Skip navigation


NEW YORK -- The ongoing expansion of Wal-Mart in food retailing -- and the potential threat that poses to traditional operators -- will continue to pose challenges for the foreseeable future, according to participants in SN's annual Financial Analysts' Roundtable here.Neighborhood Markets format, they added.Meanwhile, industry consolidation has slowed down as companies deal with integration issues

NEW YORK -- The ongoing expansion of Wal-Mart in food retailing -- and the potential threat that poses to traditional operators -- will continue to pose challenges for the foreseeable future, according to participants in SN's annual Financial Analysts' Roundtable here.

Neighborhood Markets format, they added.

Meanwhile, industry consolidation has slowed down as companies deal with integration issues and worry about more rigorous antitrust enforcement by the Federal Trade Commission, the analysts pointed out. They also said the FTC seems to be pursuing a double standard -- taking a rigorous position on supermarket mergers while allowing Wal-Mart to expand without regard to class-of-trade issues.

"The market is penalizing [supermarket] stocks for Wal-Mart's expansion into food, but the FTC refuses to recognize that as a threat," said Meredith Adler, senior vice president at Lehman Bros., New York. "On the one hand, you have Wal-Mart saying, 'We're going to focus our Neighborhood Markets in this or that marketplace,' while on the other you have the FTC saying one of the supermarket chains can't take a similar step that really might position it better."

According to Mark Husson, first vice president of Merrill Lynch, New York, the FTC commissioners "don't really understand the industry terribly well, so whenever they try to work out what the effective market concentration is, they exclude drug stores, convenience stores, any kind of food service, supercenters and clubs."

Wal-Mart's effect on the industry could increase if it decides to seek retail acquisitions as it rolls out its Neighborhood Market format, the analysts said. Such a move "would give them the ability to access a lot of real estate quickly and not add capacity," Ed Comeau, vice president for equities research at Donaldson Lufkin & Jenrette, New York, pointed out.

According to Jonathan Ziegler, San Francisco-based managing director for Deutsche Banc Alex. Brown, New York, Wal-Mart's apparent hesitancy to roll the format out is not based on the need to fine-tune its merchandising. "They're busy assembling sites," he said. "They've got to get the real estate backlogged before they can announce [an expansion]."

The analysts predicted Wal-Mart could ultimately open more than 50 or 60 Neighborhood Markets a year once it can line up the real estate, with the stores' size rising from the company's 40,000-square-foot prototype to a floorplan of 52,000 square feet or larger.

Any rollout of Wal-Mart's Neighborhood Markets would certainly boost competition, they said, "and the pressure from that move on a lot of the regional players will be all you need to force valuations to come down," Ziegler said -- a development that could prompt more regional players, who are currently resisting the urge to sell, to reevaluate that position.

Other analyst comments during the roundtable included the following:

Consolidation is at a stalemate, "[but] if we had one transaction done at a lower value, that would help to break the ice on the valuation issue," said Gary Giblen, managing director for C L King Associates, New York. "But at the moment you have a gap between the bid and the asking."

Citing statements by Cees van der Hoeven, chairman of Netherlands-based Ahold, that he expects his company to be one of only three major global players in the future, Husson said the possibility exists that Ahold will restrict its retail expansion to the East Coast to avoid overlapping with any of the industry's largest operators -- "to leave room for one big marriage between Ahold and one of the big three chains."

Despite the strength of a variety of regional chains, "hard, cold economics" will ultimately lead most of them to seek merger partners, said Ted Bernstein, director at Grantchester Securities, New York.

The industry is likely to experience limited sales growth over the next few years, "[with] growth rates becoming more and more dependent on acquisitions that over time are going to become less and less available," according to Lisa Cartwright, vice president of Salomon Smith Barney, New York. According to Debra Levin, principal with Morgan Stanley Dean Witter, New York, "The benefits of scale and best practices are going to prove important" as integration continues.

Following is the transcript of the first part of SN's roundtable discussion:


Rigorous antitrust enforcement by the Federal Trade Commission is hampering the move toward further industry consolidation, but pressures resulting from the rollout of Wal-Mart's Neighborhood Markets could force some potential sellers to reconsider, analysts said.

SN: Let's start the ball rolling by asking what you think will be the level of consolidation over the next year or so. We've seen a little bit of a pause lately from the rapid pace of consolidation, and the question arises, is there still a lot left in the story to be told? DEBRA LEVIN: What's interesting is that the motivation for consolidation is still there because supermarkets still have sluggish sales. If you look at same-store sales, most are in the 1%, 2% or 3% range, and there's not been much of a pick-up -- a little bit from inflation, but not a lot from inflation -- and the synergies from consolidation work for only so long and then they go away. So for companies that are interested in having stronger growth rates, consolidation helps, and it's likely we'll see consolidation growth in more contiguous areas. And we could also see some consolidation of regional companies, a lot of which are private -- but it's really up to the private guys to decide if and when they want to sell out.

