Future Formats

Small-format stores are unlikely to have much impact on conventional supermarkets anytime soon, analysts said during SN's 13th annual Financial Analysts' Roundtable in New York. Participants in the roundtable, Part One of which was covered in the Sept. 1 issue of SN, also weighed in on club warehouses, assessed the integration process of recent industry mergers and made some predictions about future

Small-format stores are unlikely to have much impact on conventional supermarkets anytime soon, analysts said during SN's 13th annual Financial Analysts' Roundtable in New York.

Participants in the roundtable, Part One of which was covered in the Sept. 1 issue of SN, also weighed in on club warehouses, assessed the integration process of recent industry mergers and made some predictions about future industry trends.

Among the emerging trends discussed was the sudden proliferation of new, small-format food stores.

“These small boxes are not going to move the dial for any companies for a long time,” Mark Wiltamuth, executive director at Morgan Stanley, New York, said.

According to Carla Casella, managing director of high-yield research at JP Morgan, New York, “It's still hard to make the economics work for a small store, where your rents are typically higher than [in] a higher-traffic location.”

The analysts said they doubt whether Wal-Mart, which is about to test a handful of small-format Marketside stores in the Phoenix area, will move forward very quickly.

“If the supercenter is still getting better returns, then that's where Wal-Mart is going to put its capital,” Wiltamuth said.

Casella said she agreed. “Wal-Mart [has] always gotten the best productivity out of their largest stores, [and] as long as they still have opportunities for supercenters, we're going to see small stores play second fiddle.”

Meredith Adler, managing director for Lehman Brothers, New York, said she believes Safeway, which is also testing a small-format store, might have a better chance for success than Wal-Mart, “[because] they understand the real estate [better] in many areas. And their prices are not so low that they can't do a fresh-oriented format.”

For John Heinbockel, managing director at Goldman Sachs, New York, the small-format stores with the biggest potential impact are the hard discounters like Aldi and Save-A-Lot.

“When you realize there are more than 15,000 dollar stores in the U.S. and only about 2,200 hard-discount stores targeting the much bigger retail food market, it's very clear there could be 6,000 or 7,000 or 8,000 hard-discount stores in the U.S. ultimately,” he explained.

“And when you think about the polarization of income that's coming, with the middle class either forced up or down — and probably forced down — that format would play perfectly to that customer.”

But Aldi and Save-A-Lot are growing too slowly, Heinbockel said, which might leave room for a third hard discounter to enter the market, he pointed out.

The analysts said Tesco's small-format Fresh & Easy Neighborhood Market needs considerable work before it will pose a formidable competitive threat.

Citing the stores' approach to merchandising, Heinbockel said Fresh & Easy “is not as demographically targeted as we thought it would be. Right now they're saying, ‘We want the Whole Foods customer, and we want the Trader Joe's customer, and we want the Aldi customer. We want everybody,’ rather than saying, ‘This store will be skewed toward this particular demographic in this neighborhood.’

“To me, that's the most obvious thing to tweak.”

Wiltamuth criticized the stores' heavy mix of private label and the no-frills approach to decor. But given Tesco's heavy capital investment in distribution centers and signed leases, “I think they'll just keep tweaking the merchandising until they get it right,” he said.

Adler said Tesco's decision to go with a small format in the U.S. may have been made because that was the only kind of real estate available. After being told by a Fresh & Easy executive that the company couldn't get stores in the range of 30,000 to 50,000 square feet, “I couldn't help feeling that they picked the below-20,000-square-foot size because that's what they could get, and they've worked around that,” she explained.

On other topics the analysts discussed during the roundtable, their comments included:

  • Membership clubs, and the challenge of passing along price increases: “The clubs have been posting some very big comps — high-single-digit food comps and a few low-double-digit food comps for Costco and BJ's — [so] they are definitely winning in this trade-down economy,” Wiltamuth said.

    “Costco [is] going to protect [their] membership model … by showing value to the consumer. Costco doesn't want to get to the point where members start complaining about the price increases they're seeing,” he added.

    “There could be a certain amount of discounting by [Costco] today to buy future market share,” Adler said. “It's possible Wal-Mart may not necessarily hang onto their customer when the economy gets better, but Costco could.”

