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04/01/2012

Paring Down

Given the economy's slow growth, grocery retailers and food manufacturers increasingly are refocusing efforts by shedding underperforming units and spinning off viable stand-alone businesses. They want to play to their strengths.

Kraft Foods made the largest splash with its announcement in August 2011 that it would split the company into two separate businesses, including one focused on domestic brands and another on international. Ralcorp Holdings followed in February with its tax-free spinoff of Post Holdings, designed to allow Ralcorp to better focus on its strong suit, private label brands. "We believe the separation unlocks value for shareholders and best positions both Ralcorp and Post for future success," Ralcorp chief executive officer Kevin Hunt said in a statement. Post's market share had declined under Ralcorp's ownership.

UNLOCKING VALUE

Whether the stated goal is unlocking value or cutting losses, spinoffs and divestitures have become a hot strategy that signals a consolidating retail industry. "Sometimes retailers will spin off one of their subsidiaries [when they] believe they're not getting properly valued for the two companies," says James Cassel, chairman of Cassel Salpeter & Co., an investment banking firm in Miami.

The deals can take many forms. Winn-Dixie announced in December 2011 that it was selling to smaller rival Bi-Lo for $560 million in cash. The 480-location Winn-Dixie had emerged from bankruptcy protection in 2007 but struggled to compete with low-price supercenters and had subsequently closed locations, while the 207-location Bi-Lo emerged from bankruptcy protection in May 2011. The combined company will have about 690 locations in the South and 63,000 employees.


"We believe that weaker players will look to exit the market as strong players like Walmart and Aldi continue to compete fiercely."

– Deborah Weinswig,

Citi Investment Research & Analysis

Industry analysts are predicting more consolidation among grocery retailers and food manufacturers as the economy weeds out distressed businesses, presenting acquisition opportunities to stronger players. "We believe that weaker players will look to exit the market as strong players like Walmart and Aldi continue to compete fiercely," says Deborah Weinswig, a retail analyst at Citi Investment Research & Analysis, a division of Citigroup Global Markets Inc., in a recent report.

Cash-rich Kroger is in a strong position to capitalize as weaker players exit because the company has estimated free cash flow of $1.5 billion, while Walmart's further expansion is likely to impact smaller players, Weinswig says. "We expect consolidation in the Midwest to accelerate as Walmart makes a more aggressive move to enter markets in the region. We also believe the Southeast will continue to experience consolidation as non-traditional competition continues to take share," Weinswig wrote.

The Food Institute in Upper Saddle River, N.J., logged 273 mergers and acquisitions in the food industry during the first nine months of 2011, a 39 percent increase from 196 during the prior-year period. The increased deal-making reflects the pressure on profit margins that retailers face as cash-strapped consumers alter their shopping habits, says Peter Morgan, managing director at the Spartan Group, a boutique investment bank in San Francisco. "Shopping patterns are changing constantly. People may or may not be willing to drive the distance to go to warehouse stores. Fuel prices have tremendous impact."

Food Retail Merger and Acquisition Activity (2006-2012)
Acquirer Target
Date
Weis Markets Genuardi's (asset sale - 3 stores)
Feb-12
Fresh & Easy announced closure of 12 stores
Jan-12
Food Lion announced closure of 113 stores
Jan-12
Giant Food Stores Genuardi's (asset sale - 16 stores)
Jan-12
Bi-Lo Winn-Dixie
Dec-11
Tesoro Albertsons Fuel (asset sale - 51 stores)
Sep-11
Couche-Tard/Circle K Jewel-Osco Fuel (asset sale - 27 stores)
Sep-11
Stinker Albertsons Fuel (asset sale - 14 stores)
Sep-11
Bristol Farms team and Endeavour Capital Bristol Farms (asset sale - 14 stores)
Oct-10
Remke Markets Bigg's (asset sale - 1 store)
Apr-10
Remke Markets Bigg's (asset sale - 6 stores)
Mar-10
Wakefern Shaw's (asset sale - 11 stores)
Feb-10
Stop & Shop Shaw's (asset sale - 5 stores)
Feb-10
Ridley's Family Markets Albertsons (asset sale - 2 stores)
Dec-09
Associated Food Stores Albertsons (asset sale - 36 stores)
Jul-09
Ahold (Giant-Carlisle Division) Ukrop's Super Markets (asset sale - 25 stores)
Dec-09
Delhaize Group Bi-Lo (asset sale)
Oct-09
Niemann Foods Pick-A-Dilly Convenience Stores
Jun-09
Supervalu Albertsons LLC (8 Wyoming stores)
Jan-08
Great Atlantic & Pacific Tea Pathmark
Dec-07
Whole Foods Market Wild Oats
Sep-07
Kroger Scott's (from Supervalu)
2Q-07
Kroger Farmer Jack (from Great Atlantic & Pacific)
Jul-07
Supervalu Albertsons
Jun-06
Source: Citi Investment Research & Analysis / Deborah Weinswig, Citi retail analyst

As consumers save gas by shopping closer to home, many retailers are focusing on better serving the local market through a tailored product mix, while others seek savings by treating all locations the same. "There's no one-size-fits-all strategy," Cassel says.

