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A Tough Landscape

A Tough Landscape

Food retailers struggled to navigate a difficult economic environment in 2010

The recession may be over, but for many supermarket companies, the pain lingered on through 2010.

Stubborn deflation and lingering unemployment kept a tight lid on sales growth for many operators, who wrestled with pricing and margin issues all year.

“Overall, the economic recovery is slower and weaker than we anticipated it would be at this point in the year,” said David Dillon, chairman and chief executive officer, Kroger Co., in a recent earnings conference call. “Job growth remains elusive and fuel prices have risen. These factors affect consumer confidence and grocery budgets. Many of our customers remain cautious in their discretionary spending.”

The weakness in consumer spending affected not only Kroger, but Safeway, Supervalu and others as well. (See next page.)

Even Wal-Mart stores did an about-face on pricing during the year, curtailing an aggressive rollback strategy in favor of its more traditional EDLP focus, and putting an end to its “win-play-show” assortment initiative. (See following pages for this and subsequent stories.)

Although some in the industry had expected more merger and acquisition activity among supermarket operators in 2010, the two biggest deals — the purchase of Penn Traffic by Tops Friendly Markets and the acquisition of Ukrop's Super Markets by Giant of Carlisle, Pa. — took place in the first weeks of the year. The rest of the year saw a smattering of strategic buys of handfuls of stores, including Shaw's and A&P locations in Connecticut, and excess Penn Traffic locations.

It was a busy year for legislative activity, as health care reform, financial reform, tax reform and food safety reform kept supermarket-industry lobbyists busy, even though all those issues remained in flux as the year was coming to a close.

And despite the difficulties experienced by some operators during the year, a few stood out for their strong performance — including Whole Foods Market, which returned to heady levels of sales growth in 2010, and The Fresh Market, which had one of the year's most successful stock offerings.

Pricing, Deflation Bedevil Food Retailers in 2010

PRICE WAS A MOVING target in 2010, and retailers aiming at it had be careful not to shoot themselves in the foot.

The combination of heavy price competition and product price deflation proved to be a tricky obstacle for retailers large and small in 2010. An economic recovery arriving more slowly than anticipated resulted in even more pressure, prompting several public companies to temper their earnings expectations for the year.

Safeway, Pleasanton, Calif., reported in February that a year of intense everyday price investment in 2009 had come to an end, and that it reached a desired level of price parity with targeted competitors while opening a pricing lead on other food retailers. But the results were rocky: The volume gains Safeway was expecting to get were blunted by the very price decreases they made. And the pattern of lower prices per item prompted Safeway to lower annual earnings guidance in July, and then forecast final numbers in the lower end of its revised range in November.

Officials, however, were optimistic that inflation could once again raise ships in 2011.

What little inflation did occur in 2010 proved difficult for some food retailers to pass along to consumers, since it came mainly in categories such as milk, which retailers frequently use as a vehicle for price image.

Officials of Cincinnati-based Kroger Co. in December noted that increased promotional spending by packaged-goods manufacturers — spurred in part by the broad consumer shift to private-label items that came along with the economic crisis — was contributing to continued deflation in the grocery aisles.

“This promotional spending masks some of the list price increases we have received,” Rodney McMullen, Kroger's chief operating officer, said in a December conference call discussing its third-quarter results. “The level of [quarterly] deflation is about 50 basis points excluding milk. Grocery represents about half of our supermarket business, so this level of deflation has a meaningful impact on our total company results. Inflation has been slow to develop, but we still believe it's coming.”

Pricing and promotional issues hit even harder at Supervalu, which while transitioning under a new management team was slow to lower its everyday prices and experienced sharp declines in sales along with “cherry picking” from consumers. In October the Minneapolis-based retailer said it had begun a program of “fair pricing plus promotions” to drive more consistent volume, but said its annual same-store sales would likely experience a bigger drop than initially anticipated.

“Our business is in transition, and sales [results] are not what we wanted to see,” Craig Herkert, chief executive officer, said during Supervalu's annual meeting this summer. “I can speak for our entire executive team that we are not satisfied with where we are.”

Analysts were skeptical whether Supervalu could price and promote itself back to health.

Like Supervalu, A&P was late to the pricing game, with the “Lower Price Project” intended to drive a more consistent price message with consumers introduced only this spring. But declining sales was only part of the problem for A&P, which under a heavy debt load filed for Chapter 11 bankruptcy protection in December.