GARY GIBLEN: Right now the Federal Trade Commission is tough. They're on the far end -- perhaps the lunatic fringe -- of antitrust enforcement. So the question about what will happen in the next intermediate period is really up in the air. With Pathmark coming out of bankruptcy, it's reasonable to think there will be bidders for that company in its post-bankruptcy, cleaned-up state, and over the longer term, there are certainly other candidates. But I think you'd have to have a different FTC environment before those acquisition candidates could really move forward and be ready to go. So there will probably be a little pause in the action until after the elections are over and possible changes are made at the FTC, which would help a lot.

TED BERNSTEIN: I think the FTC should certainly be at the top of anyone's list as a reason for putting the brakes on the consolidation wave, at least in the last six months or so, but I also think there were other issues at work. For example, a lot of the large, major consolidators had already made significant acquisitions and were in the process of digesting and integrating those. I think a lot of that work is well under way, if not near completion, and I think you'll see some of the larger consolidators get active again and start making acquisitions. However, I think in-market acquisitions are still going to be difficult to do, though I think they will be possible, and we'll certainly see some out-of-market acquisitions done as well.

MEREDITH ADLER: We've talked about the FTC as kind of an obstacle, but I think it's actually more serious an issue than that. The market is penalizing all of these stocks for Wal-Mart's expansion into food, and yet the FTC refuses to recognize that as a threat. Because when you look at a company like Albertson's that has some weaker market-share positions in the Pacific Northwest, for example, even though there may be properties for them to buy, they can't do it. And then there's Kroger, which is not being allowed to buy the Winn-Dixie stores in Texas. On the one hand, you have Wal-Mart saying, "We're going to focus our Neighborhood Markets in this or that marketplace," while on the other hand you have the FTC saying one of the supermarket chains can't take a similar step that really might position it better. I think that's a serious concern, and I don't know if Gary really thinks that a new government or a new president is going to change the tenor of the FTC.

GIBLEN: Well, it's a hope, not a crystal ball. There's just such extreme, rigorous antitrust enforcement right now, and I just think it would be logical to move back to a middle ground. [In the acquisition of Hannaford by Delhaize America], Delhaize America wasn't allowed to keep the Hannaford stores in the Southeast, and yet, at the same time, things are getting very soft and challenging in the Southeast, and the reason is Wal-Mart. And then, when the other competitors respond, even seasoned players down there like Food Lion feel the brunt of it. It really is a terrible double standard, as Meredith said, and it needs to be resolved in one way or another, and one way would be to change the makeup of the FTC. From my talks with CEOs, such things are possible, and it would be more likely with a Republican win in November.

ED COMEAU: The problem is, some supermarket companies in prior years have breezed through a lot of merger activity and sometimes abused agreements with the FTC, which has now come back to haunt them.

ADLER: Consolidation isn't designed only to drive earnings -- it's also driven by the fact real estate is very limited and companies want to get their hands on players with good market-share positions. In-market acquisitions have a different driver. I think we seem to still get the sense that there's a disconnect between what buyers are willing to pay and sellers are willing to ask for because we went through a pretty lofty valuation period. But the world has changed a little bit, and I'm not sure all the sellers have quite caught on that that's the case, and there are some independent regional chains with very attractive franchises who still feel they're in the drivers' seat.

JONATHAN ZIEGLER: What's likely to get consolidation going again is, as Wal-Mart rolls out its Neighborhood Market format, the pressure from that move on a lot of the regional players will be all you need to force valuations to come down. And because this is a technology-driven business, some of the smaller folks probably do need to hook up with some of the larger folks anyway so that the technology investment can be leveraged over a broader store base. And then if Wal-Mart decides to make acquisitions of real estate, that will put more pressure on because it will be more immediate.

MARK HUSSON: If you link together the FTC issue and valuations, then the logical conclusion of the FTC saying you can't do acquisitions with any overlap is that the number of potential buyers for any one chain is greatly reduced. And if you've got more chains for sale and fewer people able to buy them, then economics tell you the price probably comes down.

LISA CARTWRIGHT: In addition to those factors, you also have the issue that a lot of the regional chains that remain have very defensible positions and good market-share positions and are good franchises and don't necessarily need to sell out, like an H-E-B or a Publix.

