THE STOCK AFTER SHOCK

ELLIOT ZWIEBACH

Grocery stocks took a tumble during the first half of 2000 as investors hedged their bets following integration disappointments in the second half of 1999.

However, after becoming disenchanted with the performance of dot-com stocks in the first half of this year, investors appear to be interested in redeploying their funds back into the grocery sector during the second half, securities analysts told SN.

According to the SN Composite Index of 40 food-company stocks -- including retailers, wholesalers and on-line grocery companies -- stock prices fell 11.1% during the first half (10.2% if e-commerce stocks are excluded), which was slightly below the 9.1% drop in the Dow Jones Index and considerably behind the 1% decline in the S&P 500, which includes a broader range of companies.

Only 13 food-related stocks increased during the period while 27 dropped. Although wholesaler stocks rose 2% during the half, retailer stocks declined 10.3% and e-commerce stocks fell 33%.

The short-term integration problems late last year involving Kroger Co. with Fred Meyer Inc. and Albertson's with American Stores Co. -- despite a seamless merger of Randall's Food Markets into Safeway -- had a lot to do with declines in first-half stock performance, analysts told SN.

"Many investors were still licking their wounds after last year's integration efforts, and they took a cautious view of the group going into the year," said Ed Comeau, an analyst with Donaldson Lufkin & Jenrette, New York.

"Their biggest concerns were whether Kroger, Albertson's and Safeway could handle the merger integrations after the indigestion of last year's third and fourth quarters. But the first-half performance of those three companies, particularly Kroger and Safeway, eased some of those concerns and prompted them to begin re-evaluating their investments late in the half."

According to Jonathan Ziegler, San Francisco-based managing director of Deutsche Banc Alex. Brown, New York, "Investors took a 'show me' attitude last year, and the industry is still in the process of showing them, with each company at a different stage of integration.

"Safeway's integration of Randall's was virtually risk-free and went very smoothly, but it was tarnished somewhat through guilt-by-association with Kroger and Albertson's, whose integrations were more problematic.

"Now Kroger is on pace and Albertson's is starting to come out of the woods, and that should mean better prospects for the group as a whole."

Chuck Cerankosky, an analyst with McDonald & Co., Cleveland, said retail food stocks were down in the first quarter of the year "after a lackluster 1999" but did well in the second quarter. "The industry was putting out decent earnings reports at the end of the first quarter, with year-end numbers convincing people that some of their worries over certain issues were overdone and earnings were on track.

"In addition, a fair of amount of sector rotation was taking place, with investors moving out of high-tech and e-commerce stocks and back into old-economy stocks like food retailers after the tech group came under selling pressure in March and April as their losses continued."

Other analysts expressed similar thoughts about investor disenchantment with high-tech and Internet stocks.

"Early on, investors were selling their supermarket stocks and using the money as a source of funds for investments in high tech, but as the dot-coms struggled, investors began selling their tech stocks and the food group started recovering," Comeau said.

According to Ziegler, "Initially, the food group became a source of funds for investors looking for money to invest in tech companies because when tech stocks were strong, people got bored with a defensive group like supermarkets because they didn't feel the need to be defensive.

"But when tech stocks became volatile, it made investors nervous and anxious to move back into the grocery group, which, despite more modest growth, made it easier to sleep at night."

Looking ahead, Comeau said, the defensive nature of food stocks is making the sector more attractive to potential investors. "Although investors aren't sure the group will make them a lot of money, they're picking their spots, and that defensive posture should help the industry's performance in the second half," he said.

"If the economy slows down, then the group's defensive nature will look more attractive -- and without inflation and with higher interest rates, the stocks should outperform the general market."

Cerankosky said he is optimistic that the upward trend of the late first half will continue through the balance of the year. He also sees ongoing investor doubts about e-commerce stocks.

"Anything that was touched by the Internet last year had the imprimatur of being a great investment," Cerankosky said. "But when many of those companies continued to show losses or sales slowdowns, they got beat up pretty badly in the market, and it's hard to see much short-term recovery for another year or so."

Comeau said on-line grocery companies could still affect food stock prices, noting that if on-line grocery shopping seems to be capturing a larger overall market share, that could hurt investments in conventional food stocks.

"If the merger of Webvan and HomeGrocer is moving smoothly and Safeway, Ahold and Albertson's are expanding their e-commerce ventures, then investors may become concerned that this new channel poses a threat to conventional supermarkets," Comeau explained. "If on-line shopping rises to 4% to 5% of industry sales, then the perception will be that many marketing areas may not be able to absorb that kind of loss, and that could lead to uncertainty about the longterm growth of supermarket stocks."

Analysts' comments on selected stocks included the following:

NASH FINCH CO., Minneapolis, up 29.4%, and FLEMING COS., Dallas, up 27.4%, both of which benefitted from new management teams "moving the companies off the bottom as they addressed the problems of the past," Comeau said.

SAFEWAY, Pleasanton, Calif., up 25.9%, reflecting strong financial results. Cerankosky said the stock benefitted from excellent delivery of comparable-store sales improvements -- which doubled from 2.4% in the first quarter to 4.9% in the second -- "and from Safeway's ability to convert sales dollars rapidly into profit dollars, which enabled earnings per share to grow considerably faster than sales. Plus, the company has demonstrated it's able to integrate regional chains successfully."