Food retailers in 2010 also dealt with competitive pricing issues, particularly the effect of Wal-Mart's heavy price “rollbacks” earlier this year. BJ's Wholesale Club, in particular, noted that its need to stay ahead of Wal-Mart on pricing contributed to an earnings stumble in the second quarter.

“What the member of a wholesale club wants to see is that overt difference between the price the conventional channels are offering on their shelf compared to what you have in the wholesale club, and BJ's felt there was a need to keep those spreads large and visible,” Chuck Cerankosky, an analyst for North Coast Research, told SN in August. “The [quarterly] comps were decent, but their pricing decisions did have an impact of profitability.”

It should be noted the aggressive rollbacks did little to help Wal-Mart either, beyond signaling an end to the softer approach — and price perception — it courted under “Project Impact” initiatives in 2009.

Wal-Mart eventually settled back into its more familiar EDLP posture, and gave store managers more autonomy in rebuilding the “Action Alley” displays of hit-priced merchandise that disappeared during the “Impact” remodelings.

— Jon Springer

Wal-Mart Shifts Gears, Unveils Small-Format Plans

BENTONVILLE, Ark. — Wal-Mart Stores acknowledged some deficiencies and set out plans for future directions during 2010.

The shortcomings involved Project Impact, a strategy that advocated tighter selection, more private brands and a “win-play-show” merchandising program built around product categories that showed varying degrees of growth.

It was a program that Wal-Mart spent several years developing and implementing. But in September the company said that, though some aspects had been successful, Project Impact ultimately was eroding the chain's reputation for providing one-stop shopping. It also acknowledged that a series of price rollbacks earlier in the year had failed to restore Wal-Mart's low-price leadership position.

“Our customers will decide what we carry, based on what they buy,” Bill Simon, chief operating officer of Walmart U.S., said. “We will win in every category in which we compete. Every 4-foot section of our business will attempt to grow.

“We won't direct the customer to certain categories in the future — they will decide that.”

Going forward, price competitiveness would be measured on a basket basis, rather than an item basis, Simon added, with a return to everyday-low-price positioning. In addition, item selection would be expanded — including restoration of discontinued national brands — and the number of price promotions reduced.

Wal-Mart also said it would begin opening medium-sized and smaller stores as it seeks to move into more urban areas and small towns.

Medium-sized stores will fall in the range of 30,000 to 60,000 square feet — similar to the company's Neighborhood Market format — with smaller stores falling below 30,000 square feet. Simon said Wal-Mart expects to open between 30 and 40 such stores in 2011 at a relatively low cost of capital — as part of a learning process — so it can roll them out more aggressively in the future.

Simon said the medium-sized stores will not necessarily have a standard supermarket assortment. “We plan to build the assortment based on the needs of specific markets, as we've done with Neighborhood Market,” he explained.

“We've gained a lot of experience with Neighborhood Market, and we've become very efficient with stores of that size and made great strides in their profitability, with EBITDA comparable to that of competitive boxes of the same size.

“So after years of development, we are now prepared to accelerate the growth of medium-sized stores.”

Simon said the Neighborhood Market format became a more attractive expansion vehicle over the last couple of years, partly as a result of improved pharmacy shares and a new merchandising approach within the stores.

He was less specific about smaller formats. “Most markets around the globe have been successful with smaller stores, and we have tons of institutional knowledge [from the company's international experience] and will continue to learn more,” he said.

The smaller stores will not be similar to the 15,000-square-foot Marketside concept Wal-Mart tested in Phoenix. “Those are different from the stores we will open,” Simon said.

“Marketplace is about what's-for-dinner-tonight, and we were pleased with the products that were developed there, which are now available at our supercenters. As a result, we didn't feel we needed to move the Marketside format forward.”

One industry observer said he expects Wal-Mart's smaller units to be similar to a food-and-drug store but with site-to-store applications. “It will look like a Neighborhood Market, with a pharmacy, a limited assortment of HBC and over-the-counter drugs, and a limited assortment of food and non-edibles, but it will also have the capability of serving as a pickup point for items ordered from,” the observer explained.

That approach would be particularly desirable in an urban market, he added, where people tend not to be home during the day and would not want something delivered to their apartments. “But with Wal-Mart's highly efficient distribution, it could deliver products to these small stores where customers could pick them up.”

— Elliot Zwiebach

Discounters Ramp Up Expansion

IF NOTHING ELSE, the conditions were right for discount supermarkets in 2010. And with continued expansion of Aldi, a new rollout by Bottom Dollar and an aggressive franchising effort by Save-A-Lot, that's where the growth was as well.