GIBLEN: Even Weis Markets has gone back and forth between two factions -- they know the company is viable but they decided it's better to sell later than now despite the pressures that Mark pointed out. Still, there's a little bit of a stalemate right now. If we had one transaction done at a lower value, that would help to break the ice, so to speak, on the valuation issue. But at the moment you have a gap between the bid and the asking.

LEVIN: Well, Kroger actually got to buy the Hannaford stores [spun off by Delhaize America in the Southeast] at a lower value, but that was at a fire-sale price and mandated by the FTC, so it's probably not a shining example, but at least it was pretty good for Kroger. And besides earnings and technology as drivers of these deals, I also think procurement leverage is increasingly important, particularly as Wal-Mart gets bigger and bigger.

BERNSTEIN: But getting back to the issue of valuations, I think it's hard to make a general comment about valuations because they're all over the place, but in general, I would say that, certainly compared to a couple of years ago, they're reasonably conservative. It's partly a valuation issue, it's partly the FTC -- there are a lot of pieces to the puzzle -- but I think this trend is going to start again relatively soon, but not at the pace that we saw before. There are still a lot of regional players that can be consolidated.

LEVIN: The key for the private guys is this -- that the valuations they see in the market today may not be the valuations they want to accept if they're thinking back to prior years.

GIBLEN: Then you have the Delhaize/Hannaford deal, which gave a nice high valuation multiple (12.5 times operating cash flow) for people to use as a reference point.

ZIEGLER: Basically you need a discrepancy to occur. The public guys looking for acquisitions have to get their multiples up, and the private guys have to have pressure put on them by Wal-Mart and the investment in technology to drive their multiples down, and that's when you'll see deals. And I think that's what Safeway is working on. Safeway is very focused on sales growth to get the multiple up, and that would give them a vehicle to use for currency.


To avoid FTC scrutiny, companies might consider buying drug stores, convenience stores or other formats that the government does not consider to be the same class-of-trade, the analysts suggested.

ZIEGLER: There's also another way to look at in-market deals -- and I don't think any of the acquiring managements are there yet, except perhaps Ahold (with its food-service purchases) -- which is to buy other formats in-market, like drug stores, which could possibly get the acquisition game going again.

HUSSON: That's interesting, because the FTC is run by a bunch of gray-suited pen-pushers who don't really understand the industry terribly well, so whenever they try to work out what the effective market concentration is, they exclude drug stores, convenience stores, any kind of food service, supercenters and clubs, which are all big classes of food retailing, of course. And if the FTC says, "Oh well, that's a different kind of trade," then logically, if supermarkets want to do in-market acquisitions, all they've got to do is buy any of the classes I've just mentioned.

LEVIN: You know, it doesn't even have to be in-market. The synergies still would be there. There's nothing that's sold in a drug store that isn't also sold in a supermarket, so you're talking about procurement savings, technology advantages, overhead reduction -- it's all there, so it's all very possible.

ADLER: What's interesting is, if you talk to Albertson's or Kroger, they kind of stress their greater flexibility because they operate and understand so many formats. I think you can't argue that's a strength that makes it easier to acquire things in other markets.

CARTWRIGHT: It does add an element of difficulty to the integration process, though, and I think investors are seeing that maybe the synergies from those types of transactions take longer to achieve, as compared with the Safeway route of buying a smaller company that is typically very similar to itself culturally, and from a format standpoint, easier to integrate.

GIBLEN: Convenience stores and drug stores handle much smaller quantities of product -- less than case packs and so forth -- so the whole distribution system is different, and there wouldn't be synergies there. There would be differences in buying, not perfect transparency.

ZIEGLER: But if a retailer wants to have a Web site on the Internet, the synergies would be the same if he were operating convenience stores or drug stores in the same market because they have similar styles of distribution -- and he could use those other outlets as pickup points for groceries instead of home delivery.


The possibility of Ahold buying Albertson's, Kroger or Safeway and Wal-Mart acquiring Delhaize Belgium are among the potential combinations that lie ahead, the analysts predicted.

HUSSON: As Cees van der Hoeven [Ahold chairman] has pointed out, his company is the only one East of the Mississippi in large numbers that hasn't gone West -- apparently to avoid overlaps, so as not to sour any potential relationships in the future with Albertson's, Kroger or Safeway. And that leaves room for one big marriage still to happen in the U.S. between Ahold and one of the three big chains, if the time is right and the matchmaker could be found.

SN: Among the middle-tier players, a lot of them are either not for sale or not worth buying at the moment. Is there any other level in the industry that could become the next target of consolidation?

ADLER: You'll see small players -- 20-store kinds of chains. Both Albertson's and Kroger have done some acquisitions of that size. And I think its not insignificant that Spartan bought Seaway, because for them, that's a real change in direction. I think you will actually see more activity by most of the wholesalers to buy retail.

