Supermarket industry stocks were flying high in 1996.After recovering their momentum in 1995, food distributor shares continued their upward direction through most of last year, with SN's Composite Index of 48 food stocks up 45.4%, compared with gains of 26.8% in 1995, which was considered a good year.In contrast, the general market did not perform as well in 1996, with the Dow Jones Index up 26%

Supermarket industry stocks were flying high in 1996.

After recovering their momentum in 1995, food distributor shares continued their upward direction through most of last year, with SN's Composite Index of 48 food stocks up 45.4%, compared with gains of 26.8% in 1995, which was considered a good year.

In contrast, the general market did not perform as well in 1996, with the Dow Jones Index up 26% for the year and the Standard & Poor's 500 up 20.3%. Of the 48 stocks in SN's index, 19 companies (40%) outperformed the Dow Jones and 22 (46%) bested the S&P 500. Expectations are that the food industry stock gains in 1997 may be more down to earth, observers said.

Most of the gains occurred in the first nine months of the year, while stock performance during the last three months was relatively disappointing, Jonathan Ziegler, a securities analyst with the San Francisco office of Salomon Bros., New York, told SN.

"Going into 1996, investors did not view retail food stocks as a particularly sexy group," Ziegler explained, "so the stocks were undervalued, which created significant buying opportunities.

"Early in the year, there was an expectation of food-price inflation, which would have had a positive impact on sales, and we did see some modest inflation.

"In addition, Wall Street became more aware of advances being made through Efficient Consumer Response and home-meal replacement initiatives, and some high-profile companies, including Safeway, Vons, American Stores [Co., Salt Lake City,] and Kroger [Co., Cincinnati,' made very significant headway in improving earnings, which had a migration impact on the psychology of investing in retail food stock."

By the fourth quarter, however, Albertson's comparable-store sales showed significant lags and in flation scenarios slowed down, Ziegler noted. "And the news that Safeway would acquire Vons indicated to some investors that sales and margin growth were getting harder to come by, which eliminated some of Wall Street's enthusiasm about Safeway, which was regarded as the most dynamic stock in the group," he added.

The pullback by investors late in 1996 is part of a cyclial pattern that is to be expected after the kind of increases retail food stocks were showing, Ziegler said. "Investors need a period of digestion to allow the stocks to stablize before they go up again," he explained.

However, although a lot of gains "are behind us," Ziegler said he expects retail food stock to do well this year, though not quite as well as in 1996, "with low double-digit earnings growth that will look pretty good in an economy that won't be be growing very rapidly."

Chuck Cerankosky, an analyst with the Cleveland office of Tucker Anthony, Boston, said retail food stocks benefited in 1996 from investor interest in the ongoing consolidation activity within the industry. "When they see companies like Stop & Shop [Co., Quincly, Mass.] being acquired by Ahold, [Zaandam, Netherlands,] and, late in the year, Vons being acquired by Safeway, it leads to a valuation in other industry stocks by investors who are looking for the next company that may be acquired.

"In addition, towards the end of the year, when multiples in other industry groups weakened, retail food stock looked cheap, and that created a decent price appreciation on investments."

According to Cerankosky, another reason for the group's strong performance in 1996 was the earnings growth demonstrated by well-managed supermarket companines. "This is an industry where good management can generate superior long-term earnings growth from food-and-drug combination stores, which is a retail format that has dealt with other competitors quite nicely over the years. And chains that execute well take share from weaker chains to grow their own businesses, which boosts their earnings."

Cerankosky said it will be tough for retail food stocks to approach 1996 numbers this year, "but as companies continue to pick good locations to build additional combination stores, and as they continue to run their businesses well, they should show better-than-average earnings growth. And they should also benefit from the ability to improve backstage operations, particularly anything related to the procurement function," he added.

Debra Levin, an analyst with Morgan Stanley, New York, said retail food stocks did well early in 1996 "because of the expectation that inflation would pick up. And even when that did not hapen, the stocks continued to perform well when earnings came through in a strong way following several years of heavy capital investment programs."

She said the slowdown in the group's performance later in the year was due to profit-taking.

"But I continue to be optimistic about this year's performance," Levin said. "There is certainly still a tough competitive environment, and the issue of overcapacity will be discussed more. But it's still a very fragmented industry, and companies will benefit from consolidation and improvements in effciencies [that will keep investors interested]."

The year-end numbers for food stocks in 1996 showed 35 gainers and 13 losers--slightly better than the 34 gainers and 14 losers in 1995 and a big improvement over 1994's performance, when only 18 stocks showed gains, compared with 31 losers and one that remained unchanged.

The biggest gainers for the year were Vons Cos., Arcadia, Calif., which saw its stock price rise 112%, and Eagle Food Stores, Milan, Ill., with a stock price increase of 100%. Other strong stock perfomers were Western Beef, New York, up 98%, Riser Foods, Bedford Heights, Ohio, up 97%, and Food Lion, Salisbury, N.C., up 78%.

Stocks on the downside were led by Penn Traffic Co., Syracuse, N.Y., which experienced a price decline of 75.8%. Other losers were Sloan's Supermarkets, New York, down 39.8%; Carr Gottstein Foods Co., Anchorage, Alaska, and Grand Union Co., Wayne, N. J., each down 33.3%; and Winn-Dixie Stores, Jacksonvill, Fla., down 14.2%.

However, while stock of retail operators were strong -- up 55.1% as a group, compared with a group gain of 26.8% in 1995 -- stocks for wholesalers and diversified comapnies showed weaker growth, with wholesale stocks up only 3%, compared with 27.5% in 1995, and diversified stocks up only 8.3%, compared with a gain of 26.5% in the prior year.

Looking at some of the big gainers and losers individually, analysts had these comments: