Investors who watched their supermarket stocks languish for the past few years finally got some payoff in the first half of 2004.
Although analysts said the competitive pressures that have plagued the industry and subdued stock valuations in recent years have not abated, Wall Street began looking a little more favorably on the industry for a change during the first half.
"It's a bounce from a low point," said Andrew Wolf, analyst, BB&T Capital Markets, Richmond, Va. "Supermarkets have underperformed three years in a row, and when you're in a bull market, investors are always looking for a lagging group that could benefit with an economic rebound."
He said the performance of the industry in the first half, with the SN composite up 1.29% vs. a decline of 0.18% for the Dow Jones Index, reflects what he described as trends that are getting "less worse" than they had been.
"Earnings are still down, but they're not down as much," he said. "Same-store sales without fuel are down, but they're not down as much."
Jason Whitmer, analyst, FTN Mid-West Research, Cleveland, agreed that some industry stocks seem to have risen more because of a change in investors' attitudes than because of actual company performance.
"I'd say the biggest share-price movement you've seen over the past three to four weeks has been based more on sentiment," he said. "There's this perspective that the worst is over, and that some of these companies can bounce back a little bit."
He said he believes some industry share prices have raced ahead of themselves, however.
"I still think the fundamental outlook is basically flawed," he said. "We need to see not only better sales improvement, but we need to see less promotional activity."
The five-month strike-lockout in Southern California has made it even more difficult to gauge the underlying industry trends, at least for those companies involved, Whitmer said.
10 Stocks Underperformed
Wall Street wasn't equally generous to all of the stocks followed by SN, however. While the majority of issues (21) traded up and outperformed the Dow Jones Index, 10 stocks, including that of Wal-Mart Stores, Bentonville, Ark., did not.
The giant discounter came under pressure in the first half amid reports of resistance to its expansion efforts and a judge's decision to grant a gender-discrimination lawsuit class-action status.
The movement of industry stocks in the first half was a reversal of fortunes in many ways. Kroger, Cincinnati, which had been considered ahead of its "big three" cohorts -- Albertsons, Boise, Idaho, and Safeway, Pleasanton, Calif. -- in terms of its progress on cost-saving and price-cutting initiatives, was among the companies whose stocks slid into negative territory in the first half.
Kroger's shares fell 1.67% in the six-month span ended June 30 to close at $18.20, after the company warned investors that its earnings for the year would be down from last year as competitive pressures continued.
Albertsons and Safeway, by contrast, were among the leaders with double-digit gains in terms of percentage change in stock price. Albertsons closed at $26.54, up 17.17%, and Safeway closed at $25.34, up 15.65%.
"Kroger has the most sober view of what it has to do strategically at this point in time," said Wolf. "For most of the first half they said they had to protect market share at the expense of earnings. When they released their first-quarter earnings, they kind of backpedaled from that a little bit. They are not going to be as aggressive on margin investment and try to get more earnings to the bottom line."
Whitmer agreed that Kroger has articulated its situation differently than its two rivals.
"Some would make the assumption that they've just been more honest about their outlook," he said. "They have repeatedly said their earnings this year are going to be lower, even if you take the strike impact, and the other two really haven't been that up front."
In Albertsons' case, Jonathan Ziegler, principal, PUPS Investment Management, Santa Barbara, Calif., said investors might have finally come to the conclusion that the company was headed in the right direction.
"I think Albertsons has enunciated some pretty positive sentiment to Wall Street that things are changing and getting better," he said. "Albertsons was late to private label, it had to rationalize its assets, it introduced the dual-branded concept. There were a lot of ways in which Albertsons has been essentially coming from behind. Just of late it's outperformed. I think people are finally catching on to Albertsons."
Another factor that Ziegler said might have worked in Albertsons' favor in the first half was the fact that the company is one of the few in the industry that pays a dividend. The new tax laws that eliminate taxes on dividends make those stocks that offer them more attractive, he pointed out.
Impact of the Labor Dispute
Also working in the favor of Albertsons, Safeway and Kroger was that they were able to reach favorable terms in settling their labor contract in Southern California, setting the stage for other negotiations and reducing their costs for the long term.
The Southern California labor dispute also worked in favor of those companies that compete with the big three in that region. Austin, Texas-based Whole Foods, one of the biggest gainers of the first half (up 42.19%, to $95.45), reported strong incremental sales gains during the strike-lockout, which ended in March. Los Angeles-based Smart & Final (up 19.25%, to $12.02) and Compton, Calif.-based Arden Group (up 15.46%, to $89.48) also reported adding incremental business during the labor dispute, and their stocks, too, were among the gainers in the first half.