ZIEGLER: Well, van der Hoeven said that ultimately we're going to be down to three global food retailers, which makes it almost like the old movie, The Day of the Jackal: we knew what the outcome was, and in this instance, Cees has told us what the outcome will be, and now we just have to see how we get there. So we have a giant guessing game ahead of us, and hopefully it will generate some excitement.

LEVIN: Well, there's a real issue if Ahold partners up with one of the big three because there's a whole issue of corporate ego, and I think the large companies are really proud about the kind of growth they've had and the synergies they're achieving, so to be swallowed whole by Ahold -- there may be some real economic arguments for it, but I think there's a people issue as well.

ZIEGLER: But Cees is right in a way. In the end, let's say Wal-Mart does get bigger in food. Ahold has seen the tea leaves, and it knows Wal-Mart's got a lot of money to spend. And when you think about Wal-Mart's market cap being bigger than our entire industry's, I sort of sense that Cees isn't far off.

LEVIN: I'm just saying that I think it can take quite a long time to accomplish. It's not that it won't happen or can't happen but it doesn't have to happen soon.

ADLER: Even companies like Delhaize America and A&P, who are so determined to stay independent -- when you look at them, their position is stronger in terms of operations, but you still sit there and go, why would you want to be a $10 billion or $12 billion retailer if you're really just a large regional? -- and yet they don't seem to have any doubts that staying independent is do-able.

HUSSON: The financial outlook for Delhaize America doesn't look to be that fantastic for the next year or so, and because the stock market doesn't take a very longterm view of these things, I predict Delhaize America won't be around this time next year as a separate entity.

SN: Where do you think they'll be?

HUSSON: They'll be acquired by either the Delhaize Group in Belgium, which would enlarge its stake to a majority, or by Wal-Mart.

CARTWRIGHT: Do you think Delhaize Belgium would spin off its U.S. operations to Wal-Mart?

HUSSON: If you look at Delhaize Group Belgium's multiple, it's the worst by half of what the multiple is for the rest of the European companies. But Delhaize Group can't use its equity to get involved in the consolidation of the rest of Europe because its multiple is being held down by having an albatross tied around its neck in the U.S.

CARTWRIGHT: But by taking Food Lion and Hannaford private, that kind of straps Delhaize Belgium from a cash position, and then how do they grow in Europe?

HUSSON: If they sell the U.S. [company], they could probably invest the money and eventually actually make more money on deposit than they can [operating the U.S. company].

CARTWRIGHT: This is a question they've been asking themselves for a long time, and they haven't been willing to do that so far.

COMEAU: I kind of agree with Mark in the sense that better than getting shot, they get sold. But at the moment, they seem really committed to holding on. Look at A&P. A&P is in the same situation. There are a million reasons why that company should have been sold 10 years ago, 20 years ago, last year, this year. But it's a family company, through and through. You've got guys running it here and over in Germany that are running a family company. I think Delhaize is operating under similar circumstances, trying to do the right thing, just like A&P is trying to do the right thing, but the motivations are different than just economic.


It's still uncertain if or when U.S. operators will seek mergers with overseas operators, the analysts said.

SN: If it comes down to just one or two giants here, will the game be over overseas? Will it be too late for them to get in?

HUSSON: Well, the question is whether the giants over here would feel strong enough or able enough, or whether their shareholders would trust them enough, to begin an overseas venture themselves. In terms of scale, the likes of Safeway, Albertson's and Kroger are already giant global food retailers, but they're only in one country. The likes of Ahold would probably have a longer growth rate than the U.S. players just because they are prepared for it and, globally, they've got markets in a number of other countries, so they're constrained only by the size of the planet, not by the size of the U.S. and what's happening in consolidation here. So it's disappointing that U.S. food retailers haven't done more in the world, but that's understandable, given how fragmented they were in the U.S. and how fragmented the large chains were among themselves.

ADLER: I agree with pretty much everything Mark said. Where you may get disagreement is the timing. How long does it take before you have completed that consolidation and you can look at further consolidation as adding a level of risk? But it is also fair to say that, in some environments, it is absolutely the right thing for the industry to do, and I think, in a low-growth environment, while it may be risky, what choice do you have? And then when does it happen that you have to go overseas?

ZIEGLER: Well, they may not have to go overseas -- overseas may come after them. I think the discrepancy in multiples between the U.S. and overseas markets makes it interesting, and that reverse flow may be the way you go global and ensure best practices. But there are obviously some major hurdles, the major one I think being Wal-Mart. That's the major negative, I think, but there are some major positives. Safeway is a good example of a company trying to build a brand. I don't think it's fully evolved yet, but I think they're going to use that brand and then build a lot of new revenue-generating capabilities on top of that. They're going to be information-based.

