STOCK PROSPECTUS

ELLIOT ZWIEBACH

For the third year in a row, food stocks in 1997 held their own against the general market. Industry analysts said they attribute the stocks' positive performance to several factors, including strong earnings results, merger activities and various combinations of outside factors.

The SN Composite Index of 46 retailers and wholesalers showed food industry stocks outperforming the general market, rising 50.2% compared with an increase of 31% in the Standard & Poor's 500 and a 22.6% rise in the Dow Jones index. The broad nature of the SN index accounted for its higher level compared to other indexes and the groups of supermarket stocks followed by many analysts.

"In 1997 and during the two prior years, it's surprising how well food stocks have done," Ed Comeau, a securities analyst for Donaldson, Lufkin & Jenrette, New York, told SN last week.

"Food stocks don't usually outperform a bull market because it's hard for those companies to keep pace in that kind of environment. So although I had anticipated that food stocks would be a good group going into last year, I was still surprised at how well the group overall kept pace."

One factor that resulted in a strong performance late in the year, he said, was the desire by some investors to avoid companies with any Asian holdings, given the volatility of Asian economic markets.

"Food stocks were underperforming the market during the summer, but there was a flight late in the year to more defensive investments in light of the Asian situation," Comeau said, "and food stocks came into favor at that time as an investment that didn't have any exposure to Asia or the Pacific Rim, and where earnings were likely to hold up in 1998."

Jonathan Ziegler, a San Francisco-based analyst with Salomon Smith Barney, New York, also said the situation in Asia resulted in "investment money flooding into the [food] group because supermarkets are a domestic-based industry with no involvement in Asia."

Merger activity within the industry also helped boost stock performance, Ziegler said, led by the acquisition by Quality Food Centers, Bellevue, Wash., of Hughes Family Markets, Irwindale, Calif., early last year; and the acquisition by Fred Meyer Inc., Portland, Ore., of Smith's Food & Drug Centers, Salt Lake City, in September; and Fred Meyer's pending merger with Ralphs Grocery Co., Compton, Calif., and QFC sometime in March.

Chuck Cerankosky, an analyst in the Cleveland office of Tucker Anthony, Boston, also said industry consolidation helped the food stock group outperform the market. "The takeover premiums got sharp upward valuations that raised the supermarket stock index, and with additional takeovers likely, the stock price performance rate should continue to be strong this year," he said.

Debra Levin, an analyst with Morgan Stanley, New York, told SN she regarded 1997 as "a very mixed performance bag" for food stocks, with several companies outperforming the market -- including Ahold USA, Albertson's, Dominick's Finer Foods, Kroger Co., Safeway and Winn-Dixie Stores. Companies that outperformed the market "are the ones that continue to improve profitability, with the expectation that those good earnings trends will continue in 1998 as comparisons get easier and as companies benefit from various investments in new stores, technology or consolidation," Levin said.

The SN Index's results includes companies not covered by many analysts. For instance, the SN results included the nearly 128% increase in the price of Penn Traffic Co. and of 127% in the price of Whole Foods Market -- two companies that are not included in the smaller stock universes followed by most analysts.

Comeau said the 12 food stocks he follows rose about 30% last year -- only slightly below the S&P 500 -- and Levin said the 13 food stocks she covers rose only 22.4% -- about even with the Dow Jones results, but considerably below the S&P 500.

However, Ziegler said the 11 stocks in his universe outpaced the market with gains of 42.5%, which he attributed to the strong showings by Fred Meyer and QFC.

Looking ahead, Ziegler said investors are likely to be concerned about the ongoing impact of deflation and labor costs. However, he said an ongoing lack of inflation is likely to spur the move toward more consolidation, which is a positive; and productivity increases will probably reduce pressures on labor costs caused by a short labor supply.

Comeau said he also anticipates continued consolidation, noting, "1998 will be a year of significant consolidation activity, with Safeway and Ahold likely to make big acquisitions, along with Albertson's and Food Lion." He said most regional chains -- and even some of the industry's giants -- may become consolidation candidates over the next couple of years, either through outright sales, restructurings or bankruptcies that lead to a sale.

Two of the most likely consolidation targets this year, he said, will be Dominick's Finer Foods, and Giant Food. Comeau said he also thinks American Stores Co. "will reach a point where it may have to consider breaking

up its holdings, and it could reach that point this year." Viewing several stocks individually, analysts had these comments:

Penn Traffic Co., Syracuse, N.Y., up 127.6% A company with a small public-equity capitalization selling at a low, single-digit price where small changes in movement make up a big percentage change, Ted Bernstein, an analyst with Grantchester Securities, New York, told SN.

"There were some serious concerns about the company's financial position early in the year, but with the hiring of Phil Hawkins [as president] and the cost savings that have been realized so far, some people felt better about the company and viewed the stock as a call option, with a significant upside if it works out and a small downside if it doesn't," Bernstein said.

Whole Foods Market, Austin, Texas, up 127.2%, and Wild Oats Markets, Boulder, Colo., up 94.9%

The companies' gains are attributable to a greater knowledge by investors about the natural-food concept, said Lana Lazarus, an analyst with Piper Jaffray, Minneapolis. "Natural food has gotten a lot of press, with natural products growing at a rate of more than 20% per year, and it's opening investors' eyes," she told SN. "And both Whole Foods and Wild Oats had strong same-store sales, with attractive margins, high profits and good cash returns, and they've achieved a lot more visibility as they've both entered new markets."

