THE STRONG GET STRONGER: HOW 10 COMPANIES FARED IN THE FIRST HALF

ELLIOT ZWIEBACH

Growing discrepancies between strong and weak players characterized the financial results for the nation's top 10 publicly traded chains during the first half of 2000, and the second half is unlikely to see much closing of the gap, industry analysts told SN.

As a group, the 10 companies saw sales rise 5.7% and operating income jump 20% from year-ago results, while average same-store sales fell slightly to 1.24%, compared with plus 1.4% in last year's first half.

Individually, however, Kroger, Safeway and Ahold USA enjoyed strong overall numbers, while most of the other companies showed weakness in some financial measurements.

"For companies like Winn-Dixie and Grand Union, it wasn't so much anything that happened in the first half alone but a collection of body shots over a long period of time," said Ed Comeau, an analyst with Donaldson Lufkin & Jenrette, New York.

According to Gary Giblen, director of research for C L King Associates, New York, "The first half was gritty, but not disastrous. Aside from very severe competition, a lot of companies were in flux, which put customers up for grabs. And anytime competition is trying to seize the opportunity to gain market share at someone else's expense, you have short-term intensity that ultimately leads to long-term benefits for some players once things settle out."

Debra Levin, an analyst with Morgan Stanley Dean Witter, New York, said first-half results were impacted early on by the strong momentum of Y2K, "which resulted in heavy de-stocking in the early part of the period. In addition, while inflation remained below 1%, the competitive environment got tighter, which made same-store sales comparisons tougher."

The analysts said first-half financial performance was impacted by three factors:

Competition -- which resulted in the Southeast from pressure from Wal-Mart supercenters that affected Delhaize America and Winn-Dixie; in the Northeast from heavy promotional activity that hurt A&P, Grand Union and Pathmark, and in California from the decision by Albertson's to convert its acquired Lucky Stores to the Albertson's banner, a move that hurt Albertson's and helped Safeway.

Integration, which gave Albertson's and A&P indigestion and which enabled Safeway, Kroger and Ahold USA to make gains from operating synergies.

Expense pressures resulting from increases in labor costs, fuel, utilities and real estate.

According to Levin, "The message that came though as companies reported financial results during the first and second quarters was that synergies stemming from acquisitions were, in general, working; that scale is increasingly important for companies to compete successfully in a tough competitive environment, and that best practices give companies a particular edge when they execute well.

"The exception, of course, was Albertson's, whose acquisition of American Stores has been a real drag on earnings and whose problems in core stores have hurt sales."

Looking ahead, Levin said the strong operators will get stronger and the weaker companies will continue to struggle. "The competitive environment will remain tough, with companies like Sam's and Costco continuing to draw customers away from traditional supermarkets," she said.

She also said increases in energy costs -- including gasoline, home heating oil and utilities -- will have a negative impact on consumer spending.

Comeau said he anticipates few second-half changes. "It's unlikely we'll see any easing of competition, and the potential for continued expense pressure is still there, with inflation being the biggest wild card. I doubt we'll see any rise in inflation, but with a relatively healthy economy and big expense items, the backdrop is there."

He said he expects some retailers will be able to offset increased expenses and meet their earnings goals, while others are likely to encounter problems.

"All companies have the same pressures, but some, like Kroger, have additional synergies and improvements to be gained from previous acquisitions that could help offset increased costs, while companies like Winn-Dixie or Albertson's may not have that flexibility."

Following are analysts' comments on each of the top 10 public chains:

KROGER CO., Cincinnati, with first-half sales rising 6.6%, operating cash flow (earnings before interest, taxes, depreciation and amortization, or EBITDA) increasing 11.8%, and comparable store sales up 1.8% and 2.1% in the first and second quarter, respectively.

Giblen called Kroger's first-half performance "respectable," noting the company hasn't been able "to go full-bore forward on its predicted growth rate of 16-18% on earnings and 14% on EBITDA because it is still digesting the Fred Meyer acquisition. The good news is Kroger is ahead of its original plan on achieving post-merger synergies, but it has had to reinvest that money to keep sales going, so the bottom line is not quite where the company had expected it to be."

According to Levin, Kroger is beginning to see the benefits of synergies from procurement and private label, "and it's about to start work on information systems consolidation."