  • Prospects for consolidation: Gary Giblen, executive vice president of Goldsmith & Harris, New York, said the potential for deals exists, “but I think we'll be saying the same thing next year, because it takes a long time for the divergence between the bid and the ask to close.”

    Adler said the weak economy may not necessarily be a consideration in decisions on whether operators seek acquisitions. “Kroger [says] there are lots of things to look at, but the asking prices have been too high. Even when the economy was a lot stronger, they were saying that.”

  • The Supervalu-Albertsons integration, which the analysts said they see proceeding smoothly, despite investor complaints: “Supervalu always said it was going to be at least a three-year process, so what's Wall Street grousing about?” Giblen asked.

    “The going is slow and the tried-and-true approach has worked,” Wiltamuth said, “[and Supervalu has] kept the process on the rails. The market may complain about them being out-of-bounds on pricing and in need of remodels, but the market is going to complain anyway.”

    Adler said she agreed. “The gloom in the market seems slightly out of line with what's actually happened there. They got a lot of criticism for saying they were going to take a little more time to do something that's classy and really meets their needs, as opposed to doing a patch job just to make the stock market happy.”

  • The A&P-Pathmark integration, which analysts said is also going well: “At the same time [sales] have deteriorated at other supermarket chains around the country, [they] have held up pretty well at A&P, and improved at Pathmark,” Heinbockel said. “You go in the stores and the execution has been pretty solid, the cultures are blending together and the synergies are coming along on target.”

But as the merger moves past the one-year mark in December and into 2009, “they have to grow core EBITDA by at least mid-single-digits, if not higher, to prove the combination really does work long-term,” he added.

Giblen said A&P could “really jump-start EBITDA margins” by optimizing its supply contract with C&S Wholesale Grocers, Keene, N.H. “Then A&P would have more pricing to work with. They really should be able to maintain the sales growth with equal or better margins than a year ago because of the combined purchasing power and contract improvements with C&S.”

Part Two of the roundtable follows:

Tesco Fresh & Easy

SN: Are the smaller formats being developed by Tesco, Safeway and others — and very soon Wal-Mart — likely to have any impact on conventional supermarkets?

MARK WILTAMUTH: You're seeing Safeway try out a small-format store, and Wal-Mart's planning to try out some small-format stores. But these are all very much in the experimental stage right now. At one time Neighborhood Markets were a test, and those store formats aren't really doing much in terms of expansion, and Wal-Mart's Marketside is an even smaller test.

These small boxes are not going to move the dial for any of these companies for a long time. It's all going to come down to returns. If the supercenter is still getting better returns, then that's where Wal-Mart is going to put its capital.

CARLA CASELLA: One big consideration in going to small stores, based on a study we did earlier in the year, is that it's still harder to make the economics work for a small store, where your rents are typically higher than if you're going into a higher-traffic location. At Wal-Mart, they've always gotten the best productivity out of their largest stores, so from a staffing perspective, if you don't have enough managers coming up through the ranks to manage all the new stores you're opening, you're going to want to put them into a large store rather than a small store. Perhaps if Wal-Mart stopped growing supercenters, they would start to set up small stores. But I think that as long as they still have opportunities for supercenters, we're going to see small stores play second fiddle.

MEREDITH ADLER: And it doesn't move the needle. I would also add that historically, given Wal-Mart's pricing structure, they need a fair amount of general merchandise for the margin mix to be good, and that's why the Neighborhood Market didn't take off — because the margins made them less attractive. So maybe Wal-Mart is trying something completely different with the small-box format they plan to open. Maybe it's going to be priced differently.

I actually believe that if Safeway wanted to, they could get a return on the small formats, and they would have a better prospect than Wal-Mart does of making the small store work. They understand the real estate in many areas, and they've probably occasionally come across real estate that was wonderful but they just couldn't get the type of store in there that they wanted. And their prices are not so low that they can't do a fresh-oriented format.

JOHN HEINBOCKEL: I still think the most promising small-box concept is an old one, but an underdeveloped one in the U.S. — the hard discounter — and I've been saying for five years that Supervalu should dramatically increase the number of Save-A-Lot openings. When you realize there are more than 15,000 dollar stores in the U.S. and only about 2,200 hard-discount stores targeting the much bigger retail food market, it's very clear that there could be 6,000 or 7,000 or 8,000 hard-discount stores in the U.S. ultimately. And when you think about the polarization of income that's coming, with the middle class either forced up or down — and probably forced down — that format would play perfectly to that customer, so I think it's the biggest growth opportunity in food retailing in the U.S.