Aldi, the limited assortment retailer, continued its rollout to new markets with a touchdown in Dallas-Fort Worth last spring, and continued its growth in Florida, where it arrived in 2009.

In Texas, Aldi encountered a population to whom price is always important, local observers said.

“They've taken on North Dallas — an affluent swath all the way up to Plano — and opened stores in that market. It seems to me, Aldi feels that their message is heard by all the economic classes,” Bob Ginsburg, vice president of CB Richard Ellis in Dallas, told SN in an article last spring. “Value always resonates with the consumer here.”

The arrival coincided with a new push by Save-A-Lot to expand its footprint through a licensing program that resulted in local independents rolling out the banner in hybrid forms for the first time.

One such combination was with a Hispanic operator out of Houston, El Ahorro, which rebannered six South Texas stores under the El Ahorro Save-A-Lot name. For Save-A-Lot, the St. Louis-based division of Supervalu, such partnerships expand the brand while incorporating local market expertise.

“This relationship is a new business model for the company,” Bill Shaner, president and chief executive officer of Save-A-Lot, said in a statement when El Ahorro joined the group in July.

Also in Texas this year, H.E. Butt Grocery Co. debuted a new discount format known as Joe V's Smart Shop at a site near Houston. The store offers a limited selection of items, and advertises “outrageously low prices” including “while supplies last” deals on nonfood items like appliances and kitchen items. A second Joe V's opened by year-end.

Bottom Dollar, created as an offshoot of Food Lion in 2005, came out of the laboratory and into production this year. Concern that its expansion would give Food Lion shoppers a reason to defect dissipated when Delhaize announced the Bottom Dollar would bypass Food Lion's Southeast stronghold and instead would build in and around Philadelphia. The first of these opened in early October with 20 such stores due by year-end.

Bottom Dollar's presence was expected to bring a new dynamic to a market already undergoing a transition that put established names like Acme, Genuardi's and SuperFresh on the run, with Wegmans, Wal-Mart, Target and Giant strengthening their hold. Delhaize officials saw a niche in the market for a soft discounter.

— Jon Springer

Local, Strategic Deals Highlight 2010 M&A Activity

THE YEAR IN INDUSTRY merger and acquisition activity started off with a bang, but sputtered through the rest of the year with a handful of small deals.

By the end of January, the two largest deals of the year had been completed — the purchase of Penn Traffic out of bankruptcy by Williamsville, N.Y.-based Tops Friendly Markets and the acquisition of Ukrop's Super Markets in Richmond, Va., by Ahold's Giant of Carlisle, Pa., banner.

Both Supervalu and A&P shed a handful of locations during 2010, but larger divestitures by those companies — which many had expected might take place during the year — never occurred. In addition, Indianapolis-based Marsh Supermarkets reportedly took itself off the sales block over the summer after failing to find a buyer.

The two large deals that did take place expanded the contiguous geographic reach of the buyers, bringing them into new markets adjacent to their current operating areas.

For Giant of Carlisle, the company's acquisition of the storied, 25-unit Ukrop's chain put an end to that chain's long legacy in the Richmond market, as well as its prohibitions on opening the doors on Sundays and selling alcohol. The stores were quickly converted to the Martin's name, which Giant already used in some markets.

“We've always been interested in Richmond, and always had great admiration for Ukrop's,” Rick Herring, president of Giant of Carlisle, told SN in April. “So when the opportunity [to buy stores] came up, we just wanted to be in the mix to get some, because it would have been more difficult to get here one store at a time. This just screamed a great strategic fit.”

Sales have been improving, Ahold officials said, although the acquired stores have still been generating losses for the Giant/Martin's division.

Similarly, Tops embarked on a market-by-market conversion of most of the 79 P&C, Bi-Lo and Quality Markets stores it acquired from Penn Traffic for $85 million, converting all of them to the Tops banner. The converted stores saw immediate increases in sales of 10% to 15% in many cases, Frank Curci, chief executive officer, Tops, told SN last month.

The acquired stores are expected to boost Tops' total sales volume for the year by about 40%, to $2.5 billion.

The two chains had long eyed the possibility of a merger, with Tops' strength in western New York and Penn Traffic concentrated in the central part of the state.

The bankruptcy filing in late 2009 opened the door for the deal to finally be consummated.

“All the bad parts of Penn Traffic were cleansed away through the bankruptcy,” Curci said. “It was the perfect way for us to buy it.”