Comeau said Kroger had some concerns at the beginning of the first half about working capital, which was too high. "But it seems to be OK now, with cash flow picking up during the half."

ALBERTSON'S, Boise, Idaho, with first-half sales dropping 2%, operating income falling 2.1% and comps up 0.8% and 1.4% in the first and second quarters, respectively.

Analysts pointed out the drop in Albertson's overall sales was due largely to its divestiture of 145 stores in 1999 to win government approval for its acquisition of American Stores Co., "but the comps for the half were disappointing because Albertson's is operating in fast-growth areas and should be doing better," Giblen said. "It's one thing to have flat comps in marketing areas in New Jersey, but operating in southern California, Seattle and some of its other major markets, Albertson's should be growing faster.

"And Albertson's made itself vulnerable to competition by yanking the frequent shopper cards at the former Lucky stores in California and deemphasizing the card at Acme in Philadelphia, which shocked customers more than necessary and made them look elsewhere."

Comeau said Albertson's biggest problems are not due to the merger but come from its core stores, "which have had difficulties achieving sales and improving profitability. The company spent a lot of money investing in improved service levels as a means of driving sales, but that didn't happen, and it's going to take Albertson's time to get back on track."

According to Levin, approximately 15% of Albertson's total comp sales come from its freestanding drugstore operations -- whose sales are growing at a double-digit rate -- "so it's clear the company's supermarkets have weak comps, and they're probably negative in center store."

She also said Albertson's first-half results "were disappointing, especially in the second quarter. Clearly, the company is having difficulties integrating the American Stores acquisition, which is still putting a drag on earnings, and it's also having difficulty getting sales momentum."

Adding to the sales challenge, Levin added, is the fact Albertson's is an everyday-low-pricing company, "so its customers are more likely to be drawn to Wal-Mart than customers at Kroger or Safeway, whose stores tend to be more upscale."

SAFEWAY, Pleasanton, Calif., with sales rising 16.5%, operating income jumping 22.7% and comps increasing 2.4% and 4.9%, respectively, in the first and second quarters.

"Safeway is in good shape and cruising along well," Comeau said, attributing its strong performance in the half to several factors, including the success of its breakaway sales initiatives; the problems Albertson's is experiencing, "which boosted Safeway's share in California," and the 1999 acquisition of Randall's, which helped ramp up comp sales.

"The fourth-quarter rise in same-store sales of 4.9% is a huge number, particularly when you realize that most companies are nowhere near that level," Comeau added.

According to Levin, "Safeway has done a superb job, with industry-leading sales momentum. Its focus on breakaway sales strategies has paid off, and it continues to improve operating margins, as it's done for the last seven years."

AHOLD USA, Chanitlly, Va., with sales climbing 21.7%, operating income increasing 31.9% and comps up 2% and 0.5% for the first and second quarters, respectively.

Since Ahold opted not to acquire Pathmark at the end of 1999 to avoid what it considered undesirable divestitures ordered by the Federal Trade Commission, the company has concentrated on seeking out less traditional acquisitions, Giblen said, including companies in the food service and convenience store areas, which accounted for its big jumps in sales and operating income.

"I give Ahold a lot of credit for thinking outside the box and restyling itself from strictly a retailer to a food distributor, which makes a lot of sense," he said.

Same-store sales results were impacted by competition in the Northeast and Southeast, Giblen said, "and even Ahold's Tops stores in upstate New York suffered during the half because of strong competition from independent operators there."

Levin said that, despite comp gains of only 0.5% in the second quarter, Ahold's sales got stronger toward the end of the period.

WINN-DIXIE, Jacksonville, Fla., with sales declining 6.3%, operating income dropping 69% and comps falling 1.6% in the company's third quarter and 3.5% in the fourth.

"Winn-Dixie has historically been an undermanaged company in an increasingly competitive environment in the Southeast, and its customer base is particularly vulnerable to Wal-Mart, which goes after the same low- to middle-income customer seeking low prices," Giblen said. "Winn-Dixie has been muddling along for years, and while it has managed to survive while Food Lion and other traditional chains were taking business away, it couldn't keep on doing so when Wal-Mart began making inroads in its volume.

"Now Winn-Dixie is in the midst of a sweeping reinvention of itself, which is expected to last through the end of 2001. But until then, results will continue to be bad."

According to Comeau, "This is the year Winn-Dixie will have to prove whether putting the paddles on the patient will bring it back to life."

Levin said Winn-Dixie's restructuring effort has already strengthened its organization, "but it's still producing weak operating results, with the bulk of its efforts still ahead of it."

However, the company seems to be on the right path, she said. "Under new management, it's done some real cost-cutting, so we can expect to see some benefits down the line. But with over half of its store base competing against supercenters, it's been losing market share steadily for years while executing extremely poorly."

A&P, Montvale, N.J., with sales increasing 4.5%, operating income dropping 18.3% and comps rising 2.4% and 1.7%, respectively, in the first and second quarters.

Although A&P sales were positive during the half, they were below plan, Levin pointed out. "A&P has been trying to get a payoff on its investment in stores over the last few years, but it's had fairly disappointing results," she said.

"It's now in the second of four years of Project Great Renewal [the company's series of sales initiatives], and the company was expecting a major positive impact this year. But earnings were worse than anticipated because of increased competitive activity, which has pressured operating margins.

"In addition, the company has experienced disappointing results at 13 acquired stores -- six Schwegmann stores in New Orleans, due to delays in completing the transaction, during which sales were allowed to run down, and seven units of The Barn Fruit Markets in Canada, because A&P hasn't been able to figure out yet what format will work there."

Project Great Renewal is taking longer than anticipated to produce positive results and is taking a toll on earnings, Giblen noted. "Overall sales are up because A&P has been able to add square footage and merchandise its stores better, but it's getting poor returns on its capital spending, which has pushed earnings down."

Comeau also said one of the company's biggest concerns is the fact results at new stores over the last two years have been disappointing.

DELHAIZE AMERICA, Salisbury, N.C., with sales climbing 4.3%, operating income up 0.8% and comps falling 1.8% in the first quarter and rising 1.1% in the second.

As with A&P, Delhaize's decision to expand square footage has helped sales but hurt profits, which were also negatively impacted by the severe competitive pressures in the Southeast throughout the first half, Giblen said.

Delhaize has been able to reduce some competitive pressures during the third quarter as it rationalized the number of stores in the area since its acquisition of Hannaford Bros., Scarborough, Maine, which operated some stores in the Southeast, Giblen added.

Levin said Delhaize's response to the tough competitive situation in the Southeast helped it boost comps during the second quarter but in doing so, it hurt gross margins. Results were also affected by the higher labor costs Delhaize has had to pay to attract employees in the area's low unemployment environment, she added.

Comeau said Delhaize continued to exhibit "fits and starts" in its first-half financial performance, as it has done in the past. "They lose for a little while, then get it back, which is a function of having a price message and being in a very competitive market with Wal-Mart."

PATHMARK STORES, Carteret, N.J., with sales rising 1.7%, EBITDA falling 9.8% and comps increasing 0.7% and 0.2%, respectively, in the first and second quarters.

Giblen said Pathmark spent most of the first half "operating in a shock mode, ever since it saw the deal to be acquired by Ahold fall apart unexpectedly in December. And it also spent most of the half going through a Chapter 11, so its performance, while not stellar, is impressive under the circumstances and a tribute to Pathmark management."

Pathmark's performance was also impressive, he added, because competitors tried to take advantage of Pathmark while it was down, "although during the third quarter it's gone to triple coupons to let people know they can't kick it around anymore."

Comeau said Pathmark was able to remain fairly competitive while working its way out of bankruptcy, "but it's operating in an extremely competitive market and hasn't had the capital it's needed. Now it's finally in a position to do what it has to do."

PENN TRAFFIC, Syracuse , N.Y., with sales falling 2%, EBITDA rising 24.4%, and comps increasing 0.4% and 1.3%, respectively, in the first and second quarters, though the company has indicated it will restate those comp results downward, Giblen said. The EBITDA numbers look good "only because the company came off an abysmal base," he added.

GRAND UNION, Wayne, N.J., with sales dropping 7.4%, EBITDA declining 70.1% and comps falling 1.7% and 2.7%, respectively, in the fourth and first quarters.

Giblen said results for the half were impacted by the company's decision to delay new-store projects, to close and sell some stores and to reformat a group of stores in New England that didn't work under the Hot Dot banner.

Earlier this month the company filed its third Chapter 11 since 1995, which observers said is likely to result in the chain being sold in pieces to other operators.