Aldi is probably growing too slowly, and so is Save-A-Lot, which may allow a third competitor to come into the market. If you wanted to start it up from scratch, you could probably do it and build a sizable chain in a short period of time. Finally, the return profile of the format is very attractive. If you keep labor costs below 5% as a percent of sales, the economics are tremendous. So if you could run a small format today, that would be the one — not what Tesco is doing, not what Wal-Mart is doing. It would be that kind of format.

WILTAMUTH: I think to some extent a lot of these small-format boxes that are popping up are a reaction to Tesco's Fresh & Easy. Everyone is thinking, “Well, if Tesco tries it, then we should try it.” There are a lot of things new in that concept that haven't been proven, like having 50% of the mix in private label — that's something you have to train the consumer to accept. So assortment is a problem. Plus, it's a no-frills format, and it can be uninspiring for a consumer. They have a very narrow packaged-food-brand approach, so they go low on those prices, but they don't have the breadth. It's kind of an awkward combination for the market.

It's funny to hear how some competitors have reacted to Fresh & Easy. For example, Kroger had a SWAT team formed to deal with the Fresh & Easy rollouts. They expected a heavy sandwich program and more perishables, but none of those things showed up in the rollout. At this point, Kroger hasn't felt any impact from all these openings, and Fresh & Easy has really proven to be a dud in terms of industry impact.

ADLER: Tesco is making some changes at Fresh & Easy. They have said they are responding to criticism — though I'm not sure if it was customer criticism or analyst criticism — that the stores were too bland in terms of decor.

WILTAMUTH: Tesco has got such an investment of capital in putting down distribution centers and building out the concept and signing leases, and I think they'll just keep tweaking the merchandising until they get it right.

Low-End Discounters

ADLER: In the end, Fresh & Easy is not that big for Tesco. They're a big company, and to some degree their greatest competitive advantage is their willingness to lose a lot of money.

HEINBOCKEL: What has surprised me most about Fresh & Easy is, when you go into any of their stores, it's almost like they're merchandising for everybody. It is not as demographically targeted as we thought it would be. When you have a format like that, which is really skewed to the neighborhood, you would think it would be merchandised much more for the neighborhood. Right now they're saying, “We want the Whole Foods customer, and we want the Trader Joe's customer, and we want the Aldi customer. We want everybody,” rather than saying, “This store will be skewed toward this particular demographic in this neighborhood.” The way it is now, if someone blindfolded you, took you into a Fresh & Easy store, removed the blindfold and asked you what kind of neighborhood you were in based on the product mix, you would have a hard time telling if you were in an upscale neighborhood or a low-income neighborhood.

ADLER: When you've seen one, you've seen them all.

HEINBOCKEL: To me, that's the most obvious thing to tweak, and it probably wouldn't hinder their success. So that's probably what surprised me the most, because it seems so obvious. And maybe that's part of the testing they're doing now.

WILTAMUTH: There are also some odd merchandising things they're doing, like not carrying diapers and baby supplies.

ADLER: To be honest, I thought the offering was a tad on the upscale side, while the stores looked very downscale. For example, they had three different kinds of butter; imported fig jam; great big bars of chocolate, but no small sizes — and it was mostly dark chocolate, though they did have some milk chocolate. Most Americans don't eat dark chocolate.

WILTAMUTH: Some of their prepared foods that you take home and cook were fabulous, but they were not merchandised well. They were on the upper shelves and hard to see. So there are some real hits that haven't been exploited, and some glaring misses.

ADLER: There's one other thing to think about with regard to Fresh & Easy. I spoke with their real estate guy in Southern California and asked him how easy it would have been to get bigger boxes, as opposed to a 20,000-square-foot box. I asked, what about a 30? And the answer was, 30s were impossible, and you can forget about getting 40s or 50s. So although they say they did a lot of consumer research, I couldn't help feeling that they picked the below-20,000-square-foot size because that's what they could get, and they've worked around that. And it's not clear to me that everything that fits into a 20,000-square-foot store is really what the customer wants, and does Tesco have the efficiency, given their prices, to target specific customers? Because the complexity of the distribution side goes up dramatically when you do.