And I really don't think we should restrict ourselves to these guys selling canned peas or HMR. There's going to be a huge use of that brand, which is going to be technology-based. And I think consolidation is going to be part of it, and the consolidation in the U.S. is probably lower risk than going into mainland China right now, even though there are a lot of mouths to feed there. Think about the infrastructure you'd have to develop in China. I think there is a huge opportunity here, and Wal-Mart is going to force it


Premier regional chains may be able to resist consolidation for a few more years, but economic realities may force many of them to reconsider, analysts said during the SN roundtable.

SN: How does consolidation among the larger players affect regional chains?

HUSSON: If you look at the top 10 MSAs [metropolitan statistical areas] in America, you see that Wal-Mart is in 53 of the markets where two-thirds of the U.S. population lives. In markets that Wal-Mart has been in for more than three years, if you're not one of the Top 3 players and you're not Wal-Mart, your market share has been shrinking. At the moment, some of those chains, particularly in the larger MSAs, still think of themselves as powerful regional brands with enduring franchises, but I think they're going to wake up very soon and find they're just a collection of real estate and that's it.

ADLER: I think you have to argue about even being No. 3, because there are an awful lot of markets where the No. 3 player is a pretty distant No. 3.

HUSSON: And there are some markets, like Mobile, Ala., where you've got really appallingly compacted conditions -- where you've got Jitney-Jungle, Bruno's and Winn-Dixie as your Top 3, yet they all have pretty limited market shares.

CARTWRIGHT: But Safeway and Kroger have said they want to buy companies that have a No. 1 or No. 2 market share, so there's a disconnect between the companies that are going to be suffering and the companies that Safeway and Kroger are going to want to buy.

HUSSON: I think that with technology, private brands and buying power, you can take a regional player that looks pretty insipid in terms of its fundamentals, and if it has a decent market share, you can scrap the local infrastructure, scrap the prices, scrap everything apart from just local deal-making at the store level, and kind of download all the corporate stuff from these big retailers, and something that looked pretty insipid in terms of multiples is revivable, if the basic structure is OK.

LEVIN: The important point is that scale is going to become increasingly important, and that makes it tougher and tougher on the independents. With the overhead, the systems and the best practices they acquire, the big companies are getting better and better at using those factors, and that makes it tougher and tougher for the independents, which makes them more vulnerable to Wal-Mart and all the leading chains, and I think we'll see a continued lowering of the amount of active independents out there, though there'll always be some.

SN: Do you think there are independents, like Wegmans and Ukrop's, who will always be able to stay ahead of the curve in that sense?

LEVIN: There will always be some great independents and some great regional chains that are very innovative, who have built up their market share and who have a strong customer base and really invest in their stores and their brands and execute well.

BERNSTEIN: Look at chains like Ukrop's or Marsh, which spend a lot of time creating goodwill in the local community. In some markets, that works well. But ultimately, is that what carries the day, or do hard, cold economics carry the day? I think probably the latter does, but I think that it makes these franchises viable in the interim.

ADLER: Frankly, I think you can overplay the hand that the big chains have. At least until fairly recently, I think they very often gave up in terms of their responsiveness to the markets, their nimbleness, their willingness to try new things. Maybe they had more buying clout and they could cover their technology costs and spread it over a bigger base, but I don't think it is clearly obvious that they did a better job in every market than the reasonably well-run independents like Giant Eagle or Big Y or Price Chopper.

GIBLEN: Publix.


ADLER: But there are some next-level-down companies that aren't even on the immediate list, and I'm not all that convinced that the big guys have made their customers as happy as they could have. That's beginning to change -- they're beginning to use their size better -- but we've been talking about the regional players getting pounded since the early 1990s, and you had all these regional chains doing leveraged buyouts, but I don't think the reality confirmed that.

HUSSON: Well, FMI numbers show that if you look at the regional chains in the U.S., their EBIT (earnings before interest and taxes) has gone from about 2.9% to 2.7% over the past decade, while the Top 5 food retailers have gone from 2.7% to about 4.8%. So the numbers tell you the profitability of the regionals -- they're hanging on, but it's by their fingernails. And if you've got that kind of EBIT margin, you're certainly not reinvesting in the store base to the extent that you need to be, compared with someone like Kroger.

CARTWRIGHT: Regarding the EBIT for the smaller chains, is that an average? Maybe there are some companies that have much higher EBIT margins and some that have much lower margins, and it's the ones with the higher EBIT margins that Safeway and Kroger want.

