THE BIG GUYS SCORE

Industry performance in the second half of 1998 continued to outpace financial results for the same period of the prior year, and most securities analysts said they expect more of the same through the first half of 1999.Looking at the second-half performance of the 10 largest supermarket chains with public debt or equity, overall sales jumped 15%, operating income was up 22.5% and comparable-store

Industry performance in the second half of 1998 continued to outpace financial results for the same period of the prior year, and most securities analysts said they expect more of the same through the first half of 1999.

Looking at the second-half performance of the 10 largest supermarket chains with public debt or equity, overall sales jumped 15%, operating income was up 22.5% and comparable-store sales rose an average of 2.2%. In the second half of 1997, sales were up 5.9% over the prior year, operating income climbed 13.3% and comparable-store sales rose an average of 1.7%.

According to observers, the industry benefited from a complete lack of price inflation during the half and from past investments in technology and information systems.

Jonathan Ziegler, a San Francisco-based analyst with Salomon Bros., New York, said the industry did "extraordinarily well" during the second half, "but it's been doing well for the last several years as the companies have woken up to how to run their businesses right -- by focusing on customers, improving merchandising, making more productive use of real estate, doing a better job of inventory control, making huge improvements in private-label programs, offering more realistic pricing and shifting more efforts toward fresh and value-added product.

"In brief, the industry is doing a great job applying technology to make the business more productive."

Chuck Cerankosky, an analyst with McDonald & Co., Cleveland, expressed a similar view. "Overall good execution made good things happen," he said.

"The chains offered merchandising customers wanted to see and made continued use of good promotions. As a result, they had generally positive comps, expanding margins and good results from acquisitions -- and they got some help from the strong economy."

Debra Levin, an analyst with Morgan Stanley Dean Witter, New York, said sales in the half "continued to be solid among the major players, although comparable-store sales, while moderately improved, were still average -- an indication that the industry is benefiting from consolidation and economies of scale, which will be reflected more powerfully going forward."

According to Mark Husson, an analyst with Merrill Lynch, New York, "Profitability for companies like Kroger, Safeway and Ahold benefited from their ability to centrally coordinate more of their businesses in the areas of buying, administration and information technology.

"In addition, there was a real sense that large retailers with multiple divisions were beginning to behave like a single operation instead of several loosely knit associations. Toward that end, Kroger, for example, has taken everything but local selling out of the hands of the divisions and is beginning to realize the benefits of more efficiency and economies of scale through a central location."

The second half of 1998 was also strong, Husson said, because of an improvement in the competitive environment, especially in California, where Lucky backed off on the aggressive pricing program it had initiated earlier in the year by modifying its everyday-low-pricing program to reflect more promotional specials. "When Lucky moved prices back up, that eased competition," he said.

Ziegler noted that Lucky altered its pricing program "at about the time the merger with Albertson's was announced in August, and it may have been Albertson's influence that prompted Lucky to ease off on pricing to get earnings back up."

Ted Bernstein, a high-yield analyst with Grantchester Securities, New York, said second-half results varied among high-yield operators, with Pathmark showing strong same-store sales and Randall's Food Markets and Marsh Supermarkets "hitting the cover off the ball," while Penn Traffic Co. struggled and filed for Chapter 11 protection in March.

"But the consolidation trend is not yet over, and it could still have an impact on some high-yield regional operators," Bernstein said. The pace of acquisition is likely to slow, "because a lot of the better properties have been bought up, but it will still be relatively active," he explained.

Although two of the analysts queried by SN believe the first half of the year promises more of the same as the second half of 1998, Husson said the longterm effects of consolidation could affect some companies' financial results.

"The competitive environment has not changed, but Safeway will be busy integrating Dominick's, as well as Carr Gottstein, which hasn't even closed yet; Albertson's will be focusing on getting the American Stores deal done, and Kroger will focus on getting the responsibilities with Fred Meyer sorted out.

"So while there's no reason to suppose good returns won't continue, a significant amount of time and money will be spent dealing with consolidation issues, which means those companies will have less time for other matters. I don't think we'll see anybody drop the ball, but there could be some impact on performance improvements, and the industry could be in for a tougher time."

According to Cerankosky, "The acquisition assimilation process has yet to happen for the two big deals announced last year -- Albertson's-American Stores and Kroger-Fred Meyer -- so there's no way to say if those deals will accelerate earnings growth in the near term or if there will be any digestion problems.