After buying the store assets, Tops sold two groups of locations to Giant Eagle, Pittsburgh, and Price Chopper, Schenectady, N.Y.

Price Chopper, which had bid on a larger group of Penn Traffic stores during the bankruptcy, ended up taking six locations for $14 million, and Giant Eagle paid an undisclosed sum for five BiLo and Quality Foods locations in western Pennsylvania.

The Northeast saw a handful of other small deals during the course of the year, with ShopRite parent Wakefern Corp., Keasbey, N.J., picking up 11 stores from Supervalu's Shaw's division in Connecticut, and Ahold's Stop & Shop banner buying most of the rest of Shaw's locations in that state.

Also in Connecticut, A&P sold seven stores in the market to local independent Big Y, which is converting most of them.

“The big strategic players need to grow, and they have the capital,” said Tim Carroll, a principal with William Blair & Co., Chicago. “If there's a good strategic asset available, there's probably a big strategic guy around it — or two or three — who wouldn't mind grabbing that chunk.”

— Mark Hamstra

Chains Emerge From Bankruptcy With New Life

TWO COMPANIES that started the year in the midst of Chapter 11 bankruptcies ended 2010 with a second life ahead of them.

Bi-Lo, Mauldin, S.C., which filed for Chapter 11 protection in March 2009, emerged in May, having closed only seven of its 215 stores. Bi-Lo — which operates stores in South Carolina, North Carolina, Georgia and Tennessee — is owned by Loan Star Holdings, a Dallas-based private equity firm that acquired the chain from Ahold in 2005.

Michael Byars, who joined Bi-Lo as president and chief executive officer shortly before the filing, said at the time the bankruptcy was precipitated by the unwillingness of some lenders to negotiate terms for an extension of a loan that was about to mature — an action Byars said would not have been unreasonable in a normal credit environment.

Failure to secure the extension prompted Bi-Lo to default on a $260 million loan and file the Chapter 11 petition.

The filing was also prompted in part by unsuccessful efforts to sell the chain and by issues with its supply contracts, the company acknowledged.

In court papers Bi-Lo said sales and earnings had been falling since 2006, with operating cash flow at $52 million — less than half the $116 million the chain was generating in 2006. Observers said Bi-Lo stores were losing share because of a lack of capital investments and were being out-positioned by its competitors.

Finances were also adversely impacted by its obligations to pay rent on 35 dark stores and an empty warehouse.

Bi-Lo performed extremely well under bankruptcy protection, with positive comps of 3% to 5%. Helping to strengthen sales levels was a merchandising and promotional program instituted in November 2008 by Byars' predecessor, Randall Onstead — a “back to basics” program that focused on quality products and strong customer service, which Byars continued.

During the course of the bankruptcy Bi-Lo rejected an offer by competitor Food Lion to acquire the chain for $425 million.

Bi-Lo was able to emerge from bankruptcy last May with 207 stores and with expectations it will be able to turn itself around over the next couple of years, after which observers believe the chain is likely to continue to seek a buyer.

Bashas', based in Chandler, Ariz., operates all but two stores in Arizona. It originally ran into financial problems in April 2009, when it was unable to meet its obligations due to over-expansion and the general downturn in the national and Arizona economies, and it filed its Chapter 11 petition in July 2009.

Just prior to the filing, the family-owned business brought in one of its retired executives, Darl J. Anderson, as chief restructuring officer and named him president and chief executive officer, to succeed Mike Proulx, after the filing.

Anderson's immediate actions after the filing included reducing all employee and management salaries 2% to 15%, canceling the corporate jet and modifying the chain's insurance programs.

Like Bi-Lo, Bashas' received and rejected an acquisition offer from a rival — Albertsons LLC — during the course of the bankruptcy.

The company emerged from Chapter 11 in September after rejecting 37 leases, modifying the terms of 67 others and reducing its store count from 177 to 132.

A court-appointed financial adviser said at the end of the bankruptcy that Bashas' had been able to operate for a year without post-petition financing or a revolving line of credit “[and is] now properly positioned, from a managerial and operational standpoint, to enable the [reorganization] plan to work as contemplated.”

— Elliot Zwiebach

Legislative Activity Leaves Retailers in Limbo in 2010

WASHINGTON — For food industry lobbyists, 2010 provided no shortage of legislative and regulatory activity.

Supermarket operators have a stake in financial reform, tax reform, health care reform and food safety reform, some of the biggest pieces of legislation to move through Congress in the past year — although all remain in a state of flux.

