Writing a New Chapter

Writing a New Chapter

Don't look now, but Winn-Dixie has some momentum. The results went from pretty bad to pretty good, pretty suddenly, Andrew Wolf, an industry analyst with BB&T Capital Markets, Richmond, Va., observed recently. It was as if someone pushed a button and the turnaround started happening. Wolf was referring to financial results released by the Jacksonville, Fla.-based retailer last month that included

Don't look now, but Winn-Dixie has some momentum.

“The results went from pretty bad to pretty good, pretty suddenly,” Andrew Wolf, an industry analyst with BB&T Capital Markets, Richmond, Va., observed recently. “It was as if someone pushed a button and the turnaround started happening.”

Wolf was referring to financial results released by the Jacksonville, Fla.-based retailer last month that included identical-store sales increases of 1.6% and adjusted EBITDA of $46 million for the fiscal third quarter that ended April 4. The earnings report provided the first glimpse of Winn-Dixie's post-bankruptcy financial condition — a picture that was prettier than many had expected but which approached the optimistic outlook of the retailer's reorganization plan.

To be sure, Wolf remains skeptical of Winn-Dixie achieving a long-term turnaround, noting that low-volume stores and high-caliber competitors are formidable obstacles to overcome. But even the most pessimistic observers note that if Winn-Dixie has a shot, now is the time to take it, while competitors such as Wal-Mart and Bruno's stumble and companies such as Kroger, Safeway and Delhaize provide fresh examples of once-struggling franchises that have been turned around.

“If you're going to try to execute a turnaround, the conditions couldn't be better,” Wolf told SN. “Winn-Dixie is definitely a company that's benefiting from the rising tide of the industry.”

Winn-Dixie in late November emerged from 21 months operating under Chapter 11 bankruptcy protection. Peter Lynch, the retailer's president and chief executive officer, shortly afterward laid out a plan of five initiatives he said could help Winn-Dixie achieve the “tremendous upside potential” described in its plan of reorganization. The initiatives were: rebuilding trust in the Winn-Dixie brand; investing capital into stores; merchandising and marketing stores to meet neighborhood needs; training and developing employees; and generating profitable sales. Lynch was not available to comment for this article.


TRUST AND TRAINING

Jerry Funk, the federal judge who heard Winn-Dixie's lengthy bankruptcy case, at one point in the proceedings remarked that he had never heard from Lynch himself, despite his name being at the center of the retailer's plans for a turnaround and, as a result, the subject of a series of retention compensation plans requiring Funk's approval.

Where was Lynch? For much of the time, he was in stores speaking with employees and polishing what he considered to be a “tarnished” Winn-Dixie brand. As part of the effort, Winn-Dixie adopted a new logo and a new slogan — “Getting better all the time” — and Lynch played the part of the understanding CEO, acknowledging the retailer's culpability for having developed a reputation for dirty stores and poor service, and appealing to customers who chose not to shop there anymore to give Winn-Dixie another chance.

Brand renewal at Winn-Dixie most recently has moved to its private-label products. Beginning next month, Winn-Dixie will roll out a three-tiered house-brand portfolio designed to make the items more relevant to specific groups of shoppers, Lynch said. New packaging, advertising, sampling and product guarantees are part of the effort, as is a house-brand educational program for store-level workers.

As part of an effort to address service levels during the bankruptcy period, thousands of Winn-Dixie employees were asked to reapply for their jobs. The company subsequently raised overall staffing levels. Winn-Dixie is investing around $70 million annually to get labor back into stores, Lynch said, arguing that better customer service — including the establishment of “specialist” positions and a new incentive program for store managers — will lead to larger shopping baskets and support the new merchandising strategies also going on at stores.

“Too often, companies take the labor out of the stores, and then you just cannot execute on the merchandising and the marketing programs, and that's essential to the turnaround of our company,” Lynch told analysts in a conference call earlier this year. “So we made the commitment, and I am feeling very good about it.”

Burt P. Flickinger III, managing director, Strategic Resource Group, New York, said he counted Lynch's ability to motivate associates among his strongest qualities. “He's inspired a team that was badly beaten down,” Flickinger said of Lynch. “He's a great motivator and one of the most personable executives in the supermarket industry.”

Karen Short, an analyst for Friedman Billings Ramsey, New York, in a recent research report estimated that Winn-Dixie upped staffing to 95 workers per store from estimated averages of 78-81 workers per store in 2004 and 2005. That extra staffing should effect continued increases in sales per labor hour and, ultimately, better levels of labor productivity as sales rise, Short said.

Winn-Dixie's new incentive program for store managers, known as the President's Club, rewards top performers with stock in the company. Lynch in a recent conference call added that the program is also a valuable recruitment tool, with 50 new managers hired from outside the company already this year. “A great store director is worth his or her weight in gold,” Lynch said.

