STOCK MARKET STUMBLE

ELLIOT ZWIEBACH

Food stocks as a group underperformed the general stock market in 2000, although they could reverse that trend in 2001, securities analysts told SN last week.

The defensive nature of food stocks could make them more attractive during the period of economic uncertainty that may lie ahead, the analysts said -- in contrast to 1999, when new-economy stocks caught investors' eyes, or in 2000, when those stocks tanked and made some traditional retailers look more attractive.

In 2001, investors may again turn to food stocks as a safe haven -- but only to stocks of companies with a track record of long-term success, the analysts pointed out.

Of 38 companies listed in the SN Composite Index -- which encompasses traditional and alternative retailers in the United States and Canada, plus wholesalers and on-line food retailers -- only 15 saw gains in their stock prices during 2000, compared with 23 that experienced price declines.

Topping the list of gainers were Nash Finch Co., whose stock rose 83%; Safeway, up 75%; and Kroger Co., up 43%. At the other end of the spectrum were Grand Union Co., which is liquidating, down 100%; e-tailers Webvan and Peapod, down 97% and 91%, respectively; Homeland Stores, down 86%; and Wild Oats, down 81%.

Overall, the SN Composite Index fell 14.8% for the year, compared with drops of 6.2% in the Dow Jones Index and 10.1% in the Standard & Poor's 500. During 1999, all three indices were up, with the SN index outperforming the other two.

Analysts told SN they attribute the industry's negative performance in 2000 to the growing dichotomy between the strongest and weakest players.

According to Gary Giblen, senior vice president and director of research for C L King Associates, New York, "It's a classic case of someone having his head in the oven and his feet in the freezer -- it's misleading to say the average temperature is comfortable or meaningful because it obscures what is really happening.

"Basically, operators who were most skillful in acquisition integration, like Safeway and Kroger, did well, and those that stumbled with a similar strategy, like Albertson's and Delhaize America, did not. In addition, the bigger companies generally tended to do better not just as a function of size but also as a result of their ability to expand private label, develop category management programs and maintain discipline on capital spending, while those with lesser skills tended to fall by the wayside."

Chuck Cerankosky, an analyst with McDonald Investments, Cleveland, expressed similar thoughts. "The industry had some very distinct stock leaders whose strengths were offset by some very distinct underperformers, including e-retailers, who definitely pulled overall results downward. Clearly, we saw a swap of enthusiasm away from e-tailing back to traditional retailing as investors walked away from anything they viewed as a questionable business model that dealt more with hope than sensibility."

Debra Levin, an analyst with Morgan Stanley Dean Witter, New York, also said larger companies tended to outperform the market while weaker ones dragged the food group down. "Stocks for companies that are able to show strong, solid earnings growth, market share growth and positive integration benefits were able to do well, while those generating disappointing results got hurt," she said.

Jonathan Ziegler, managing director for the San Francisco office of Deutsche Banc Alex. Brown, New York, said, "The stock market has no tolerance for weaker names, and in a market that focuses on growth rather than value, the strong companies with growth names outperformed the market, whereas in a value economy, there are expectations that some weaker companies could turn around through internal operations or takeovers."

Looking ahead to stock performance this year, Ziegler said it's likely the strong operators will continue to outperform the weaker ones, but stock prices may depend on the economy. "Investors will want to buy food stocks if the slowing economy evolves in a bathtub-shaped curve [curved sides, flat bottom], where earnings growth would continue to make those stocks attractive; but if the economy evolves in a V-shaped curve, where interest rates fall and taxes are cut to stimulate spending, then investors will look for more cyclical retail investments to take advantage of the upswing."

According to Levin, "There's a risk of rotation out of the food sector if interest rates are cut because that would prompt investors to focus more on higher growth stocks."

Cerankosky also said the companies whose stock did well last year should continue to lead the industry this year, though that may not mean the industry will keep up with the market. "Stock selection will be critical, and if the market is led by the same handful of names, we could again see the group underperforming the overall market," he said. "Though if you exclude disasters like e-grocers, then the bogey will be easier to overcome and some of last year's underperformers could move up and help the group outperform the market."

Giblen said the overall market is likely to remain "choppy, which could mean that food retail stocks should outperform the market because of their classic defensive nature. Companies like Safeway and Kroger have a lot of predictability because they've cracked the code on delivering consistent earnings growth in the mid to high teens in a tepid economy.

"But companies like Winn-Dixie and A&P will probably continue to underperform the market in both their stock prices and operationally and expose their weaknesses to an even greater degree."

Looking individually at some of the gainers and losers, analysts' comments included the following:

NASH FINCH CO., Minneapolis, up 83.3% -- an upswing Giblen said he expects to be short-lived "as it becomes clearer to investors that the company's ability to sustain the growth levels it has enjoyed, coming off a low base, is just not there."

Giblen also said he expects potential investors to be discouraged by the prospect of Nash Finch's independent customers beginning to wilt "under pressure as never before" from Wal-Mart and Target supercenters, "thereby raising the company's bad-debt expense."