SN: Given the current economy, many discounters are doing well, but we've also had Costco saying it's had trouble passing along price increases when maybe it should have. Can you talk a little bit about the dynamic there?

WILTAMUTH: We've had a major signpost laid out by Costco — that they are going to protect their membership model by showing value to the consumer. That has completely blown up any bullish thesis that was out there. A lot of the bulls were thinking that Costco's pretax operating margins were going to go up from 3% to 4%, and that's just not in the cards if they're choosing to emphasize their membership model.

The reason Costco feels it has to protect the membership model is that membership fees account for 75% of their earnings. Costco doesn't want to get to the point where members start complaining about the price increases they're seeing in the store — it needs to make sure it's really showing that value to the consumer. So they use this environment to capture market share.

ADLER: And there could be an argument that, unlike some other discount formats, Costco is going to have a stickier new customer. There's a lot of fun in a Costco store — there's that treasure-hunt element — and so there could be a certain amount of discounting by them today to buy future market share.

WILTAMUTH: And a Costco customer has laid out $55 for a membership, and that's an incentive to keep coming back.

The Stock Market

HEINBOCKEL: When you think about it, most store formats offer either value or quality, whereas the club, as it was designed by Price Club years ago, really offers both. The value is good, and the quality is very good. The quality of the meat is outstanding; the quality of the produce is very good; the quality of the electronics is great; the quality of the jewelry is good. So I think you've got that unique straddle, and you should be able to hold onto the customers you pick up. Plus, the membership nature of the model creates greater customer loyalty than you normally find in most other formats.

WILTAMUTH: The clubs haves been posting some very big comps. We've been seeing high-single-digit food comps and a few low-double-digit food comps for Costco and BJ's. They are definitely winning in this trade-down economy.

ADLER: And in the end, it's a niche, because you have to have cash flow. When you look at demographic data in the United States, it's very shocking to realize that 60% of the U.S. population makes less than $50,000 a year, or something like that. And Costco's cutoff is really $75,000 a year.

WILTAMUTH: Costco skews upscale in a way that's very similar to the Safeway customer demographic.

ADLER: And they're locating their stores where that demographic exists — they're not trying to operate in rural North Carolina. But in the end, Costco can't hurt the entire industry, because it's too small and too high-end.

The Debt Market

WILTAMUTH: Wal-Mart is also picking up some traffic, and they benefit from the trade-down game also.

ADLER: Interestingly, the CEO of a competing company said it's possible Wal-Mart may not necessarily hang onto their customer when the economy gets better, but Costco could.

WILTAMUTH: But the curse with the [club] stocks is that it's a very crowded trade. A lot of investors have been plowing money into Costco, BJ's and Wal-Mart for the trade-down theme, and now that there's a question mark on the margins, everyone who has crowded in is nervous. So things are going to be changing there in terms of valuations.

SN: The stock market has been very volatile of late. How long do you think that kind of activity will continue?

HEINBOCKEL: Volatility will probably decrease once much of the downside earnings risk is priced into any given subsector. It all comes down to asking yourself, what's the worst-case scenario for 2009? Pick a stock, come up with a realistic worst-case earnings scenario — trimming both comps and EBIT margin — and then put a 10 multiple on it, and that's probably pretty close to the ultimate bottom in any stock. Now, figuring out what the worst case is is obviously a lot tougher than that, but I think that gets you close.

If the subsector trades closer to this “bottom,” that would be encouraging from an absolute performance standpoint. Obviously, from a relative performance standpoint, supermarket stocks would be greatly impacted by the degree to which we get a strong economic recovery. This group is obviously not as well positioned for an economic recovery as some of the more discretionary ones that are comping down 6%, 7%, 8% or 9%. Right now is when the subsector should be making some hay in terms of relative outperformance. Certainly you could get caught in that trap where you don't have much more downside, but you don't get as much upside when the economy recovers, and we may be getting close to that.

ADLER: I personally believe the volatility is here to stay, although I agree there will come a point where valuations will go down. But we have seen market valuations lose connection with reality for many stocks over the last year, and sometimes I have trouble understanding how the value of a business like a supermarket could change 10% in a week, because one should be valuing the whole future stream of cash flows and taking the present value of that.