Efforts to polish the Winn-Dixie brand are paying dividends, Lynch added. Winn-Dixie gained 4.1% in customer satisfaction in 2006, well ahead of 1.4% improvement among all supermarkets, according to figures from the American Consumer Satisfaction Index. Only Safeway (up 4.2%) showed more improvement on the year.

While there is no doubt Winn-Dixie still needs to work on its appeal to shoppers, Short believes customers will respond positively if the company follows through on promises to provide better service and cleaner stores. She recently visited some Winn-Dixie stores in Miami, where employees were almost too anxious to help.

“Overall, customers want them to win,” she told SN. “There's conventional wisdom out there that says, ‘Why would you ever shop Winn-Dixie when you could be shopping Publix?’ But there are people out there who are rooting for Winn-Dixie.”

Neil Stern, senior partner at retail consulting firm McMillan-Doolittle, Chicago, said the efforts to improve store conditions and service have provided a foundation upon which Winn-Dixie can address more complex issues.

“The fundamentals of the store experience — the cleanliness of stores, the in-stock conditions and staffing — they focused on that to a point where I think it's helped their business quite a bit,” Stern said. “The question from there is, can you grow?”

COMPETITIVE ENVIRONMENT CHANGING

A lengthy stay in Chapter 11 addressing debts and rightsizing the company (more than 400 stores were closed in the Chapter 11 process) left Winn-Dixie little opportunity to address physical upkeep of the stores it intended to continue operating. Investing in badly needed remodels has been a top priority for the company since it emerged from Chapter 11.

Around 20 remodels are expected to be finished by the end of this month, which is the end of Winn-Dixie's fiscal year. For fiscal 2008 Winn-Dixie expects to complete 75 remodels, with about half being “offensive” renovations.

Key among the newly completed stores is a location in Mcclenny, Fla., not far from corporate headquarters in Jacksonville. That store, said Lynch, “serves as a laboratory for some of our most innovative ideas for enhancing the shopping environment, product mix and customer service.” Much of the changes at Mcclenny, Lynch added, focus on perishable goods.

Other remodels have showcased local merchandise and a flair for neighborhood marketing, said Lynch. The company said 103 of its 522 stores will focus on Hispanic customers, noting that stores that primarily serve Cuban populations would differ from those with a Mexican clientele. All stores in the neighborhood marketing program will share a special tag line, “El sabor de tu pais” (“The flavor of your country”), used in advertising programs and promotions.

“They've done a very good job merchandising,” said Flickinger. “Before, Winn-Dixie was overfocused on produce, and they undermerchandised the rest of the store. Now they're hitting on key core grocery categories that have always been the driver of their business. Their delis are still substandard, especially as compared to Publix, and I don't think they can fix that anytime in the near future. But on dairy, frozen, meat and grocery and produce, Winn-Dixie is doing a much better job.”

Lynch estimates Winn-Dixie will spend $1.5 million to $2 million per store renovation, with the goal of a 15% sales gain per store on “offensive” renovations and a 15% abatement of competitive impact on “defensive” remodels.

An aggressive plan of remodeling can provide a needed boost in sales productivity at Winn-Dixie, said Short of Friedman Billings Ramsey. According to her projections, 75 annual remodels providing a first-year gain of 14% followed by a 4% decline in year two could lift sales per square foot from around $288 today to $338 by 2011. Remodeled stores also drive better profits by shifting the sales mix to a greater percentage of perishable items.

In the fight for customers, Lynch has said he envisions Winn-Dixie residing in the same “quadrant” as Publix, emphasizing service and selection. While Publix is famous, particularly in Florida, for “owning” that positioning, observers agree there is probably more room to compete in that niche, particularly when the alternative is picking a pricing fight with Wal-Mart.

“I'd rather be up against Publix than up against Wal-Mart,” said Wolf, who added that as Winn-Dixie looks to improve store positioning without necessarily going “upscale,” the company could look to the market renewals of Delhaize's Food Lion chain.

Moving to a higher-service positioning, “albeit challenging, is actually realistic,” added Short, whose study of store locations and demographics concluded that 58% of Winn-Dixie stores have middle-to-upper-income consumers living within two miles.

Getting caught between Wal-Mart's relentless price advantages on one side and Publix's exemplary service and execution on the other was considered one of the prime reasons Winn-Dixie ran into difficulties in the first place, observers noted.

WAL-MART'S SLOWDOWN

More recently, some of Winn-Dixie's competitors have shown vulnerabilities, sources said. Wal-Mart, Bentonville, Ark., has experienced only modest gains in same-store sales and recently announced it will slow the pace of its supercenter growth. Competition in the Florida panhandle and in Alabama may slow, now that Bi-Lo Holdings has indicated it will put its efforts behind its Bi-Lo franchise in the Carolinas, and not Alabama-based Bruno's. In New Orleans, A&P is trying to sell its Sav-A-Center franchise.

Flickinger contends that Publix has lost some of its edge in customer service, particularly in certain Florida markets, as it focuses efforts to expand out of state. (Market share and same-store sales for the Lakeland, Fla.-based chain remain strong, however.)

