UNDER PRESSURE

MARK HAMSTRA

Uneasy investors -- troubled by a wave of accounting misstatements, an uncertain economic outlook and increasing competitive pressures -- took the stocks of publicly traded food retailers on a turbulent ride in the first half of the year.

The composite index of the stocks SN tracks throughout the year was down 3.54% through the first six months of 2002, which actually put them ahead of both the Dow Jones Index, which was down 7.77%, and the S&P 500, which was down 13.78%. Sixteen stocks showed improvement in the first half, while 19 showed a decline, including the three largest supermarket retailers: Kroger, Albertson's and Safeway.

"I think investors were troubled by the slowdown in sales growth, which led to downturns in stock prices," said Chuck Cerankosky, analyst, McDonald Investments, Cleveland. "Plus, we had some specific earnings announcements, especially those by Safeway, that hurt investor confidence."

Safeway's announcement last month that its second-quarter, same-store sales would be down 1.1% and that its earnings for the quarter would be below analysts' estimates helped steer investors away from food retailing stocks, analysts said. Both Albertson's and Kroger had already announced restructuring programs of their own, and the benefits of those maneuvers have not yet manifested themselves sufficiently to attract investors back to the sector.

Meanwhile, the industry didn't do anything to endear itself to investors by unveiling a series of accounting misstatements, which only fueled the fire set by the massive financial scandals at Enron, Global Crossing and WorldCom.

"This is an environment where all sorts of little announcements turn into unbelievable disasters," said Cerankosky. "The market -- and investors in general -- react with a sell-now, ask-questions-later mentality in the current environment."

Ahold saw its stock tumble more than 28% in the first half after the company restated last year's earnings to reflect differences in accounting standards between the United States and Europe. A&P's stock was similarly hammered when the company said it would take a charge for improperly recording vendor allowances, and just last month Supervalu said an internal audit turned up an accounting problem that forced it to take a charge of $17.6 million. Smart & Final also had to restate its earnings because of accounting issues at a subsidiary, contributing to its stock decline of more than 25% through the first six months of 2002.

In the meantime, investors are seeing steady same-store sales gains from the likes of Wal-Mart and Costco, and they fear that such operators are muffling top-line improvements of traditional supermarket companies.

"It's been a difficult year in terms of sales growth, and that trend continues to be difficult," said Jason Whitmer, analyst, Midwest Research, Cleveland. "Therefore, with any kind of price-perception fears or Wal-Mart fears, those seem to be the two main reasons why people don't want to get into these stocks."

He said he thinks fears of a potential supermarket price war -- fueled in part by Kroger's plan to use its savings to become more competitive on price -- are "overblown."

Some analysts said the prospect of a reversal in the fortunes of supermarket stocks remains uncertain.

"Whether it is the Wal-Mart factor or not, some of the large U.S. chains coming off major acquisitions are having trouble driving growth," said Patrick Schumann, analyst, Edward Jones, St. Louis. "There are probably several reasons -- competition, the pricing environment being very competitive and a pullback on expansion to concentrate on gaining momentum in the core business line -- but the outlook for growth is very challenging right now."

Schumann, who follows Canadian supermarket company Loblaw, said the situation in Canada differs because, for one thing, Wal-Mart is smaller in Canada and the market is less fragmented among the major Canadian chains. The stocks of both Loblaw and Sobeys, the two largest Canadian companies tracked by SN, had strong first-half performances.

U.S. supermarket stocks could be poised to rebound, however, according to some analysts.

"I think there's going to be a bounce in the stocks, because they are trading near their historical-low valuations," said Andrew Wolf, analyst, BB&T Capital Markets, Richmond, Va. "Meanwhile, we have a somewhat-improving economy, and the competitive situation vs. last year is better, because it was very competitive last year.

"On that basis, we should see a little bounce in same-store sales, and we're already starting to see a bounce in same-store sales at Kroger and Albertson's. If that continues in the second half of the year, and earnings-per-share growth stays around 10% to 15%, the stocks will do well in the last half of the year."

Following is a closer look at some individual companies' stock performances in the first half of 2002.

PENN TRAFFIC, SYRACUSE, N.Y., whose stock rose 88.7% after gaining about 10% in the last half of 2001, was buoyed by its status as a turnaround company, prompting investors to value it differently than they do other companies that have had a longer track record of success.

"They are trying to come back from a restructuring," said Whitmer. "The market has really been looking for turnaround stories for a couple of years."

The company, which operates supermarkets under the Big Bear, Bi-Lo, P&C and Quality banners, posted same-store sales and net-income gains for the fourth quarter of last year and the first quarter of this year.

WILD OATS, BOULDER, COLO., whose stock gained 62.1% in the first half after a slight decline in the last half of 2001, was the No. 2 gainer behind Penn Traffic through June, and analysts like the company's prospects because of its leadership and strategic direction.

"People are comfortable with the new management there, and they are learning that there are some new operating procedures in place," said Cerankosky.