Natural- and organic-foods specialist Whole Foods estimated that it will retain 30% of the customers it added in Southern California.
"In a market like Southern California, that's not an unreasonable assumption," said Wolf, referring to the region's trend toward healthful eating.
United Natural Foods, the Dayville, Conn.-based distributor of natural and organic products, topped the list of stocks followed by SN with a gain of 61.01%, closing at $28.91 after it regained the supply contract for Boulder, Colo.-based Wild Oats (up 8.82%, to $14.07).
Other top gainers included regional operators Foodarama, Freehold, N.J.; Marsh Supermarkets, Indianapolis; and Harris Teeter parent company Ruddick, Matthews, N.C.
Minneapolis-based Nash Finch, one of the top gainers in 2003, continued to perform well through the first half of 2003 with a gain of 12.04% to $25.03 despite an ongoing weak performance from the company's retail division. In May, the company revealed that it would shutter 21 stores, including its Avanza and Buy n Save divisions.
Meanwhile Supervalu, also based in Minneapolis, continued to attract investors with its performance, analysts said. The company's shares grew 7.07% to $30.61 in the first half.
"At Supervalu, both wholesaling and retailing have been doing well," said Whitmer. "Not only have its Save-A-Lot stores continued to perform well, but its other big-box retail concepts have also been doing very well."
Ziegler also said he believes Supervalu still stands to gain incremental wholesaling revenues from former customers of Fleming, Dallas, which ceased operating as a supermarket wholesaler last year.
"I think there's still a lot of business out there to be had," he said.
Some analysts apparently don't share the sentiments of Whitmer and Ziegler, however.
Last week Steven Chick of J.P. Morgan, New York, issued a downgrade -- to "underweight" from "neutral" -- on Supervalu's stock, citing the losses this year of two of Supervalu's largest customers and challenges to meeting earnings expectations.
This year Supervalu revealed that regional customers D'Agostino's, Larchmont, N.Y., and Haggen, Bellingham, Wash., were leaving Supervalu to join other wholesalers.
"Although these contract losses contribute to the 2% to 4% annual attrition [that the wholesaler said can be expected annually], we estimate that Supervalu will need to garner another $200 million to $300 million in gross wholesale gains in order to achieve our estimates for the year," Chick said in the note, according to reports.
The stock fell about 3% after the report came out.
The market gave a thumbs-down to other wholesalers during the period, including Spartan Stores, Grand Rapids, Mich., and Fresh Brands, Sheboygan, Wis., which were among the industry's worst performers in the first half.
Despite the relatively weak performance of Wal-Mart, other broad-line operators saw their stocks increase in value as those companies continued to grow at the expense of traditional food retailers. Shares of Costco, Issaquah, Wash., were up 10.76%, to $41.18; Minneapolis-based Target's shares gained 10.6%, to $42.47; and shares of BJ's Wholesale Club, Natick, Mass., were up 8.89%, to $25.
Competition in Canada
Three of the 10 stocks that lost value in the first half were Canadian issues: Loblaw, Toronto; Sobeys, Stellarton, Nova Scotia; and Metro-Richelieu, Montreal.
In Canada, pricing pressures have been acute, especially in the eastern provinces, where Loblaw has been leading an aggressive price-cutting effort to the detriment of earnings at major competitors.
As a result, investors punished shares of Metro and Sobeys as those companies sacrificed margins to be more competitive on price.
Bill Chisholm, analyst, Dundee Securities, Toronto, said he expects to see pressure on those companies' stocks through the rest of the year.
"I think in the short term it's more of the same, because the earnings momentum is not there yet," he said. "But, these things run their course. These are all well-managed, well-financed companies, so there's no question of them getting into any financial difficulty, I don't think. It's just not going to be the year for supermarkets [in Canada]."
GAINERS
Of the stocks tracked by SN, following are the top five gainers in share-price value during the first half of 2004.
United Natural Foods, up 61.01% in the first half of 2004, after a gain of 41.66% in 2003.
"United Natural is very similar to Whole Foods," which it also supplies, said Wolf of BB&T Capital Markets. "They are both completely tied to the growth of natural foods."
The difference, he said, is that while Whole Foods "has to execute every day in the store," United is involved in the natural-products industry through an array of different channels, including as a supplier to such regional operators as Wegmans, Rochester, N.Y. The biggest customer group for United is natural independent grocery stores, which Wolf said is growing at a rate of about 7% to 8% annually.