According to Ziegler, "Safeway is the first grocery stock investors think of if they want to buy a supermarket stock. And if you're going to own just one name in the group, investors feel comfortable with Safeway because of the quality of its deals and management.

"Also, Steve Burd [Safeway chairman, president and chief executive officer] knows how to appeal to Wall Street," he added.

SOBEYS, Stellarton, Nova Scotia, up 22.8%, and LOBLAW COS., Toronto, up 20.3%, reflecting strong post-acquisition earnings performances.

According to Marilyn Brophy, a securities analyst with Scotia Capital, Toronto, Sobeys is trading at 12.7 times earnings, making it one of the most inexpensive stocks in North America. "And although it's leveraged [following its buyout of Oshawa at the end of 1998], earnings have either met or exceeded expectations, reflecting synergy savings, ongoing store renovations and an impressive reduction in debt."

Loblaw continues to deliver annual earnings growth of approximately 25% a year, Brophy said. "Since its acquisition of Provigo in late 1998, it's added the Atlantic operations of Oshawa and delivered strong earnings, with a very aggressive capital spending program, a clean balance sheet and a good management team," she added.

KROGER CO., Cincinnati, up 16.9%, after financial results helped reassure investors that the integration of Fred Meyer was proceeding smoothly.

According to Cerankosky, "Investors were concerned about Kroger's ability to integrate Fred Meyer, about the departure of some Fred Meyer management and about some balance-sheet issues. But the company reported a good fourth quarter and a particularly strong first quarter, which resolved the balance-sheet issues; it delivered good comparable-store sales and margin expansion, and there is every indication the integration is now proceeding as planned."

Ziegler said Kroger has the second-largest market capitalization and is the second place investors go when looking for a strong stock, after Safeway. "Institutional investors are beginning to believe in Kroger management now that the acquisition is going fairly well," he said.

ALBERTSON'S, Boise, Idaho, up 3.1%, following problems early on with integration in its California operation.

"The company saw its stock dip going into the first quarter, reflecting the downward slide of results last year," Cerankosky said. "Combining the Lucky operation with Albertson's in California was a big challenge, but the company knew that was its biggest integration/turnaround prospect, and investors have realized management has a good handle on the situation after things got out of control last year, and the benefits from that integration should continue to build."

SUPERVALU, Minneapolis, down 4.7%, due in large part to investor misperceptions. "Supervalu is a misunderstood story," Ziegler said. "The company is still perceived to be a food distributor, although it's becoming more of a retailer, and the company is trying to change that perceived image. It's still in a transition mode, and it hasn't completely made the transition."

Cerankosky said he agreed. "Supervalu's stock performance is probably the most puzzling of all stocks I follow because it has not only had good earnings growth, but that growth has also been better than expected and estimates have been raised several times.

"Yet the stock has had difficulty achieving upward movement because the company is seen as a wholesaler, though its sales increases are coming from its retail operations. But even as a wholesaler, it's producing attractive results."

WHOLE FOODS MARKET, Austin, Texas, down 10.9%. "Whole Foods made some mistakes during the year, including getting caught up in developing an Internet site," Ziegler said. "That caused disruptions for investors, who didn't like the site concept, but the company corrected the problem by becoming an equity partner in a third-party Web site, and now it is focusing more attention on its core business, and it was one of the best stock performers during the month of June."

DELHAIZE AMERICA, Salisbury, N.C., down 12.9% "because investors are concerned [with the merger with Hannaford Bros., Scarborough, Maine]" Comeau explained. "They recognize the company has a good management team that's trying to do the right things, but experience tells them putting mergers together can be risky early on."

Also hurting Delhaize, Comeau added, was the fact that second-quarter earnings came in below expectations.

According to Ziegler, Delhaize's cornerstone, Food Lion, "was well-positioned, and investors liked what it was doing. Food Lion stood for something and it really connected with consumers. But with the acquisitions of Kash n' Karry and now Hannaford, what the company stands for is more of a muddled proposition."

WINN-DIXIE STORES, Jacksonville, Fla., down 40.2%, because of disappointing financial results.

Ziegler said Winn-Dixie has continued to report disappointing numbers and to yield market share, although with the hiring of Al Rowland as president and CEO, "the company seems more receptive to change than it had been." However, the company is being hurt by its longterm lack of communication with Wall Street, he added.

According to Comeau, Winn-Dixie's earnings shortfalls have made an issue of the company's high dividend, "which will be hard to support going forward without a turnaround in earnings in the next two years."

A&P, Montvale, N.J., down 40.4%, due to two factors, Comeau said. "Earnings in 1999 were affected by the Great Renewal program, which promised benefits in 2000. But then at the beginning of 2000 the company announced Great Renewal 2, which means one more year of earnings dilution. A second factor was the pre-release announcement that first-quarter earnings would be below expectations."

WILD OATS MARKETS, Boulder, Colo., down 43.4%. "Wild Oats has definitely disappointed people," Ziegler said. "But management is finally waking up and repositioning the stores to appeal to a broader market segment, along the lines that Whole Food follows, and that should help the stock."

GRAND UNION CO., Wayne, N.J., down 94.8%. "They've dramatically missed their numbers," Comeau said. "The former CEO [Wayne Harris] misled the investment community's expectations when he said new-store development plans were coming on line, earnings were fine and the chain's strategy was working. But the chickens came home to roost when the numbers blew up in the fourth quarter."