SAFEWAY, Pleasanton, Calif., up 74.8% -- displaying a stock-price strength that analysts said was certainly sustainable going forward.

Cerankosky said Safeway's stock performance in 2000 was a mirror image of 1999, when its stock price declined. "Everything that was read as a negative for traditional retailers like Safeway in 1999, particularly acquisition integration and e-tailing, proved to be a positive in 2000. Safeway decided last year it would not be knocked out of its traditional business by perceived risks and delivered earnings as expected."

According to Giblen, "Safeway does everything right. It is the best company in the industry by any benchmark, and it has never stumbled on any acquisition. With its purchase of Genuardi's pending, Safeway has made it clear it will do another acquisition in 2001, and because it has been so highly successful with all of its integrations, the stock should stay very strong."

Ziegler said he agreed. "Safeway looked so good because management did a convincing job posting a very favorable outlook and then delivering the goods. What handicapped the company early in the year was the money flowing into the Internet sector, but when those stocks proved disappointing, the money flowed back into the strong players in the retail sector, and Safeway was the first to receive that investment."

Levin said Safeway did "a tremendous job" improving sales while maintaining strong earnings, and the pending acquisition of Genuardi's "is like an in-market acquisition and should be easy to integrate, with the expectation it will continue to drive strong earnings growth."

KROGER CO., Cincinnati, up 43.4% -- as doubts about its integration challenges in 1999 faded in 2000, analysts said.

"Kroger was viewed early in the year as having some integration problems with the Fred Meyer acquisition," Cerankosky said. "But those were resolved quickly when earnings came in better than expected, and once investors saw that Kroger management could pull off a big acquisition, money flowed back to the stock."

Ziegler also said Wall Street was impressed last year when it saw Kroger could deliver the numbers it said it would deliver, "and that built management credibility and made Kroger a good-sleep-at-night stock that could deliver in an otherwise tumultuous market."

According to Levin, "Kroger has done a tremendous job integrating Fred Meyer, with increased earnings and improved gross margins from increased general merchandise, better private-label programs and benefits from best practices, and it has really executed quite smoothly. In addition, Kroger has initiated smaller acquisitions that are helping results."

PATHMARK STORES, Carteret, N.J., up 38.2% -- following a Chapter 11 reorganization in September that eliminated most of its debt and made it a public company.

According to Giblen, the Chapter 11 process made Pathmark's bondholders into equity holders. "But many bondholders didn't want to own stock," Giblen said, "resulting in severe though artificial selling pressure.

"At the same time potential equity investors were becoming aware of Pathmark's dramatic operating strengths and excellent management, so the former bondholders found a ready market for their Pathmark stock."

Another positive factor for Pathmark stock, he added, was the perception the company could become a takeover candidate -- a perception that intensified when Safeway announced plans to acquire Genuardi's late last year and said it would be just a stepping-stone to further growth in the Northeast, which increased speculation that Pathmark might become a Safeway target.

Ziegler said Pathmark's position as a desirable property in a desirable marketing area also helped the stock, "and the reduction in the debt certainly added value," he noted.

WHOLE FOODS MARKET, Austin, Texas, up 31.8% -- which benefited from the public's escalating interest in natural foods, analysts said.

Levin said the biggest boost to the stock price came after Whole Foods decided to exit from Amrion -- "the weakest part of its operation" -- that consisted of an Internet company combined with a vitamin manufacturing and direct marketing business.

Ziegler also said Whole Foods' decision to get rid of its vitamin business helped the stock. "The company was delivering consistently strong same-store sales and strong earnings in its core business," he said. "But management took its eye off the ball on its peripheral businesses before deciding to sell those operations and focus on core growth opportunities -- a decision for which investors rewarded the stock."

According to Giblen, the increase in Whole Foods' stock price reflects the growing consumer interest in natural foods, "which is by far the most exciting growth element in food retailing today, and Whole Foods is the dominant player in that area." The stock also benefited from the blowup of Wild Oats stock during the year, he added.

DELHAIZE AMERICA, Salisbury, N.C., down 12.9% -- a decline analysts said was due to the ongoing perception that it paid too much money late in 1999 to acquire Hannaford Bros. Markets, Scarborough, Maine.

The $3.6 billion Delhaize paid for Hannaford resulted in "significant dilution of earnings per share," Levin said. "In addition, the company had weaker-than-expected sales due to the competitive environment in the Southeast heating up and the need for Delhaize's Food Lion to promote heavily to drive sales, and that hurt earnings."

According to Ziegler, "The Hannaford deal soured Wall Street, which felt Delhaize overpaid for those stores and then was hurt further when it had to sell the Hannaford stores in the Southeast. In addition, same-store sales remained relatively soft during the year, which reflected the promotional spending that was necessary in the Southeast."

Giblen said he agreed. "The stock has never recovered from the perception that Delhaize overpaid for Hannaford or that Hannaford was not a strategic acquisition," he explained. "In addition, it was apparent early in the year the company was suffering more than expected from the competitive environment and was taking it on the chin more than anticipated from supercenters and other competitive factors."