Some of the initiatives contained measures the supermarket industry had been seeking for some time, such as the debit-card regulations contained in financial reform bill and the tougher food safety provisions of the Food and Drug Administration Food Safety Modernization Act.

The financial reform bill for the first time directs the federal government to monitor and regulate interchange fees, which retailers have long complained are artificially inflated by card issuers to repay the issuing banks. While the reform bill only affects debit cards, retailers were still encouraged by the progress.

“This is a long-fought victory for supermarkets and their customers across the country. Our members' extensive work on this spans more than the past decade,” said Leslie G. Sarasin, president and chief executive officer, Food Marketing Institute, Arlington, Va., said when the bill passed through Congress.

The legislation gives the Federal Reserve Board nine months to create rules that set a framework for interchange fees to be at a level that is “reasonable and proportional” to the costs incurred by card issuers. It also allows retailers to begin offering discounts or incentives for consumers to pay using cash, checks, debit or credit cards, and also allow retailers to set a minimum transaction for the acceptance of credit cards, not exceeding $10.

Peter Larkin, president and chief executive officer, National Grocers Association, also in Arlington, said NGA “is now committed to working with the Federal Reserve Board to establish regulations that will follow the law and the regulatory intent of Congress.”

The food safety bill, meanwhile, had passed the House last year, but was left simmering on the back burner for most of 2010 while Congress tackled health reform and financial reform. Then, after passing the Senate by a strong 73-25 margin earlier this month, the bill had to be rerouted through the House again as part of a broader piece of spending legislation because of a technicality.

The food safety legislation, which would give the FDA more power to inspect facilities and order recalls, and also places more emphasis on the prevention of foodborne illness outbreaks, is widely supported by supermarket operators, although some producer groups oppose exemptions that were included at the last minute for small enterprises.

Tax reform also languished for most of the year before Congress took it up in the current lame-duck session.

Of particular concern to many independent, family-owned food retailers is the estate tax, which had expired at the end of last year and is slated to return at a rate of 55% in 2011. A compromise could bring the tax back at a rate of 35%, with an exemption on the first $5 million for individuals.

While the supermarket industry overall had few quibbles with the health care reform bill, some provisions proved irksome, including new restrictions on personal health savings accounts.

Effective Jan. 1, 2011, the new law would prevent consumers from using such funds — set aside pretax specifically for health care spending — from purchasing certain over-the-counter medicines without a prescription.

Both FMI and NGA were seeking a repeal or delay of those provisions, which they say would negate the considerable efforts retailers have already made to accommodate such spending accounts.

— Mark Hamstra

Whole Foods Reemerges as Growth Leader in 2010

AUSTIN, Texas — Despite the weak economy, a continuing reliance on quality and a strong emphasis on price kept Whole Foods Market here in good stead with consumers during 2010.

Consumer confidence is ramping up, John Mackey, chairman and co-chief executive officer, told investors late in the year. “Year-over-year branded-product sales growth continued to outpace exclusive-brand growth, and customers selectively traded up to higher-priced items in certain discretionary areas such as seafood, cheese and housewares.”

Whole Foods was able to attract customers by pulling back on store expansion over the past few years, tightening its cost controls and using the money it saved to invest in pricing — promoting value along with quality. As a result, after a couple of years of modest same-store sales growth, comps moved up significantly last year, closing in on 9% as the year ended.

Given its stronger results, Whole Foods said it plans to begin reaccelerating expansion in the next few years.

Whole Foods has been able to reinvent itself, one observer said, “and it's extraordinarily impressive. It's hard to change your price image, but Whole Foods did a number of things to get a credible price image, and it shows up in same-store sales. And it was not done at the sacrifice of gross margin — the lowering of prices was made up for with increased traffic, a richer merchandise mix and a cost-of-goods pushback on vendors.”

Added another observer, “I think the Whole Foods customer went on strike for six months like everyone else's customer and traded down to a cheaper store and then back up to Whole Foods … and apparently volumes at Whole Foods are off the charts as consumers are back spending money.”

According to a third observer, “Whole Foods has done a great job of bucking the trend. I definitely underestimated its ability to attract the shopper back, but Whole Foods did a remarkable job in a relatively short space of time of really improving its price perception.”

Whole Foods has also benefited from the shift among consumers wanting to eat healthier, the observer said, noting that its move to improve its pricing image “made it easier to make that decision to eat healthier.”

— Elliot Zwiebach