"However, from what I can tell so far, the first half of 1999 looks much the same as the second half of last year, and there haven't been any nasty outbreaks that might upset earnings."

Ziegler said the first half of 1999 seems to reflect strong performances from most companies, "with Kroger, Albertson's, Safeway and Ahold indicating their numbers are coming through really well."

He said he does not foresee any sales disappointments, "and I'm betting we'll see better-than-expected numbers because of deflation in dairy, which should allow margins to pick up in the second quarter as the wholesale cost of dairy products comes down faster than retail prices."

However, Ziegler said he expects competition to catch up with dairy prices by mid-year, forcing those prices down. He said he also expects "a tremendous increase in sales in the fourth quarter as people begin to stock up for Y2K."

The analysts' comments on the second-half performance of each of the 10 largest public chains follow:

KROGER CO., CINCINNATI, with second-half sales up 8.5%, EBITDA up 15.2%, and comparable-store sales up 3.6% in the third quarter and 2.4% in the fourth.

Husson said he attributed Kroger's "decent comps" to its Big Buy/Big Sell program, a two-year-old program in which Kroger buys promotional goods for all divisions and requires them to promote the products simultaneously. When the program started, there were few deals involved, Husson said, "but now there's a huge new program every two weeks, and it's proven to be a very strong promotional platform that has helped sales."

Cerankosky said Kroger benefited during the half from previous investments in its distribution infrastructure that included upgrading facilities, reconfiguring how product is distributed and implementing technology and information systems.

SAFEWAY, Pleasanton, Calif., with second-half sales up 2.7%, operating income up 17.5%, and comps up 4.8% in the third quarter and 3% in the fourth.

According to Ziegler, Safeway continued to focus on improving same-store sales and to take market share from other operators by offering clean stores with well-stocked shelves, good private label and good customer service. Safeway also benefited from the solid West Coast economy, he added.

Husson said Safeway's second-half results benefited from ongoing improvements in its Canadian operations "and the quarter-by-quarter increases in the contribution from Vons Cos., which just keep getting better."

Cerankosky said he agreed that the assimilation of Vons -- "a good acquisition for Safeway" -- is contributing to the bottom line, "and even Dominick's [acquired in November] contributed a bit to second-half results. And Safeway continued to benefit from a long string of good expense controls, coupled with better margins and a successful remodeling program."

AMERICAN STORES CO., Salt Lake City, with sales in the half rising 4.3%, operating income up 23.8%, and comps up 1.3% in the third quarter and 2% in the fourth. (Operating income results exclude a pre-tax writedown of $195.3 million involving a stock option charge related to American Stores' pending merger with Albertson's.)

Cerankosky said American Stores' second-half comps were actually "a little bit on the weak side," noting that, after removing results from its pharmacy operations, comps on the food side were flat in the third quarter and up 0.9% in the fourth.

He also said American Stores "had some second-half issues with people who aren't paying attention to operations as closely as they might have if there wasn't a takeover looming. With an 18% reduction in headquarters staff at American Stores, the merger may be distracting some people who are spread a little thin."

ALBERTSON'S, Boise, Idaho, with sales up 10.3% in the second half, operating income up 11.6%, and comps up 1.7% and 0.4% for the third and fourth quarters, respectively.

Analysts noted that Albertson's sales benefited from the addition of 56 stores acquired earlier in the year, including 10 units of Seessel's, Memphis, Tenn.; three Super One stores in Iowa; 14 Bruno's stores in Tennessee and Georgia; and 29 units from Buttrey Food & Drug Stores, Great Falls, Mont.

Cerankosky said Albertson's earnings in the half recovered nicely from the prior year, when the sales trend was less stable. "The acquisitions helped the bottom line," he said, while revenues from the acquisitions, especially the Buttrey deal, gave "a nice impetus" to the top line.

Husson said Albertson's spent a great deal of time and effort during the half integrating its acquisitions, "including a lot of effort integrating systems, at a cost of $18 million."

He said the chain also went after sales more aggressively during the half, which hurt earnings and had a small effect on the company's first-quarter results as well.

According to Ziegler, comparable-store sales during the half were hurt by strong competition from supercenters, "which affected Albertson's center-store sales because people tend to do more stock-up shopping at the larger stores."

AHOLD USA, Atlanta, with sales up 24.2%, operating income up 34.6%, and comps rising 0.3% in the third quarter and 3.5% in the fourth. Ahold USA is a division of Ahold, Zaandam, Netherlands.