“I think when Winn-Dixie declared bankruptcy, Publix declared victory,” Flickinger said, “but they're letting a wounded competitor come back to life. Winn-Dixie also got some breathing room when Wal-Mart sent one of its top Florida-based people to California. So you have the bad becoming good again, and the great are becoming good. It could be a real horse race in some markets.”

Lynch, in a recent conference call, estimated that the competitive environment in fiscal 2008 will be less intense than fiscal 2007, noting that Wal-Mart and Publix had fewer competitive openings planned than they did a year ago. “Having said that, we still have two great competitors out there,” he cautioned.

During the quarterly conference call last month, Lynch took particular pride in noting that Winn-Dixie's identical-store sales increases came while the company reduced promotional spending and other costs. Gross margin as a percentage of sales was 27.9%, jumping from 25.7% in the previous quarter and 26.5% in the year-ago period.

“It's hard to tell if Winn-Dixie is gaining share, considering Publix's results were pretty strong too,” said Short. “But you don't necessarily have to be stealing share in high-population-growth areas to get same-store gains. My guess is there is some benefit from inflation, some benefit from population growth, and a little share gain.”

The quarter provided industry-watchers with the first glimpse into post-bankruptcy results at Winn-Dixie. The “clean data” illustrated, among other things, how much better off the new entity is now that it has junked its stores in the Carolinas and focused primarily on core markets in Florida and the Gulf States.

According to Short, rounds of store closures since fiscal 2005 reduced the total number of stores from 913 to 522 while increasing the remaining stores' average weekly sales from around $209,000 to $260,000. The 374 stores closed during fiscal 2005 produced average weekly sales of less than $150,000, while being more expensive to run, and less profitable, than the higher-grossing stores remaining, according to her estimates.

Stern said Winn-Dixie's relatively strong showing in the early going post-bankruptcy shouldn't come as a big surprise.

Maintaining such a pace, however, will be a formidable test, Stern said.

“When retailers first emerge from Chapter 11, they have a lot of things going for them. They've gotten rid of the stores they've wanted to get rid of. And the stores you've got are profitable,” Stern told SN. “The tough part of it is, did you make any changes to the fundamental issues that got you there? If your sales are continuing to slide, you're going to be back where you started, so the key is to change the trajectory.”

Strong market reaction to Winn-Dixie's results — its stock climbed by more than 30% following its earnings news last month — illustrated the sensitive financial leverage typical of retailers fresh out of bankruptcy, Stern added. “It's what makes retail so attractive to private firms,” Stern said. “Relatively small increases in sales activity or cost reductions can yield a lot of benefits on the bottom line.”

Sales volumes, though improved, still present a formidable challenge for Winn-Dixie, one that historically has been difficult to solve, said Wolf.

“Sales per square foot and profits per square foot are positively related, and these guys don't have very good sales per square foot,” Wolf explained. “It doesn't mean that they can't do better, because they've shown that they can. But how much can you do?

“Five years ago, Kroger was in a skid. Same-store sales were negative. Look at how long it took them to turn around their pricing, their pricing perception, their merchandising, their go-to-market strategy and their brand with consumers. It took them two years before the numbers showed anything. Why would it be any better for Winn-Dixie?”

Projected Sales and Earnings

A year ago, Winn-Dixie's plan of reorganization set aggressive targets for sales and earnings. Projected results from financial analyst Karen Short of Friedman Billings Ramsey indicate the retailer will make progress, but about a year behind the initial schedule and not quite as dramatically.

FISCAL YEAR* SALES (REORGANIZATION PROJECTION) SALES (ANALYST PROJECTION) EBITDA (REORGANIZATION) EBITDA (ANALYST)
2007 $7.29 billion $7.17 billion $108.7 million $23.7 million
2008 $7.66 billion $7.40 billion $180.7 million $85.3 million
2009 $8.20 billion $7.80 billion $272.2 million $188.2 million
* Fiscal year ends in late June.
Sources: Court documents (reorganization projection) and Friedman Billings Ramsey (analyst projection)

Fewer Stores, Better Production

As part of the Chapter 11 process in 2005 and 2006, Winn-Dixie closed more than 400 stores. The following charts illustrate how each round of closures affected the average productivity of Winn-Dixie's remaining store base.

FISCAL 2005 CLOSURES

OLD BASE NEW BASE CLOSED STORES
Number of stores 913 539 374
Weekly sales per store $208,975 $249,937 $149,943
Gross margin 25.58% 26.11% 24.30%
1Q 2006 CLOSURES

OLD BASE NEW BASE CLOSED STORES
Number of stores 587 520 67
Weekly sales per store $237,764 $251,924 $127,872
Gross margin 26.03% 26.07% 25.40%
2Q 2006 CLOSURES

OLD BASE NEW BASE CLOSED STORES
Number of stores 574 522 52
Weekly sales per store $260,925 $269,421 $234,188
Gross margin 25.34% 25.31% 25.70%
Source: Friedman Billings Ramsey