HEINBOCKEL: What would be shocking, though, with Safeway and even Supervalu, is if you didn't expect that sales were going to weaken sequentially, but that earnings were going to be OK. I haven't found anything in any of what they've reported recently that was surprising in the least. You could say management was less optimistic about business, or that there's more uncertainty with regard to the consumer, but we know all that. Back in January or February, that was new, that was surprising. But it isn't anymore, so the stocks' sell-off seems overdone.

Consolidation Prospects

SN: What are some trends right now in the debt market?

CASELLA: The debt market is ugly compared to the equity market. The average bond I cover is off $17 since last June, which is big in bond terms. But what's more important is access to capital for operators — there is access to capital for investment-grade companies like Kroger and Safeway, but anything below that gets very expensive. We've seen retailers with very low leverage and solid cash flow who, in a normal market, would expect to pay an 8% coupon, but who now have to pay over 11% if they want to come to the market. So, the cost of financing in the debt market is very expensive.

And it's not just bonds — it's also in the bank-loan market, which used to be an easy place to get financing. That's probably what's keeping some of the bigger mergers and acquisitions from happening — it's definitely limiting buyouts and limiting activity for operators who need financing for big projects or acquisitions.

ADLER: Do you have any idea what's happened to the default rate? Has it started to move yet?

CASELLA: It is starting to move, and we've had more defaults year-to-date than we had in all of 2007 in the high-yield market in total. So far this year, $20.8 billion of bonds and loans have defaulted, compared with $4.2 billion in all of 2007. But the default rate is still nowhere near the levels we saw in 2001, when it peaked at $64.1 billion. It's still in the area below 3%, and we see it going toward mid-single-digits next year — to about 6.5% — which is still below the 10.5% default rate we reached in 1991 and the 8.3% in 2001.

ADLER: Are yields anticipating something much worse than that?

CASELLA: I think the yields are anticipating worse than that, and maybe sooner than that. It's tough to say. It's lack of activity that's affecting yields — investors are just pulling money out of the loan market and the high-yield bond market to some extent, owing to fund liquidations and fewer collateralized loan obligations. It's not that they are demanding higher yields — they're just allocating money in other places for the time being.

Supervalu-Albertsons

It used to be that retail was a sector people wanted to get away from because of the consumer, but now food is trading off considerably as well because of commodity costs. The average supermarket high-yield bond that I cover was off a little over 300 basis points in the last year, and the overall market was off 440, so the supermarket sector is proving somewhat defensive, though not as much as in the past.

SN: Aside from capital being expensive, do you see opportunities for consolidation in the near future?

CASELLA: I don't think too many companies are looking for major transactions.

ADLER: If Supervalu were to tear itself apart, Kroger would be interested in pieces of it — but that's not going to happen.

GARY GIBLEN: I think some deals could happen at some point. Weis Markets is always out there. They produce decent sales, with margins ever lower, so at one point they will just say it's not worth it anymore. Marsh Supermarkets is owned by Sun Capital, and Marsh could be of interest to a few players. But I think we'll be saying the same thing next year, because it takes a long time for the divergence between the bid and the ask to close.

ADLER: I ask Kroger about mergers and acquisitions every quarter, and their answer is always that there are lots of things to look at, but the asking prices have been too high. It's interesting that even when the economy was a lot stronger, they were saying that.

HEINBOCKEL: The Northeast is still very fragmented. We've always talked about the consolidation opportunities there, and A&P-Pathmark was the first step in that process. But with so many private companies, you can't force it. It's got to happen at the right time. This certainly is not the right time economically. You've got to be talking about an incredibly compelling asset if you are not buying your own stock back under five times EBITDA — you'd much rather do that than go buy a questionable regional chain.

It's very interesting that the Big Three have such a small presence in the Northeast, broadly speaking — no presence in New York, and a modest presence in Washington/Baltimore. So you look at that and say there's an opportunity there, but it's a longer-term opportunity.

SN: Speaking of consolidation, how is the Supervalu-Albertsons integration progressing?

ADLER: What's the definition of integration? I think the biggest challenge for Supervalu — and what they are spending all their time on — is building a merchandising and marketing organization, which neither company really had before. According to Jeff Noddle [Supervalu chief executive officer], Supervalu was a buying organization, and Albertsons had started to develop a selling organization, but they hadn't really gotten very far before they sold out to Supervalu. So Supervalu has a long list of things they are doing. It's pretty sophisticated, and it's still in the early stages.