Whitmer, however, said his company is "not in the long-term camp with the natural-food retailers, just because we think it's going to get more competitive over the next two to three years, and therefore you're going to see some limited top-line growth as well as some gross margin pressure as price becomes more of an issue."

SOBEYS, STELLARTON, NOVA SCOTIA, whose stock was up 30.2% in the first half, after a gain of 21% in the last half of 2001, continues to benefit from its massive presence in the Canadian market.

"Sobeys and Loblaw have a very sizable portion of the market in Canada and will be able to dictate a little bit more of their future because of their position and relationship with consumers," said Schumann.

LOBLAW, TORONTO, whose stock was up 20.2% in the first half of 2002 after a rise of about 4% in the last six months of last year, also benefited from strong sales trends in Canada.

The company, Canada's largest food retailer, posted its best quarter ever in the first period of this year, and the company pledged at its annual meeting to continue sales growth through the addition of nonfood offerings in its stores.

"It's much less fragmented at the top [in Canada than in the U.S.]," Schumann said. "Both Loblaw and Sobeys are looking at good momentum continuing."

SUPERVALU, MINNEAPOLIS, whose stock increased 10.9% in the first half of this year, following a gain of 26% in the last half of 2001, would have been up even more this year if it hadn't reported accounting problems at a pharmacy division.

The revelation last month that it would take a relatively small charge -- it first estimated that it would be between $19 million and $21 million, but it actually was $17.6 million -- sent the stock on a one-day slide of nearly 22%. Analysts said it didn't help that on the first full day of trading after the announcement, WorldCom unveiled a $3.8 billion accounting debacle in which it misstated its expenses to show higher profits.

"They got hit all in one day, and we actually upgraded the stock based on the price pullback," said Cerankosky, citing the company's strong management and strategic focus.

Some analysts said investors might also have been troubled by the company's same-store sales trends in the first quarter, which were down 1.1%, although the company projected they could turn positive by the end of the year.

WHOLE FOODS, AUSTIN, TEXAS, whose stock was up 10.7% in the first half, following an increase of 60.7% in the last half of 2001, appears to be effectively distinguishing itself from the rest of the supermarket sector with ongoing indications of strong growth.

"They continue to exceed sales expectations, and that's the primary driver, not only for earnings, but for the stock accelerating over the last 12 months," said Whitmer, speaking about both Whole Foods and Wild Oats.

Cerankosky agreed, calling Whole Foods "a finely running machine.

"It has a very generous price-earnings multiple, but it also has very high same-store sales, plus a good organic growth rate," he said.

WINN-DIXIE, JACKSONVILLE, FLA., whose stock turned in a first-half growth rate of 9.4%, on the heels of a near-50% decline in the last half of 2001, benefited from some strategic sales initiatives, analysts said.

"Their same-store sales had been disastrous -- down 5% for over a year -- but the bleeding has stopped, and they may actually turn positive, based on some loyalty-card success that they've had," said Wolf. "That may not be long-lived, but any improvement gets priced into the stock."

ALBERTSON'S, BOISE, IDAHO, whose stock fell 3.3% in the first half, after a gain of 1.5% in the last half of last year, appears to be poised for positive sales and earnings growth after its divestiture program shed unprofitable stores.

"Everything looks like it is heading in the right direction," said Cerankosky. "The earnings improvement still has a long ways to go, but that's understandable at this point in time."

Whitmer, however, said Albertson's hasn't shown "a whole lot of evidence yet in terms of things improving in terms of market-share gains or sales," although he said the company has made "some great moves and has a great team over there."

KROGER, CINCINNATI, whose stock was down 4.6% in the first half of 2002, following a drop of 16.5% in the last half of 2001, also appears poised for a rebound, analysts said.

"They seem to be the best of the group right now," said Whitmer. "They really seem to have some good earnings momentum on their side, as well as some strong prospects to take costs out and return those as investments in price and promotion."

Cerankosky said he believes Kroger's recovery is well under way.

"I think one of Kroger's strengths is to keep market share and capture market share," he said. "The culture at that company is to play hardball, and they got away from that philosophy toward the end of last year. Then they got back to more of their traditional focus on the top line, and less focus on margin, and with the first-quarter earnings report, they showed that strategy was working."

A&P, MONTVALE, N.J., whose stock was down 21.4% in the first half after a gain of more than 60% in the last half of last year, deflated investor confidence with its accounting problems.

Analysts were in a wait-and-see mode last week as the company prepared to file its 10-K annual report with the Securities and Exchange Commission six weeks after it was originally due.

SAFEWAY, PLEASANTON, CALIF., whose stock tumbled 30.1% in the first half of the year, following a 13% drop in last year's second half, was punished for its weak second-quarter forecast, but some analysts predicted a quick turnaround of the company's downward dip.

"Safeway has been the best [at reducing costs]," said Whitmer. "That's kind of been their niche for the past 10 years. That's given them a little more trouble recently with some of their initiatives going sour, but for the most part their back-end initiatives have been extremely successful in the last 10 years."