Despite a smooth transition in assuming the supply contract for Wild Oats, however, United saw its share price slide last week after the company projected earnings that were slightly lower than analysts' projections. Among the causes: rising medical costs for employees.
Foodarama, up 58.96%, after a decline of 5.91% in 2003.
Foodarama saw its shares climb at a relatively steady pace in the first half, after the operator of 26 ShopRite stores in New Jersey reported strong financial performances in the first and second quarters.
Sales for the first quarter were up 14.6% compared with the first quarter of the previous year, and same-store sales grew 3.6%. Net income for the first quarter ended Jan. 31 was $1.24 million, more than three times the net income in the year-ago period.
In the second quarter, net income grew even faster, to more than six times the prior-year results, totaling $956,000 on a 9.6% increase in sales and a 2.7% increase in same-store sales.
Whole Foods, up 42.19% in the first half of 2004, after a gain of 27.31% last year.
"Whole Foods had a huge first half," said Wolf, although he noted that he recently removed the "buy" rating he had on the stock since 2001 because he felt that its share price was trading at its maximum relative to projected earnings.
The company remains one of the fastest-growing food retailers in terms of both new stores and same-store sales.
In the second quarter, the company reported 17% gains in identical-store sales, while square footage grew by 7%.
Marsh Supermarkets, up 27.13% in the first half of 2004, following a decrease of 14.62% in 2003.
The regional operator opened its first two "lifestyle" prototype stores, and last month posted gains in operating income for its fiscal fourth quarter and year ended March 27. Same-store sales were negative in the low single digits, however, as the company faced a weak economy in its core Indiana markets and increasing competition.
Ruddick, up 25.42% in the first half, after a gain of 30.75% during the preceding year.
The parent of the Harris Teeter supermarket chain and the American & Efird sewing-machine thread division saw its shares bolstered by the performance of its upscale supermarket banner.
For the second quarter, Harris Teeter sales rose 3.6% vs. year-ago results, and comparable-store sales were up 2.41%. For the first six months of fiscal 2004, sales rose 3.2% and comparable-store sales increased 1.91%.
LOSERS
Of the stocks tracked by SN, following are the top five losers in share-price value during the first half of 2004.
Spartan Stores, down 32% in the first half of 2004 after growing 231.13% in 2003.
Spartan's huge gain in share price last year could not be sustained this year despite improvements in operating earnings and same-store sales. Comparable-store sales were up 5.4% for the fiscal fourth quarter ended March 27, representing the fourth consecutive quarter of comparable-store sales growth. Operating earnings improved to $5.8 million, compared with $870,000 in the year-ago period. Comparable-store sales for the year increased 3.2%, and operating earnings improved to $12.6 million compared with an operating loss of $38.4 million in the previous year.
The company's earnings were still negative for the year, however, after one-time charges totaling $47.7 million.
Fresh Brands, down 30.18% in the first half, following a decline of 33.33% in 2003.
After leveling off during the first few months of the year, shares in Fresh Brands slid as the company's operating performance faltered and it underwent a management transition. Fresh Brands posted what it termed a "disappointing" first quarter, with a loss of $1.7 million.
Winn-Dixie Stores, Jacksonville, Fla., down 27.64%, following a slide of 34.88% in the preceding year.
The company unveiled plans to sell or shutter 156 stores, but needs more cash to revive its remaining operations, analysts said.
"Winn-Dixie has come back a little bit, but it still has an uncertain future," said Whitmer of FTN Midwest Research.
He said the company's recent doubling of its credit facility might not be enough. "[Investors] are trying to figure out what the potential is for them to fix up their assets and get some cash, not just from financing a new credit facility but from selling off some of their assets and reinvesting it in their base," he said.
Metro-Richelieu, down 14.16% in the first half of 2004, following a gain of 23.38% in 2003.
"Metro just reported its first down quarter in five years," said Chisholm of Dundee Securities, who added that he expects another down quarter for the company. "Metro is still very profitable, but year-over-year profits are down."
Sobeys, down 12.4% after falling 14.62% in the preceding year.
Sobeys' earnings have been down several quarters in a row, Chisholm said, as the company struggles to lower its prices to compete with Loblaw, especially in Ontario.
"I think this program of investing in gross margin is still going to be affecting them through the first half of the [fiscal] year," said Chisholm.