GIBLEN: Supervalu always said it was going to be at least a three-year process, so what's Wall Street grousing about? It's fair to say that it's become a three-year-plus process, because the economy tripped them up a bit. Also, it doesn't help that Albertsons was milking prices in the later stages before the sale, so there's repair work on price image to be done.

WILTAMUTH: The good news from the merger, though, is that there hasn't been any big blowup, so I think the going is slow and the tried-and-true approach has worked. To Noddle's credit, they have kept the process on the rails. The market may complain about them being out-of-bounds on pricing and in need of remodels, but the market is going to complain anyway, and Supervalu has kept it slow and steady, and they are ahead of schedule on debt pay-downs.

ADLER: The gloom in the market seems slightly out of line with what's actually happened there. Some of the delays in terms of synergies were smart business moves. The technology they installed in Minneapolis, for example, is extremely productive, more productive than even they thought it was going to be. Now they have people putting that technology into [a distribution center in] Lancaster [Pa.], and doing that slowed down some of the consolidation. But you would have to be kind of stupid to do the consolidation first and then disrupt everybody before putting the new technology in.

A&P/Pathmark

They got a lot of criticism for saying they were going to take a little more time to do something that's classy and really meets their needs, as opposed to doing a patch job just to make the stock market happy. I think they made the decision to go with a new merchandising system because neither company's existing systems had the functionality they wanted. Again, I've heard a lot of criticism from people who say, “How come Supervalu didn't know it had to do this before they bought the company?” Well, maybe that's because it was illegal for them to see inside the company before they bought it.

WILTAMUTH: They still have a lot of wood left to chop, but they are making progress. For investors looking at the stock, you have to look at a three-year window and say, “Once they get through all this, are they going to look more like Kroger on the other end?”

CASELLA: I think they also underestimated how much work they had to do to prop up the Albertsons stores, which were definitely losing share, and there was a lot of work that needed to be done there.

ADLER: There may have been places where they didn't understand how bad it was. For example, in Southern California, which was the single biggest part of the acquisition — it was 25% of the Albertsons store base — Supervalu had a long, hard debate about whether they wanted those stores, which really stood for nothing in consumers' eyes. The stores were just plain vanilla.

WILTAMUTH: You can't build that market share from scratch.

HEINBOCKEL: The Albertsons real estate Supervalu bought in Southern California is good. If you go around and look at the stores, they are big stores in the right places, but they look like they were built in the 1970s, and a lot of them still have the Lucky decor, so that market needs a ton of capital. And I know they have said they are not going to cluster Premium Fresh and Healthy remodels, but if there was ever a place they should consider clustering, Southern California has got to be the place to do it, because it is the biggest market, and arguably the most important, and it is the place where they could change consumer perceptions more quickly.

ADLER: But Supervalu said right after the transaction was completed that they weren't going to put capital in any store until the basic store-level execution standards had gone up, because they would just be throwing the capital away. Not that their store-level execution was terrible, but I think they felt there were a lot of other things to do before lowering prices. Would you do it if you didn't need to?

HEINBOCKEL: You could argue that with the housing market the way it is, this would be a good time to emphasize price in Southern California.

SN: What are A&P's prospects following its merger with Pathmark?

Future Headlines

HEINBOCKEL: I think they've done a fairly good job integrating Pathmark to date. What you are looking to do in many of these integrations — because there have been so many stumbles historically — is to not change a ton of things that face the customer; not to disappoint the customer; not to have any major blowups. From that standpoint, I've been surprised that sales have improved at the same time they have deteriorated at other supermarket chains around the country. I thought they'd stay where they were, but they've held up pretty well at A&P and improved at Pathmark. You go in the stores and the execution has been pretty solid, the cultures are blending together and there hasn't been much slippage from that standpoint. And the synergies are coming along on target. So I think the integration has gone well.

What they need to prove is that they can grow EBITDA in the core business, excluding the impact of synergies, because you've always looked at A&P and said, “There's a terrific margin opportunity,” and you've looked at Pathmark forever and said, “There's a terrific margin opportunity.” But individually, they have never capitalized on that opportunity. Now you put them together and say, “There's a big margin opportunity,” and they have to prove that, beyond synergies, the core business can grow EBITDA and can expand margin.

SN: Was swapping out some Super Fresh to become Pathmark the right decision?