Ahold got a big boost in second-half sales from its acquisition of Giant Food, Landover, Md., which it completed in November, analysts pointed out.

Husson said comps were hurt in the third quarter by price wars in the New York-New Jersey-Long Island market, "which abated by the fourth quarter, enabling comps to accelerate dramatically."

Stop & Shop in particular had "fantastic comp increases, up 6%," Husson said, "and all the Ahold-owned stores did better during the half because of less reliance on everyday low pricing and more promotional aggressiveness -- the result of Bob Tobin's influence." Tobin, formerly chairman of Stop & Shop, now oversees Ahold's U.S. operations.

WINN-DIXIE STORES, Jacksonville, Fla., with sales rising 3.5%, operating income up 4.7%, and comps up 1.6% in the third quarter and down 1.4% in the fourth.

Analysts said comparative-store sales at Winn-Dixie were negatively affected during the half by the chain's third-quarter shift from everyday low prices to a more promotional formula, "and while customers are adjusting to that, it's hurting same-store sales," Ziegler said.

FRED MEYER INC., Portland, Ore., with sales up 69.5%, EBITDA up 87.7%, and comps up 3.4% in the third quarter and 4.8% in the fourth.

Analysts said Fred Meyer's strong sales and earnings increases reflect its acquisitions during the year of Ralphs Grocery Co., Compton, Calif., and Quality Food Centers, Bellevue, Wash., plus the late 1997 addition of Smith's Food & Drug Centers, Salt Lake City, and its Smitty's operation in Phoenix.

Besides growth from acquisitions, Fred Meyer also benefited from being in some of the fastest growing markets in the United States, Husson said, "so performance was strong in every division and the synergies from its acquisitions began to come through, as planned."

He said Fred Meyer achieved $90 million in synergies during 1998, putting the company ahead of plan on achieving savings of $155 million over two years.

FOOD LION, Salisbury, N.C., with sales down 0.6%, operating income up 39.2%, and comps up 1.8% in the third quarter and 3.7% in the fourth.

Cerankosky said Food Lion sales comparisons were hurt by having one less week in the year and by "the adjustment factor" following the elimination a year earlier of its former Southwest operations. "But with fourth-quarter comps up 3.7%, the sales trends are very good," he said.

He said Food Lion also did a good job in the second half using category management to improve its gross margins "to an extent you don't usually see in a company running conventional stores with an EDLP merchandising strategy."

Levin said operating income benefited in the half from Food Lion's Kash n' Karry Food Stores division in Tampa, Fla., which had been dilutive in the second half of the prior year. Also helping to improve income results late in the year was an easing off of the heavy promotional activity the company engaged in during the third quarter, she said.

A&P, Montvale, N.J., with sales down 1.1%, operating income down 7.7%, and comps up 2.6% in the third quarter and 4.8% in the fourth. (Operating income results exclude a writeoff of $296 million for Project Great Renewal, A&P's strategic initiative to accelerate store modernization, open new superstores and eliminate underperforming locations.)

Levin said A&P's comps benefited during the half from "a stronger focus on store execution, including customer service, in-stock conditions and cleanliness," while the chain's new-store program began paying off with stronger numbers.

According to Husson, the chain's comp-store sales improved "after A&P got rid of underperforming stores with weak comps."

PATHMARK STORES, Carteret, N.J., with sales down 1.4%, operating income up 2.3%, and comps up 1.3% in the third quarter and down 0.8% in the fourth.

Bernstein, the high-yield analyst, said sales dropped during the half because of increased competitive activity.

However, he said, the modest increases in same-store sales resulted from better merchandising, particularly in the perishables area, "and operating results improved because Pathmark saw a full year of cost-saving benefits from its distribution agreement with C&S Wholesale Grocers, plus it did a good job controlling expenses."

Bernstein said he expects Pathmark to continue to see improving operating results pending completion of its merger with Ahold, which is expected at year's end. "That transaction represents a brilliant move by Ahold because, with the addition of Pathmark, it will control the Northeast market in a big way, and that will make it tough for operators like A&P to compete."

He said he expects Pathmark to hold on until the Ahold deal is completed "and then to pull ahead of the competition. It's a good chain with good brand equity, and once it has the advantage of Ahold's capital and liquidity, Pathmark should be able to compete more effectively."