.2%, in the fourth.

Larry Johnston, chairman and CEO, said Albertson's was meeting challenges of the marketplace, which included aggressive supercenter competition.

"Performance in the fourth wasn't as strong as in the third, so as a recovery story one would expect better performance," said Currie. "What they are doing with the cost structure will help operating performance, but all eyes must be on sales performance, and whether they can have sustained profitable sales improvement over the year," he said.

"Albertson's has now emerged as a company with a clear future and vision," Giblen said. "It took a year for the new CEO to get his feet wet and understand what he had to do."

SAFEWAY, Pleasanton, Calif., saw sales rise 6.7% and operating profit increase by 15.1%. Comps were up 1.6% and 2.1%, respectively.

Said Steve Burd, chairman, president and CEO, "In spite of the soft economy, we were able to accelerate cost-reduction efforts to fuel double-digit earnings growth."

Ziegler said he was disappointed with Safeway's performance in the second half. "Although they are probably doing fine on the West Coast with not much overlap with Wal-Mart, other markets such as Texas are dragging them down," he said. The Genuardi's integration has caused a temporary disruption in that market, according to Ziegler, by "Safewayizing it" with private brands.

Safeway's first-quarter results, reported earlier this month, shows a deceleration in sales, analysts noted, but most expect improvement as the economy continues to get brighter.

"I still think they are the gold standard," said Giblen. "Although they are a little tarnished at the moment, they do have revitalized competition. Wal-Mart is better in food than it use to be."

"Look at Safeway's performance on an underlying basis," said Currie. "They've missed every quarter. But it has made up bottom-line expectations by buying back shares, or having lower tax rates or pushing its margins up. The sales performances have declined period by period, and that is not healthy."

AHOLD USA, Chantilly, Va., sales rose 17.4%, including its food-service business. Retail sales alone were up 6.8% to $10.9 billion. Comps posted 3.8% and 3.1% increases for the quarters, respectively.

This period reflected the impact of Grand Union stores, which were converted during the first six months of 2001. The company also acquired PYA/Monarch, Parkway and Mutual food-service businesses. Bruno's Supermarket acquisition was being completed during the period.

Shriver of Credit Suisse First Boston, described Ahold's U.S. retailing business as good last year with the exception of Bi-Lo, which was experiencing challenging market conditions.

"Ahold has phenomenal success in bringing together Ahold USA and leveraging its scale and skill and those aspects of the business end where it is appropriate," said Shriver. "They are doing it on a global basis as well."

Shriver sees the acquisition of the food-service businesses as a big opportunity for Ahold USA retailing operations. However, right now Ahold is in the early stages of integrating those businesses.

DELHAIZE AMERICA, Salisbury, N.C., sales were off by 0.2%. Operating income soared 79%. Comps increased 2.3% in the third quarter and dropped a negative 0.5% in the fourth. In the third quarter, Delhaize closed 19 Super Discount Markets in Atlanta and sold nine Save-A-Lot stores to Supervalu. The benefits of the merger with Hannaford Bros. continued to be realized.

In the fourth quarter, comps fell due to a weak economy, particularly reflected in the results at Kash n' Karry, where seasonal residents' return was delayed. December sales were negatively impacted vs. the prior year due to unseasonably warm weather and the midweek holiday.

According to Shriver, "Delhaize clearly missed guidance for comps over the course of the year. A lot of focus has been on integrating Hannaford. The challenge for Food Lion is what it is offering relative to Wal-Mart. It has to find other reasons to differentiate itself than on a straight price comparison."

WINN-DIXIE, Jacksonville, Fla., sales were flat at 0.2%. Operating profit rose 139%. Comp sales were off a minus 5.2% and 4.3% for the first and second quarters, respectively. The company unveiled an aggressive new marketing campaign in October 2001.

Comps decreased in part due to the elimination of unprofitable sales departments and the elimination of unprofitable sales items in remaining departments.

Said Al Rowland, president and CEO, "Our focus is to grow Winn-Dixie profitably based on strong financial fundamentals. We intend to build our sales through continued improvement in store operations, improved merchandising and an aggressive marketing campaign."

"Winn-Dixie is in Wal-Mart territory so it has real challenges," said Ziegler.

"Some of the things Winn-Dixie is doing to improve, like remodeling stores and relaunching advertising, should accelerate them up to flat," said Husson.

"Short term, I am bullish on Winn-Dixie," said Giblen. "Beyond short term, I question how much of a sustainable strategy they have to grow and compete."

"It's a high-risk stock," said Currie. "The competitive situation will get worse. The company is doing some good things, but there is big question mark over the asset base."

A&P, Montvale, N.J., sales rose 1% and operating profit was up 138%. Comps were up 3.1% in the third quarter and flat in the fourth at 0.5%.

The company announced in November 2001 a program to improve operating results by disposing of underperforming assets, including 39 stores.

Elizabeth Culligan, president and chief operating officer, said, "We acted decisively in fiscal 2001 to review and improve our store network in terms of overall quality and growth potential. That effort, and the initial results of ongoing programs to upgrade our operating disciplines and merchandising execution, were major factors in our performance."

Currie and other analysts said Culligan has been a big catalyst in A&P's turnaround. "They achieved what they set out to do and turned business back into profit, improved sales and operating performance, and cut costs. It's been a steady recovery story," Currie said.

PATHMARK STORES, Carteret, N.J., sales slid to a flat 0.2%; operating profit also dropped 8%. Comps were up 2.3% in the third quarter but sank to 0.9% in the fourth.

Said Jim Donald, chairman, president and CEO, "Outstanding effort and execution were keys to our strong third-quarter financial and operating performance, despite a recessionary economy and the uncertainties surrounding the tragedy of Sept. 11."

Giblen sees Pathmark as a "wonderful" turnaround story. "They are choosing to invest margin to drive market share, yet comps are still on the flat side."

"They have been able to restructure, and that has been driving earnings growth," said Murphy. PENN TRAFFIC CO., Syracuse, N.Y., sales rose 1.2%. Operating profit was up 7.7%. Comps increased 2.3% in the third, but fell flat to 0.9% in the fourth.

"A softening economy and a greater-than-normal amount of promotional activity made the fourth quarter a challenging one for us," said Joseph Fisher, Penn Traffic's president and CEO.

Said Giblen, "Joe Fisher has done a great job in getting things accomplished in terms of quick payback on initiatives long overdue. The company has driven positive comps and EBITDA growth. The short-term performance is better than the premium quality companies."

HARRIS TEETER, Mathews, N.C., sales were flat at 0.1%, but operating profit rose 43%. Comps were up 2.5% in the fourth quarter and fell to a minus 1.1% in the first.

"Harris Teeter's earnings have picked up nicely," said Husson. "Sales are still rather difficult to come by, but it looks like they have been successful in refocusing their business on core markets rather than having poor-performing stores stuck out in the provinces like Atlanta. Getting out of those areas and focusing on the Carolinas has been a big win for them. We conducted a recent competitive study in the marketplace indicating that consumers that shop Harris Teeter are very impressed by them."