HUSSON: I'm not saying they all are as high as the average. All I'm saying is that in order for that to be the average, there have to be some people going backwards quite a lot. And if there are so many others going forward, they would tend to be at the higher end of the size scale for the independents, which means there are a lot of retailers that are really just holding on literally by their fingernails. We've all got sightly different numbers, but the Top 10 food retailers have got about 45% to 50% of the market in the U.S. That means that everybody that's not Top 10 is part of the other 50%, and there are still loads of them out there. And I think that when we talk about good regionals, we will end up talking about the same few names -- maybe eight or 10 good names -- but together, what do they account for, 10%?

ADLER: I think that's too low. In the Top 50 U.S. markets, about a third of the Number 1s and Number 2s are private, family-held companies. So it's probably a little bit bigger than you think, though maybe we're just quibbling about small differences.


The integrations at Albertson's, Kroger, Safeway, Ahold and Delhaize America have each faced different issues that have affected the post-merger period, the analysts said.

SN: How are the integrations of the industry's major mergers progressing?

ZIEGLER: Albertson's tackled the toughest problem first, which was the integration in California. But now its California stores are all on one system. And they rushed that through to get it done and get the pain behind them. And if you go back in time, Lucky North and Lucky South didn't talk to each other, so frankly, Albertson's has consolidated three systems into one, and they've got it behind them and the brand is starting to build. On the other hand, there is still a mixture of Albertson's private label and Lucky private label on the shelves of the converted stores, and I'm a little bothered by the amount of time it's taking to clear out that Lucky inventory. So I think there is still further work to do. ADLER: Albertson's says it learned a lot about integration in California, and the Acme integration seems to be going well.

LEVIN: And the good thing is, they've changed their approach and they're going to do the rest of the conversions much slower and much smarter by having a group of pilot stores in each division, so it should be a lot smoother going forward. It certainly was very disruptive and disappointing when they did the initial California integration.

GIBLEN: With Kroger, I'd say it's even clearer that they're past their difficulties. They had some initial problems early on in the basic operations of Quality Food Centers, Smith's and parts of the Fred Meyer company, but they shuffled some management around and they seem to have those situations in hand. They also had some difficulties in Phoenix, where they changed some formats around, but they've basically completed that project and that situation has stabilized, so they're probably further along than Albertson's in terms of achieving solid integration benefits.

ZIEGLER: Well, don't forget that Kroger bought a quality company that was running pretty smoothly, whereas with Albertson's, I think what you had was basically one leper buying another, and you had a leper colony coming out of it. On the other hand, Albertson's didn't pay very much for American Stores. It was like buying a house that's a handyman's special -- you have to put a lot of love, attention and work into it to get the thing turned around. But they didn't pay a lot for it going in, and Kroger did pay more for more of a quality company that's humming. Another difference is that Albertson's really had a fire lit under it to get to one operating system, whereas Kroger bought companies that were really pretty solid, so they don't have the same kind of urgent need to integrate it. LEVIN: The one company we haven't mentioned yet is Safeway, whose mergers have just gone swimmingly along. They've done a great job integrating everything they've bought, whether it was Randall's or Carr Gottstein or Dominick's.

CARTWRIGHT: They have had some issues, but because the acquisitions were smaller and because Safeway addressed those issues quickly, we really haven't seen them affect the earnings performance of the company.

SN: So the question is, could Safeway do that on a larger scale of acquisition?

CARTWRIGHT: I don't think they want to. They like their strategy. They like having a lot of control over the integration process.

I think Safeway and Kroger are certainly going to be better off after having made the acquisitions they've made. They'll be stronger companies. But just looking out over the next five years or so, this is an industry with limited top-line growth, where the growth rates are becoming more and more dependent on acquisitions that over time are going to become less and less available, and I think that means that the earnings growth rate for the industry overall has to come down and the returns have to come down.

HUSSON: It's a lot different from Ahold's experience with integration the last three years, where you could argue that they had to peel back layers of fat, and over the past three years Ahold's EBIT has basically doubled. But Ahold, I sense, is running out of targets on the East Coast, where it prefers to keep itself away from the other major players so as not to compromise some further marriage, if it ever happens, with one of them.

SN: Now we're in the midst of another integration right now -- Hannaford and Delhaize. What do you think we're going to see there?

LEVIN: They've certainly had enough time to plan it.

GIBLEN: The two companies have pretty complementary strengths, so actually, they're just going to utilize those strengths in different ways in different regions, and I see smooth sailing.

COMEAU: However, both businesses are not exactly robust at the moment. They can do OK to the degree there are any synergies, and I'm not sure there are. But you could see poor financial performance from the company, and if they don't have a good year or two in terms of financial performance, you don't know whether it's the lack of synergies or simply the sagging of the two businesses. At the end of the day, I believe Delhaize America basically bought a management team -- that's all they bought -- and it's a good asset but one that won't necessarily mean big synergies.


