Industry observers have begun to view the prospect of consolidation striking supermarket operators in the Northeast the way Californians might view the next earthquake. They are certain it is coming, but can never be sure quite when.
While major cracks have yet to open along the Northeast fault lines, tremors have been ongoing for two years now. Many suggest a pairing of Montvale, N.J.-based A&P and Carteret, N.J.-based Pathmark as the event that would begin to shift the landscape.
That particular combination, sources say, could for the first time create leadership positions in the historically fragmented markets of metro New York, New Jersey and Philadelphia, while saving millions in product costs and overhead. Moreover, analysts say, the risks of not consolidating are considerable, leading many to believe that a merger — either between those two or among them and others — is only a matter of time.
“Consolidation is an inevitable situation,” Gary Giblen, an analyst at Brean Murray Caret, New York, told SN.
While cautious about any talk of specific discussions, officials of the respective companies have made little secret of their desire to be part of something larger themselves. A&P is searching for greater scale and lower costs, and it could certainly use a few more productive sites. The chain is awash in cash and free of debt after selling its profitable Canadian division in 2005, but it is relying on an expensive store renovation program to power a recovery.
Pathmark in 2005 acquired a new majority owner: Ron Burkle's Yucaipa Cos., which is the very definition of a change agent. While sales volume isn't the concern at Pathmark the way it is at A&P, profits are: The company is counting on merchandising improvements to generate more profits from existing sales, but with costs high, new growth — and the financial strength to effect the consolidation that would bring it — has been difficult to come by.
Some say struggles with their existing businesses have prevented the sides from coming together already. “Two drunks can't necessarily stand up straight by leaning against one another,” Giblen remarked. “To add integration onto the company-specific turnarounds could really overload their systems.”
Reading the (Great A&P) Tea Leaves
In a conference call in early January, Christian Haub, A&P's executive chairman and scion of the controlling Tengelmann family, was asked whether he was any more confident in getting consolidation done then, as compared to a year ago. His reply — “I don't think I want to get into that kind of comment” — just might have spoken volumes, some believe.
“In past conference calls, [Haub] had been pretty vocal about consolidation, and about Pathmark specifically,” noted Karen Short, an analyst at Friedman Billings Ramsey, New York. “Him essentially saying he wasn't at liberty to discuss it, after discussing it more freely during the last call — well, I thought it was interesting. I am just speculating, but maybe you clam up if you don't want to rock the boat.”
If Haub were at work on a major deal, it wouldn't come as a surprise. Haub has spoken frequently on the topic since A&P's Canada deal in 2005, including an awkward episode at an investor conference last spring where Haub said A&P was “ready, willing and able” to consolidate, while a row of Pathmark and Yucaipa executives watched silently with arms folded.
And A&P has made a deal since then, albeit a small one. It acquired six Clemens Markets locations from C&S after C&S purchased them from Clemens, and converted them to its Superfresh banner. Officials said the stores were acquired “at a very reasonable cost,” and that would help spread labor costs across a larger base — one of the benefits it sees from consolidation as a whole.
Some analysts believe A&P would prefer to get its own operations in order before taking on another's, but in the competitive Northeast, that can be a tricky endeavor. For example, A&P in November decided against promoting Thanksgiving turkeys as aggressively as some competitors, only to see same-store sales get hammered.
“In a highly competitive, zero-sum market, even minor pricing stances can reverberate,” Perry Caicco, analyst for CIBC World Markets, Toronto, wrote in a recent research note. “Clearly, consolidation and some accompanying orderliness are needed in this market.”
A&P in the meantime is seeing promising results from at least some internal initiatives. The retailer is spending some $200 million a year upgrading stores to new formats. Its fresh store makeovers, particularly “offensive” renovations, have provided dramatic increases in sales and return on invested capital, company officials said.
However, not all observers are convinced of A&P's continuing success, and it will be some time before its entire store base finds the appropriate format. John Heinbockel, analyst for Goldman Sachs, New York, earlier this year said A&P was entering into “a tenuous, sales-driven turnaround” that suggested the road to profitability “might be tougher than previously thought.”
Another market observer, who asked not to be identified, expressed doubt that A&P's discount Food Basics would succeed, or that the fresh remodels would necessarily work in every market the company tried them.
“The fresh store might work great in Bergen County [N.J.], but I don't know how great it will work in Middlesex County or Union County — areas that are more middle-income, more price-sensitive, and more influenced by Pathmark and ShopRite,” the source said.
These concerns, some sources say, may force A&P to seek the benefits of consolidation sooner rather than later.
“We're hearing that things have been very active” between Pathmark and A&P, Burt P. Flickinger III, managing director of Strategic Resource Group, New York, told SN in a recent interview. He said, however, he wouldn't expect a deal to be reached until after the chains agree to terms on labor contracts that expire this fall.