According to Barbara Miller, an analyst with BT Alex. Brown, New York, "Whole Foods is viewed as a company with strong fundamentals that's been beating analysts' earnings estimates, and it's recognized as a leader in a high-growth segment of retail. In addition, it's beginning to build a brand image through acquisitions of manufacturing companies at a time when there's not yet much brand loyalty in the natural-food segment."

Miller also said that Whole Foods stock did particularly well early in the year "when weaknesses in its southern California operation resulted in an unusually low stock price, which made it one of the best buying opportunities available."

Dominick's Finer Foods, Northlake, Ill., up 67.8% The chain's rise is due to several factors, Comeau said: a good store development plan, a good earnings year and a move late in the year to convert its Omni combination stores to its new Fresh format, "all of which have really strengthened Dominick's position in the marketplace." Also spurring the price of Dominick's stock, Comeau said, is the major investment by Yucaipa Cos., Los Angeles, "whose past success has led people to regard Dominick's as an investment with good value."

Kroger Co., Cincinnati, up 58.1% This increase reflects the company's low-stock price in 1996 following a retail clerks' strike in the chain's Denver division, Levin said. "So the stock started from a low base, and Kroger has done an excellent job improving earnings and operating profitability, and that has inspired investor confidence in the company's long-term earnings potential," she said.

According to Cerankosky, "Investors have also been impressed that Kroger's aggressive store-expansion program has not held back its ability to improve profit margins. And improvements in its balance sheet broadened the investor audience available to buy shares."

Comeau said, "The market has been willing to reward the fact that Kroger's financial results have improved and earnings expectations are being met. And there's a lot to be said for a company able to punch out stable operating performance."

Safeway, Pleasanton, Calif., up 48%

Levin said growth was spurred in large part by Safeway's acquisition of Vons Cos., Arcadia, Calif., last spring. "That was an excellent strategic move that was reflected in the company's stock price," she said. Cerankosky said he agreed. "The Vons acquisition resulted in a significant increase in Safeway revenues in one fell swoop and showed investors Safeway was willing to make bold moves and expand on its successful strategy of growth through building new stores," he said.

Comeau said Safeway's stock has benefited from several good quarters in which earnings expectations were exceeded.

Winn-Dixie Stores, Jacksonville, Fla., up 38.1% The company's stock rose despite struggling with tough sales trends throughout the year, particularly in its Cincinnati and Atlanta operations, Levin said. "But investors believe earnings will improve, and this is one instance where the stock price is in contrast with the company's fundamental operating performance," she noted.

Albertson's, Boise, Idaho, up 32.6% The price increase was a result of the chain's "tremendous job recapturing momentum, with better sales trends due to improvements at newer and weaker-performing stores. Albertson's has developed a lot of programs with more merchandising flair for the stores, and that's been reflected in the stock performance," Levin said. To 43

The company's stock performance reflects "a very sharp improvement in its stock price" toward the end of the year, following a strong third-quarter report, Cerankosky said. "That [third-quarter] performance caught a lot of people by surprise after a disappointing first half. But the company came through on its assurances that it had programs in place to get earnings growth back on track, and that became evident in the third quarter.

"Albertson's stock also benefited from the fact that its third-quarter results came out within a day or two of American Stores' third quarter, which was very disappointing, so there was a pool of money available that flowed from American to Albertson's stock."

American Stores Co., Salt Lake City, up 0.6% "The company said its results suffered due to increased competitive and promotional activities in the supermarket division and a failure to keep close tabs on the drug store division when that division moved to Salt Lake," Ziegler said.

"But while the Lucky operation in northern California was fine, the South division was hurt by Ralphs and Food 4 Less in southern California, and Costco also made some inroads there. In Chicago, Jewel lost some market share to Dominick's Fresh store program, while in Philadelphia the newer, larger Acme combination stores are not pulling enough of the load to help the older store base there."

According to Cerankosky, American Stores was challenged throughout the year to raise earnings through margin expansion without having much revenue growth, "and that was a challenge it couldn't offset in the third quarter, which resulted in a sharp sell off as earnings fell due to cost pressures on both the drug store side and the food side, where American had to give up some of the savings from greater efficiencies to reinvest in price promotions."

Giant Food, Landover, Md., down 2.4%

Giant fought off a potentially larger stock decline by launching an aggressive promotional campaign to recapture sales lost during a protracted teamsters strike that extended into the early part of 1997, Levin said.

A&P, Montvale, N.J., down 6.9%

A&P has a long road to recovery ahead of it, Levin said. One of A&P's strongest advocates in the past, Levin said the company's stock did well in the first half, "but a severe pickup in competitive activity in the Northeast during the third quarter hurt, and it will be a long process of recovery."

Smart & Final Co., Vernon, Calif., down 16.3%

"[Those results] disappointed people last year," Ziegler said. "The company had come through the California recession with impressive same-store sales gains -- in the medium single digits -- but the numbers got soft in mid-1997 as Smart & Final encountered integration and distribution problems in the Florida operation it acquired in 1996."

Food Lion, Salisbury, N.C., down 18.5%

Levin attributed Food Lion's weaker performance to the company's acquisition of Kash n' Karry Food Stores, Tampa, Fla., at the end of 1996. "It's taken longer for the chain to be profitable than Food Lion had anticipated," she said, "because initially Food Lion didn't understand the operation, and it took a while to replace management there and establish distribution synergies.

"And it will still require more remodeling to get those stores in shape, so profitability was unlikely till the fourth quarter of 1997."

Comeau said the impact on Food Lion's stock price should be only short term. "After coming off a strong year in 1996, 1997 was a transition year for Food Lion, as it digested the Kash n' Karry acquisition and dealt with competition in its core Southeastern markets. But 1998 should be another good year for the company."