Wal-Mart's newest format could pose a major industry threat if the company decides to acquire established retailers as a way to obtain sufficient real estate for a major rollout, analysts pointed out.

SN: Looking ahead, what's going to happen with Wal-Mart and its various formats?

HUSSON: Well, the Wal-Mart Neighborhood Market, at 40,000 square feet, looks a bit like a Food Lion with a Rite-Aid bolted to the side. Maybe Wal-Mart could buy both of them. We know the FTC doesn't count supermarkets and supercenters in the same breath, nor as the same business apparently, and Food Lion has been able to penetrate some bigger cities, whereas Wal-Mart's ability to do so is almost nil.

CARTWRIGHT: Historically, Wal-Mart has grown without making acquisitions.

ZIEGLER: But that's history. They've made acquisitions. They bought Pace and McLane. COMEAU: What about Woolco [in Canada]? That was a pretty mind-blowing acquisition when they made it. Just because they haven't done it yet ... I mean, they surprised people when they bought Pace, they surprised people when they bought Woolco, they went into Germany and then bought Asda in the U.K. So why wouldn't they be able to buy a supermarket chain, even someone like a Winn-Dixie or a Food Lion?

CARTWRIGHT: No, they could, it just seems like in the U.S., that hasn't been their choice of strategy.

COMEAU: It would give them the ability to access a lot of real estate quickly and not add capacity but just reutilize it.

CARTWRIGHT: I don't know -- you guys were saying this last year.

ZIEGLER: Well, it didn't happen.

HUSSON: Some of the sites Wal-Mart has taken in Dallas are old Food Lion sites that Food Lion got out of after the Prime Time Live report [a negative TV report about in-store conditions that aired in 1992], when the whole Texas thing didn't seem to work too well. ZIEGLER: Now Wal-Mart may take the Winn-Dixie sites in Dallas.

HUSSON: I've got a theory. The Neighborhood Markets are kind of a quasi-supermarket, and as Wal-Mart keeps trying to reinvent the box, sooner or later they'll start opening 55,000-square-foot supermarkets. And then they've got to stand in line to find the sites along with everybody else.

COMEAU: And they've got to make money -- at least a little bit -- when they go into these metro markets. They don't want to have an unsuccessful metro market strategy because then they'd have everybody dumping on them that they don't know what they're doing.

SN: There are only eight Neighborhood Markets now, and Wal-Mart keeps saying it's not going to roll them out until it gets them right. What is it that they're trying to get right, or what are they waiting for?

ZIEGLER: They're assembling sites. They're busy assembling real estate.

SN: So it's not a merchandising question?

ZIEGLER: They've got to get the real estate backlogged before they can announce it, so they're out there buying property.

HUSSON: And they're saying it's passed the test -- it's not a test anymore.

COMEAU: There's not a big learning curve on that stuff anyway. It's not like Wal-Mart doesn't know the food business.

SN: So at some point, are they going to open 50 or 60 Neighborhood Markets a year, instead of 10 to 15?

ADLER: More than that, I would think..

COMEAU: They're doing 120 supercenters a year, and these are much easier to do.

SN: They're easier to do if you can line up the real estate.

LEVIN: Wal-Mart has enough resources to spend as much as it wants to spend, so it's really just a manpower issue, and that takes some time.

ADLER: And they do have to generate a return. I still think that's a crucial issue. We've all said that it's hard to imagine how 40,000 square feet is going to work. Then you have to start raising questions about the bigger you get, the bigger the site you need, and you can't just pay anything for the real estate. And at 40,000 feet, I think mix is an issue, but returns are still, in my view, an issue as well.

CARTWRIGHT: But if they're rolling these out as fill-ins in markets where they already have supercenters, that seems like a pretty high-return project.

ZIEGLER: Isn't that what their game plan is?

GIBLEN: Yes, they've started doing it in Oklahoma where there are a lot of vulnerable independents. They're going to pick off markets one by one, starting with the weaker ones where they can get returns.

HUSSON: But there's a challenge there, and that's getting enough store managers and pharmacists. There's a huge shortage of both in the U.S. that are skilled. And if you look at someone like Food Lion, which requires similar kinds of real estate in similar kinds of markets, their store-opening program is 60 or 70 a year, which means it's going to be tough to get Neighborhood Markets at twice that level to have any meaningful impact on the landscape of the nation.

SN: So they have to obtain real estate?