Pathmark's Cost Challenges
Shortly after his Yucaipa Cos. gained a controlling stake in Pathmark in 2005, Ron Burkle in an interview with SN laid out a general plan of attack.
“At Pathmark, we think we can get cash flow from $140 million to $150 million a year back up to $200 million, with the stock rising to $20 a share,” he said. “With that as a base, we would hope we could acquire other companies and lead consolidation in that part of the country.”
As with A&P, that recovery may be more gradual than anticipated, and could run Pathmark into the arms of a consolidator before long, some observers said.
Pathmark has been busy making merchandising changes designed to generate a more profitable mix of sales in its stores, including a recent deal with Wild Oats Markets to sell private-label organic goods. Boulder, Colo.-based Wild Oats is also controlled by Yucaipa, leading to some speculation that the Wild Oats brand could figure more prominently in future Pathmark iterations.
“There's been a lot of market talk that with Yucaipa having a big investment in Pathmark and a big investment in Oats, and with Oats currently without a CEO, there could be some combination there,” Andrew Wolf, an analyst for BB&T Capital Markets, Richmond, Va., told SN.
But nearly any means of growing Pathmark will require borrowings the company can ill afford, given its cost structure, Short contended.
“Pathmark right now has a choice,” Short said. “They're sitting on a great asset with great real estate and great brand equity, but they have to invest in the stores. You can ramp up capital spending to ramp up same-store sales, but then you've eaten into the revolver, you have less flexibility, and it could be a year before you see a boost in the top line.
“I'm not suggesting they're going to have aliquidity crisis, but it's not a great situation,” she continued. “They're taking a really big gamble going at it as a stand-alone. The logical business decision at this point is that it's time to sell.”
Changing Market
Though most U.S. markets experienced at least some consolidation activity a decade ago, the trend never caught on in the New York metro area. Today, sources say, some of the factors chilling potential deals then — ranging from the perceived toughness of the Federal Trade Commission to the perceived irrationality of some competitors — have relaxed some.
“In the past, it was said the market was too difficult competitively because of ShopRite, who was viewed as an irrational competitor that was so preoccupied with its price image and volume in the marketplace they would do anything, including self-destructive things, to maintain market share and volume,” the unnamed market observer said.
That image is softening now that Wakefern, the cooperative comprising ShopRite owners, saw its leadership transition to Joseph Colalillo from Thomas Infusino in 2005.
“You had the old guard there, who came from the old school and said, ‘We must protect volume at all costs,’” another anonymous source told SN. “Now you have a young, smart businessman in there, who some believe will take a more pragmatic view of the marketplace.”
Ironically, improvements made by A&P and Pathmark in the last year may have also eased some competitiveness, Giblen added. “ShopRite can be more rational, because the others have gotten stronger and are not as easy to push around as they were when they were struggling,” he said. “Then, ShopRite had more to gain in a price war.”
While observers say a complicated ownership structure makes Wakefern/ShopRite unlikely to be a consolidator, or a target for a buyer, they are watching to see what ultimately happens with another competitor, Stop & Shop.
The Quincy, Mass.-based banner is in the midst of a radical change to an everyday-low-pricing scheme to strengthen itself against the backdrop of activist shareholders demanding that its parent company, Ahold, divest its U.S. holdings. Private-equity groups and Belgian-based retailer Delhaize Group have been said to be interested in Ahold's U.S. banners, which include Stop & Shop as well as Giant of Landover and Giant of Carlisle. A source told SN last year that Delhaize's interest was genuine, but that any potential deal was far along the horizon.
Ahold in the meantime is marketing its U.S. Foodservice business, a deal many expect could fetch billions. While shareholders and other retail businesses across the globe will angle for some of that money, a portion could be invested back into Stop & Shop, particularly for defensive renovations, Flickinger said.
FTC Concerns
Pathmark throughout its 40-year history has been the target of multiple takeovers, and was left at the altar once — in 1999, when Ahold walked away, citing differences with the FTC over divestitures to satisfy antitrust concerns. (The solution proposed then by regulators would have required Ahold to spin off dozens of stores, including many to A&P, reports said.)
With that scenario still in mind, dealmakers would do well to present a strong case to regulators this time around, sources said.
“It makes sense to do a lot of up-front work on the store base to have a compelling argument to present to the FTC,” said Short. “If A&P is buying, and they're told they have to divest [what equates to] $50 million in EBITDA instead of $25 million, they have to be prepared to walk away.”
Giblen noted that the FTC “has a history of extreme swings of permissiveness,” and said the atmosphere might turn more difficult for retailers if Democrats gain additional power, or the White House, in 2008.