CUTTING COSTS

The consolidation in the grocery industry mimics the strategy mass merchants have used to cut costs. Eliminating regional banners in favor of one national brand was the approach Federated used to cut costs when it acquired Macy's in 1996, later rolling up regional department stores and branding them all as Macy's. "A Macy's is generally a Macy's now. ...

It gives them more control [and] power to deal with national brands," Cassel says.

Consolidation can present savings in operations and marketing, but some markets adjust more quickly than others. "You lose the local flavor. ... It's not the same store that I grew up with," Cassel says, referring to Macy's. In some cases, a retailer's core customers have left for newer or lower-priced competitors, and the retailer hasn't been able to lure them back. "Usually you are doing it [consolidating] because there's a [regional] brand that's underperforming," Morgan says. As an alternative, store remodels can stave off disaster in some regional locations, but retailers need to determine whether they'll be able to recoup their investment. Mid-tier supermarkets, such as Winn-Dixie, have lost market share when a Walmart comes to town.

A retailer's success often depends on selecting the best locations for the customer base. But when an area's demographics change or a competitor moves in, retailers can't always defend their turf. Companies should do a location-by-location cost analysis to determine which stores are contributing to the bottom line. "They need to analyze where it's working and where it's not," Morgan says. When retailers start to eliminate underperforming locations, they also need to consider the impact to the overall company. "As you think about cutting off locations, to the extent they are contributing to the bottom line, can you rationalize the overhead?" Morgan asks.

CHANGING NAMEPLATES

Retailers that have more than one banner to cater to slightly different consumer sectors have the flexibility to change a location's nameplate to better meet new market conditions. "When you have multiple brands, you can attack based on which brand makes sense in which neighborhood," Morgan says. "You might have a different nameplate, but you're basically selling food."


"There aren't a lot of people that really want to own a retailer that's not performing, especially if it's in a bad location."

– Peter Morgan,

Spartan Group

When retailers face financial straits that could lead to bankruptcy, closing down an operation entirely might be the only option. "There aren't a lot of people that really want to own a retailer that's not performing, especially if it's in a bad location," Morgan says. After cost-cutting has been tried, eliminating the financial drag by shuttering a location might be the only option.

By closing about 126 underperforming Food Lion locations and eliminating its Bloom banner in the United States, for example, Delhaize America hopes to position itself for future growth. It plans to add more locations than it closes when it opens 600 to 700 new Food Lion locations.

But growing too quickly can backfire. Successful companies should take care not to become overambitious. Some industry observers suggest Supervalu might have gobbled up too much all at once with the Albertsons acquisition in 2006, because the company has struggled to realize the gains it had expected. With its Save-A-Lot banner, however, Supervalu has found smaller-format stores can work where larger ones might fail, presenting another option.


Management should determine which banners or locations are "core to the future and which are a drag on earnings and a drag on capital."

–James Cassel,

Cassel Salpeter & Co.

Reducing store size sometimes can be a better alternative than abandoning a location altogether. "That's one way to address somewhat of a shrinking market," Cassel says. Management should determine which banners or locations are "core to the future and which are a drag on earnings and a drag on capital," he says.

Ultimately, the decision to pare locations comes down to an allocation of resources. Companies should spend about 80 percent of their time and resources on their best operations, Cassel says. But often they end up spending most of their time on troubled operations. "That leads your good assets to suffer," he says. Instead of regarding a divestiture as a failure, consider it an opportunity.

Freelance journalist Ann Meyer is senior editor of Retail Leader, editor of SmallBusinessExecutive (www.SmallBizChicago.com), and chief executive of L3C Chicago, L3C. Meyer formerly wrote a small business column for the Chicago Tribune. Her work also has appeared inBusinessWeekSmallBiz, Crain's Chicago Business, Specialty Coffee Retailer, Multichannel Merchant, Prepared Foods and other business publications.