LEVIN: Or they can grow more slowly. They don't necessarily have a mandate that they have to start opening 100 Neighborhood Markets a year. If they populate the Dallas/Fort Worth area with them, assuming they get it to the format they want, then they need to get the returns they want -- and we don't have any outright evidence of what those returns are.

LEVIN: In the meanwhile, the supercenters are working just fine for them.

CARTWRIGHT: And supercenters are not their sole source of growth. They're growing through many other means, so why do they have to go out and make a big splash and overpay for Food Lion?

HUSSON: What do we think they're going to do in sales per store in a 40,000-square-foot unit?

ADLER: $250,000 a week?

COMEAU: Depends where it is. If it's in a metro area, you'd hope for $300,000 to $350,000, whereas if it's in a secondary market, they can get a nice return doing $200,000.

HUSSON: So it's going to be something like a $10 million- to $11 million-a-year type of store.

COMEAU: You don't find high-volume stores anywhere in the South.

HUSSON: You're going to need a lot of those stores to make a significant impact on the metro market. If you open, let's say, 35 in Dallas/Fort Worth, then you're looking at a market share of maybe only 3%.

CARTWRIGHT: And why is that a bad thing?

HUSSON: Sense of scale.

COMEAU: It depends what they do. Why wouldn't they buy Minyard's or the Winn-Dixie stores [in Texas and Oklahoma]? Then it's a bigger number. It's not necessarily new share, but it's new management.

HUSSON: I don't disagree with you. All I'm saying is that it just makes acquisitions more likely.

COMEAU: Absolutely.


Wal-Mart supercenters have improved their merchandising abilities in food, but despite their potent competitive threat, they are still located in very few major population centers, the analysts said.

SN: Some people have said Wal-Mart's success is not only sheer size but also very good local marketing. They focus in on regional products, and they also make themselves a part of the community.

ADLER: It's also efficiency and price.

HUSSON: Those things are all just a prerequisite for being in business today. I don't think Wal-Mart's any better at local marketing than anybody else.

ADLER: What I hear about their supercenters is, if they have a good store manager, they do well, which is pretty much true of everybody. But Wal-Mart does especially well if a supermarket store manager is running the supercenter, whereas when they have discount people running them, they don't do as well.

SN: Are the supercenters doing better in food now than they have been doing?


ADLER: In the areas of both perishables and average center-store groceries, they've learned a lot.

BERNSTEIN: Part of the evidence that they are doing better is just to look at the Southeast U.S. The Southeast is incredibly painful, competitively speaking, and I think that's because, in large measure, Wal-Mart has become a better food retailer.

SN: So the threat is not just more growth of supercenters -- it's that supercenters are getting better?

LEVIN: The supercenters are Wal-Mart's major growth vehicle. They're rolling them out rapidly, and their market share is growing, with stronger sales than any of the [supermarket] companies we follow.

HUSSON: They've got a big maturity cycle, though. They start off pretty low but build every single year after year.

ZIEGLER: How many food-distribution centers have they announced going forward -- 10?

LEVIN: Isn't it 20 over the next five years?

ZIEGLER: It's some amazing number, and if you multiply 20 times 300 stores [the approximate number of stores a DC can supply], you're talking about a pretty big base.

SN: But they're still mainly in smaller towns.

ADLER: It takes 18 acres for a supercenter, and you're not going to find that sitting around in all areas.

HUSSON: Wal-Mart's only got about 25% of its supercenters and about 30% of its sales in the Top 100 MSAs, where 63% of the population is, which means that 70% of its sales are in places where the other 37% of the population is. So it's really in only a small portion of the country. And a lot of the big markets where they haven't gone yet seem very Wal-Mart unfriendly -- places in the Northeastern corridor, for example. If you were to stand on top of the World Trade Center in the next five years and have a look out and see if you can see a Wal-Mart supercenter, you'll probably need a pair of binoculars strong enough to see Boston. And places in southern California like Los Angeles, San Bernardino, Riverside and Orange County, are going to be very tough for Wal-Mart to get into because of the planning environment. There was a brave attempt by the legislature in California last year to prohibit any stores over 100,000 square feet that sold more than 15% food, obviously orchestrated by the UFCW [United Food and Commercial Workers Union]. It was passed on a Friday night when no one was looking, and it wasn't signed into law, but I think at the time, the governor said it had a lot of merit.

ZIEGLER: Actually, the governor vetoed it. He didn't sign it.

HUSSON: But he actually said there was a lot of merit in it and that every single local municipality was responsible for trying to interpret what was best for the local community, given some of the issues that had been raised about traffic and noise pollution and other kinds of pollution. So I think, given the planning environment, it's not a foregone conclusion that the re-population of the West Coast for supercenters is actually going to happen.