ALBERTSON'S, Boise, Idaho, down 17.8% -- a direct and ongoing consequence of its problems integrating American Stores Co., analysts said.

The decline in Albertson's stock was due to a lack of sales momentum, Ziegler told SN. "The market feels Albertson's has not handled the integration as well as it should have, particularly with the name change at the Lucky Stores in California. Albertson's has a fabulous real-estate portfolio that it can still turn around, but it will take time -- and Wall Street doesn't pay attention to companies that have a problem."

Levin said Albertson's earnings estimates have been coming down for over a year, "and sales have been less than expected, so the stock price has been weak."

According to Giblen, "Wall Street feared the worst when Albertson's changed the name on the Lucky Stores, and those fears have come true. Albertson's has clearly struggled with the whole American Stores integration at the same time its core stores are not performing well, and the company is underperforming the most pessimistic expectations."

According to Cerankosky, "American Stores represented a turnaround situation for Albertson's, especially in California, and things have not gone as well as planned, with disappointing earnings. As a result, investment dollars have flowed out of Albertson's and into Safeway and Kroger."

WINN-DIXIE STORES, Jacksonville, Fla., down 19.1% -- an ongoing turnaround story that has made potential investors anxious, analysts said.

"Al Rowland [Winn-Dixie president and chief executive officer] has strengthened the company and made significant changes," Levin said, "but it's still too early to tell if the changes will work or if sales and earnings will get stronger, and most stock investors gravitated to other stocks because there's too much uncertainty in a turnaround situation."

Although Winn-Dixie stock has recovered from its low point, Ziegler said, "it all goes back to delivering disappointing sales and earnings, and it's not getting better very quickly. Winn-Dixie still has not found the right formula to compete with Wal-Mart, and the outlook is tough."

Giblen said he believes Winn-Dixie's problems are irreversible. "For investors, there are likely to be more negative surprises, and Winn-Dixie may not be sufficiently viable to continue to operate independently," he told SN. "The first stage of its turnaround resulted in some easy cost savings, but the company is still totally unfocused. A lot of chains have low prices and better services and perishables so Winn-Dixie is left without a viable position, and Wal-Mart is smart enough to keep the pressure on a weak player like that."

SUPERVALU, Minneapolis, down 30.6% -- a victim of poor performance by its retail division late in the year, analysts pointed out.

Supervalu's retail sales were doing well until late in the year, Giblen said, "when the results and the outlook became highly cautionary. As a result, the stock went down more in December than in any other month because portfolio managers traditionally don't want to be stuck with an underperforming stock at year's end, so they were anxious to sell at any price -- and stocks that blow up late in the year, as Supervalu did, have exaggerated selldowns."

Cerankosky said Supervalu suffered early in the year from investors' negative view of wholesale stocks. "The market has been slow to recognize Supervalu's strength as a wholesaler while ignoring its strong retail segment, so Supervalu missed the run-up in stock price that Safeway and Kroger enjoyed, despite the fact it was meeting earnings expectations," he said. "And then at the end of the year it announced that the retail segment would fall way below expectations, and that gave a blessing to investors who were staying away."

Ziegler noted that Supervalu's retail segment had a couple of quarters in which same-store sales were negative -- due to over-expansion in Chicago and pressure from supercenters, he said -- "and the market doesn't applaud that. Now Supervalu is struggling to deal with that, and it still hasn't come up with a clear program to revitalize sales."

SPARTAN STORES, Grand Rapids, Mich., down 46.4% -- primarily because of a stock selloff by a major customer shortly after the company went public last summer, analysts said.

According to Giblen, when Spartan acquired Seaway Food Town, Maumee, Ohio, in mid-2000 and became a public company, D&W Food Centers, Grand Rapids -- one of Spartan's largest wholesale customers -- felt that Spartan's decision to operate the Seaway units as corporate stores would divert too much of management's attention, "and that created an artificial situation when D&W sold its stock, and although Spartan is doing well, there hasn't been much investor excitement," Giblen said.

Cerankosky also said D&W's decision to sell its stock "created an extreme amount of supply in the market that pushed the stock price down."

A&P, Montvale, N.J., down 74.9% -- due in large part to investor disappointments over the company's lack of return on previous investments, analysts said.

"Clearly, A&P has been a chronic underperformer over the years," Giblen said, "but it seemed it had cracked the code and found a way to get things turned around. But what did the stock in was the lack of execution. A&P spent hundreds of millions of dollars to build a lot of new stores but it didn't keep them operating well, and as a result it had to cut back on capital investments. In addition, the company's financial condition deteriorated because of poor returns, and A&P has not delivered on the operational turnaround that was promised."

According to Levin, A&P earnings have been "very disappointing, and the company seems to have given up all the benefits it appeared to capture with its restructuring. The ramp-up in spending on new stores and remodels has not generated the kinds of returns that had been anticipated, and operating margins are weak. In addition, the company is continuing to make changes in every business system and process, with disappointing results, and there are real questions about the strength of earnings going forward."