BOISE, Idaho -- Albertson's here said last week it plans to invest in sales, reduce expenses and pare back capital spending in the wake of an earnings shortfall during the second quarter ended Aug. 3.
News of the shortfall triggered a drop in Albertson's share price and in most other supermarket and drug-store stocks last week, prompting some securities companies to downgrade the ratings for the entire sector in anticipation of margin erosion throughout the industry.
In a conference call with analysts last week, Albertson's executives said the shortfall was caused by increased labor costs in the chain's service departments, which boosted operating expenses during the quarter, and by disappointing business in July, which cut into comparable-store sales results.
When final second-quarter numbers are released Sept. 5, Albertson's said, it expects earnings per share of 50 cents, excluding merger-related costs -- or 46 cents with the merger costs included -- compared with expectations of 62 cents per share.
Total sales for the quarter were up 4.6% to $9.2 billion, the company said, while comparable-store sales, including replacement stores, increased 1.4% -- an improvement over the 0.8% increase in comps in the first quarter but below what the chain was anticipated to do.
Peter Lynch, president and chief operating officer, said same-store sales were better during the first two weeks of August than they were for the whole month of July. The chain's goal, he added, is to increase comparable sales by 3% a year.
According to Gary E. Michael, chairman and chief executive officer, "July was a tough month for us, and the remainder of the year looks like it will be just as challenging. We still like our new company, but it's turned out to be more complex than we anticipated when we put it together" following the merger with American Stores Co. 14 months ago.
He said Albertson's California stores, which had been a drag on earnings in prior periods, "made some progress" during the quarter; however, "other key markets" -- which he did not specify -- "are experiencing significant market-entry activity by competitors, resulting in an irregular pricing environment."
He also said Albertson's "needs to get back to 13% to 15% annual earnings growth. We're still making a lot of money, but just not enough.'
To strengthen its financial performance going forward, the company said it will introduce a series of initiatives, including the following:
To Invest gross profits to drive sales. "If a competitor is selling milk at half price, we have to react -- we can't be out of line on key items," Michael said. "But it's not about being stupid. We will be intelligent and precise in whatever we do." According to Lynch, "We might be a little high in a couple of markets, but we will look at that and make sure we're priced where we should be."
To put more focus on the center of the store. "We've talked with manufacturers, and we will partner with them to get customers back into the center store," Lynch said, though he did not discuss any specifics.
To cut selling, general and administrative expenses by $250 million in 2001 by reducing store labor in perimeter departments, consolidating warehouses, cutting back on office staff, reducing overhead and improving the ratio of full-time to part-time employees. "Expenses have crept in as we've gone through the integration, and we think we can eliminate some costs quickly," said Craig Olsen, executive vice president and chief financial officer.
To reduce capital expenditures by $500 million over the next two and a half years by opening fewer stores than originally scheduled. "But we have no plans to cut back on remodeling plans because we think it's very important to keep updating the existing store base," said Mike Reuling, vice chairman. Added Michael, "We will stick to existing markets for growth. We don't need any new territory right now."
To renew its "culture of thrift," "something we've lost focus on during the last year," Lynch said.
Ed Comeau, an analyst with Donaldson Lufkin & Jenrette, New York, said he does not view Albertson's problems as a signal that broad-based price wars are about to affect the entire industry. "It is a problem specific to Albertson's," he said.
"Much of the sales problem relates to new competition from Wal-Mart supercenters in the Rockies and the South, as well as increased competition from Safeway and Kroger in California.
"The core issue is not the company's ability to reduce expenses or integrate American Stores. Rather, it lies almost entirely in Albertson's marketing capabilities and is similar to the situation the company faced in the second half of 1996. But while the company's marketing abilities have improved since then, it may still be outpaced by its competitors."
Jonathan Ziegler, San Francisco-based managing director of Deutsche Banc Alex. Brown, New York, said Albertson's has been so focused on integration "that it lost its focus on the old Albertson's stores. So it needs to do some severe category management in those stores and sex them up a little bit.
"But all its problems are healable. It hasn't broken its spine, just its leg, and it will require a cast for a short period, not major surgery."
Meredith Adler, an analyst with Lehman Bros., New York, said Albertson's decision to shore up its center-store operations is due to the competitive threat posed by Wal-Mart supercenters, "which have gotten to be a much better competitor in dry grocery by beefing up assortments and improving merchandising, and which clearly offers better prices than most conventional stores on those products.
"Center store at Albertson's is apparently a bigger weakness than we realized, but exactly what Albertson's plans to do to improve the appeal of this section is hard to say. Its merchandising managers are visiting stores run by other retailers to identify best practices in dry groceries, and eventually some of that will be incorporated at Albertson's."
In last week's conference call with analysts, Michael stressed some of the positive developments in the integration process, including the consolidation of two Acme distribution centers in the Philadelphia area into a single larger facility "with only minor disruptions," and the pending rationalization of its distribution facilities in southern California, with the planned closing of a Buena Park warehouse next month, "which will allow us to take costs out of the system."
According to Olsen, Albertson's plans to sell the Buena Park facility.
Olsen also said the integration of Acme is on track, with 45 stores already converted to the Albertson's systems and completion of the conversions anticipated in early October; he also said about one-third of Albertson's in-store pharmacies have been converted to the American Stores system, with conversions progressing at the rate of 20 to 30 a week and completion scheduled for April.
Referring to the company's disappointing sales in July, Michael said, "We thought we had a strong plan, and we're not making excuses, but we saw shortfalls all across the U.S."
According to Lynch, "Our sales plans just never took hold the week before and after the Fourth of July and during the two weeks that followed. It was a coast-to-coast phenomenon, not limited to any one area."
He said competitive activity ebbed and flowed from region to region during the quarter, "with some markets experiencing very intense competition, and we're getting hurt in a few of them."
Michael said competitive openings will continue to accelerate, with 40 supercenter openings in the next couple of months in Idaho, Utah, Wyoming, Montana and parts of the South.
According to Olsen, Albertson's average ticket sales were up throughout most of the company, though traffic was down somewhat. "We think we can help boost traffic by driving center-store sales," he noted.
Michael said most of the company's sales disappointments were in the center store rather than in perimeter departments. "We're seeing improvements in our service departments, and we need to get more out of them," he said. "But we don't think our expenses are out of line, and we're determined to increase sales in our service departments -- that's not going to change."
According to Lynch, "Perimeter departments produce good profits, and we do them better than supercenters. But we need a better balance in labor."
Lynch acknowledged that expenses "were heavier than they should have been," and Olsen said the decision to shift the sales mix from lower-cost groceries to higher-cost service departments during the quarter " was a good business decision. But it increased our costs in labor and benefits, and now we must invest more in center-store to balance the mix."
The warehouse consolidations in Philadelphia and southern California will help Albertson's cut costs, Michael said, "because we'll be more efficient. With fewer facilities, we'll have less labor and less inventory, and the trucks will have shorter runs with fuller loads."
In terms of capital spending, Lynch said, Albertson's will cut back its store-opening program, scheduling 55 new combination stores this year instead of 90 and 35 freestanding drug stores instead of 50, although it will not alter its plans to remodel 110 supermarkets and 20 drug stores. He also said the company's plan to open 90 fuel centers this year will not be changed.