Sunday, September 21, 2003

Kroger growth tougher

Acquisitions best way to compete

By Randy Tucker
The Cincinnati Enquirer

Faced with competition from superstores, warehouse clubs and even gas station mini-marts, traditional grocery stores are losing market share at a brisk clip.The nationwide food fight has forced pure players such as Cincinnati-based Kroger Co. to muscle up by acquiring new stores from smaller competitors to ensure growth and capture more food sales.

"It's pretty tough to gain share when all the competitors are selling the same products at the same price or lower," said Bob Goldin, a food industry consultant with Chicago-based Technomic Inc. "Acquisitions are a way for grocers to gain additional revenues and a higher share in markets where there is no room for new stores because they're already built out to capacity."

So far this year, Kroger has acquired at least 19 stores, including the purchase out of bankruptcy of six Eagle Food Centers in Illinois earlier this month.

Since its merger with Fred Meyer in 1999, the company has added more than 230 stores through acquisition.

And company officials said earlier this week that they would continue to seek strategic acquisitions, despite a disappointing second quarter in which earnings were down 28 percent, compared with the same quarter last year, missing Wall Street's expectations.

"There's a lot of opportunity out there," Kroger CEO David Dillon told analysts in a conference call Tuesday. "Industry consolidation has been a long-term trend that I think will continue for a long time."

The encroachment of giant discounters such as Target, Meijer and Wal-Mart Supercenters - now the nation's No. 1 food seller - has been the main reason for the frantic pace of acquisitions.

Just 10 years ago, warehouse clubs and supercenters accounted for about 2 percent of all retail grocery sales in the U.S.; now, they account for between 12 percent and 13 percent, according to the Food Institute, a New Jersey-based trade group that tracks grocery-related information.

Wal-Mart - considered the biggest threat to established grocers - has led the growth in non-traditional food retailing with an estimated $80 billion in annual food sales at its more than 1,200 supercenters, including two new locations in Greater Cincinnati that compete directly with Kroger on its home turf.

By 2007, Wal-Mart's food sales could top $162 billion, giving the behemoth retailer a remarkable 35 percent share of supermarket sales, based on projections from Retail Forward, a Columbus, Ohio-based retail consulting firm.

Wal-Mart's "aggressive expansion will continue to wreak havoc and steal share away from conventional food, drug and mass retailers at an alarming pace," said Sandy Skrovan, vice president at Retail Forward and author of the book Wal-Mart Food: Big, and Getting Bigger. "For competitors to survive in the Wal-Mart world, the key is to be what Wal-Mart is not."

Race for second place

But for most competitors, the battle with Wal-Mart for market share isn't even a fair fight.

The best they can hope to do is "grow a little bigger themselves and carve a little bigger piece of the pie," said Mark Hughsam, an equity analyst who follows Kroger for Morningstar Inc.

"There is really nothing you can do to stop them (Wal-Mart) from taking market share," Hughsam said. "Wal-Mart is going to be No. 1. The question is, who is going to be No. 2?"

Today, the runner-up spot belongs to Kroger. But to maintain that position, the company will have to grow. And the simplest way to do that is through acquisitions.

Acquisitions allow companies to grow without the cost of new construction and minimal investment in overhead, advertising and distribution.

But the biggest benefit of acquiring new stores might be the cost benefit, because bigger companies can negotiate better deals with suppliers, and, therefore, offer lower prices on the products they sell.

The same is true in the food industry and is a big reason why traditional groceries are losing market share to Wal-Mart, whose prices are more than 30 percent lower than established grocers in many markets, Hughsam said.

"You have to be price competitive in this industry," he said. "To do that, you have to grow larger so you can bring down your costs and reduce the cost disadvantage between you and the competition."

Kroger has muscle

Most industry experts think Kroger is in the best position of any of its peers to capitalize on the consolidation trend.

Despite poor earnings, the company reported continued strong cash flow in the second quarter and isn't burdened by heavy short-term debt.

"That's why their name always pops up when somebody is on the market," Hughsam said.

Most recently, Kroger has been rumored to be the frontrunner to make a bid on the Boulder, Colo.-based natural and organic food retailer Wild Oats Inc., which operates a store at Rookwood Commons in Norwood.

"It would make sense for them (Kroger) to pick up a company like that," Hughsam said. "It would give them a foothold in the organics market, which is a high-growth industry.''

In fact, average sales in the organic industry have grown 20 percent annually, compared with 2 percent to 4 percent growth among mainstream food products, according to the trade publication Supermarket News.

Meanwhile, among traditional grocers, Hughsam noted that Winn-Dixie's sales continue to fall while most other stores' sales have stabilized.

Jacksonville, Fla.-based Winn-Dixie - which operates Thriftway stores locally - might be forced to shed stores to cover its losses and could be an attractive target for Kroger in markets where the Cincinnati firm is looking to expand.


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