ADLER: I think they're trying to say they have something unique at Pathmark and something unique at A&P or Super Fresh, and without saying necessarily that one is better than the other, each one should be in the right places. What's going to be more interesting is what they do with the low-income format, Food Basics.

HEINBOCKEL: Food Basics is situated well for this environment. But that said, Pathmark is positioned well for this environment too. I think the challenge for Pathmark is that Stop & Shop has improved their price image, and Pathmark was always secondary to ShopRite with respect to price perception in New Jersey. So the franchise is being tested a bit on the pricing side. I think they've got to push on price a little harder than they have been and recapture more of the historical value orientation.

One of the things I thought they would do is bring back the old No Frills black-and-white brand and really push it heavily, because most of the people in the New York market still know it and recognize it. They'd probably have to package it a little better than it used to be, but at the end of the day, Pathmark has that historical value image — not a bad thing to have in this environment — and a broader customer appeal than Food Basics. So you can argue the time is right to do more with Pathmark and maybe de-emphasize Food Basics a little bit.

GIBLEN: What would really jump-start the EBITDA margins and margin growth would be optimizing the C&S [Wholesale Grocers] supply contract, which has been a topic of discussion for many years and never seems to get fully optimized. But at least they're trying now, and that would help them a lot. Then A&P would have more pricing to work with. In the most recent quarter they had decent sales growth, but a drop of some 140 basis points on gross margin. They really should be able to maintain the sales growth with equal or better margins than a year ago because of the combined purchasing power and contract improvements with C&S. But that's unfortunately not happening in any big way yet.

HEINBOCKEL: They certainly didn't give you the sense that the C&S savings would flow through to the bottom line, which I think investors would really like to see. I mean, when you've got a 3 comp, do you need to reinvest a significant amount back in the business as much? Probably not.

SN: What do you think will be the industry's biggest headlines in the next 12 months?

GIBLEN: I think the big headline is going to be, “The Cash Pileup and What to Do With It.” I think we're going to see a continuation of lower capital expenditures and store expansion, and that will lead to other uses of cash flow or share buybacks. There's going to be a lot of money floating around, because there is not much of an acquisition market, and there is less capital-spending money, and that could come back to shareholders. Hopefully, it will not foster ill-considered acquisitions because the money is burning a hole in their pockets.

CASELLA: I think the headline is going to involve a continued grappling with food-price inflation. On the packaged food side, suppliers are passing the costs on, but we're just starting to see proteins moving up, and I think with ethanol or oil and gas moving up as well, there's going to be a lot of noise around inflation.

ADLER: The headline I would expect is, “Whole Foods Is Going to Cut Its Dividend.” Either that or it's going to run into major problems. [Editor's note: A week after the roundtable, Whole Foods did announce it would stop dividend payments.]

HEINBOCKEL: The headline I see in the next year would involve more interesting union contract negotiations. I say that because, if people's cost of living is increasing meaningfully, be it for energy or food or whatever, you could certainly see that the focus within union contracts will go from health care benefits to wages, because people need greater salaries just to get along.

It may be as innocuous as a simple shift in the focus of negotiations and there's a bump-up in wages in exchange for something else, and the bump-up in wages would probably take the form of a lump sum payment rather than a contractual wage rate increase. Or it could be a little more contentious. We've gone five years, almost six, without one day of work stoppage at all. I don't think that's going to come to an end necessarily, but I do think the negotiations are going to be a little tougher.

WILTAMUTH: My headline would be, “Food Inflation Rages On; Demand Declines in Grocery,” and that will lead to some dislocations for some packaged food companies.

I also think it's possible that with Wal-Mart already beginning to slow its cap-ex spending, we'll see a little more aggressive move from them. I think they have been embraced by Wall Street for their move to slow down their supercenter rollout, and I think especially now that the economy is a little weaker, that's a little more incentive to back off of growth. If we get some meaningful cuts out of Wal-Mart's supercenter expansion, that could be good for grocers.

If things get really bad, another headline could be, “Grocery Stores Lose Safe Haven Status, Fall to All-Time Valuation Lows.”

ADLER: All-time valuation lows are pretty low — remember the dot-com bubble?

WILTAMUTH: But that's the risk we're looking at if same-store sales continue to erode and the industry can't fix that through price investments — and if price investments are not getting the returns, then that would be a real problem for the stocks.