When Supervalu Inc. and a host of partners agreed to the $17.4 billion breakup of Albertsons Inc., divvying up its nearly 2,674 stores, it was the latest in a series of consolidations and bankruptcies in the supermarket industry. Just six months prior, Winn-Dixie Stores Inc. said it would pull out of 14 markets and sell 326 of its troubled units.
Conventional wisdom might lead one to believe that with so much potential for stores going dark and the constant fear of Wal-Mart and Costco gnawing away at the traditional supermarket business, strip center owners would be concerned about the health of their properties.
But many think the deals are actually helping the industry by weeding out the weaker Albertsons, Winn-Dixies and others. Landlords can then replace them with a growing number of successful, alternative supermarkets that have emerged during the grocery wars by finding their place in the food chain.
“Everybody's got to shop,” says Richard Moore, a REIT analyst with KeyBanc Capital Markets in Cleveland. “A grocer of some kind can be very important to a center.”
The reason — and this has always been true — is that rental revenue from grocers is secondary to the fact that they drive traffic. Successful supermarkets create a steady stream of repeat customers, drawing patrons about 2.2 times a week, according to the Food Marketing Institute.
Grocers themselves don't account for the bulk of the rental revenue that strip center owners rely upon. But by driving repeat business that makes a center popular, they bring in in-line tenants who pay significantly higher rent. Moreover, the continued success of a grocer is important because in-line tenants also often have clauses in their leases that allow them to vacate if the anchor goes dark.
“Our money is made not so much from getting rent from our anchors, it's the success those anchors have in drawing businesses to the sideshop retailers,” says John Pharr, senior vice president of operations and leasing for Jacksonville, Fla.-based Regency Centers, a leading owner, operator and developer of grocery-anchored centers. “You have to create the right merchandising mix.”
Regency's top grocery tenants — Kroger, Publix, Safeway and Albertsons — anchor about 200 centers, but only account for about 19 percent of a center's rent. The rest is from in-line tenants and outparcels. According to ICSC research, median anchor rents at open-air centers in 2004, the most recent year for which data is available, was $8.04 per square foot. Meanwhile, median rent on in-line stores was $14.07 per square foot while median rent on outparcels was $16.25 per square foot.
This helps explain why — despite the massive shakeout within the grocery sector — sales volume on strip centers has remained at all-time highs and cap rates continue to plummet. In 2005, 615 grocery-anchored centers changed hands, according to Real Capital Analytics. The number has risen every year since 2001, when there were 259 such deals. Overall, investors spent just over $11 billion on grocery-anchored centers, compared with $3.3 billion in 2001. In that time, average cap rates dropped to 7.4 percent from 9.6 percent. In 60 deals so far in 2006, the cap rate has dropped even further, to 6.8 percent.
The landscape today is this: Weak grocers have dropped off like flies and the sector faces further shakeout due to the ever-growing pool of competitors, like Wal-Mart, attempting to siphon off the repeat business grocers generate. But those that remain have figured out how to compete and retain their piece of the market. And a whole class of specialty players — either focusing on the high end or tapping into ethnic markets — have emerged.
The choice of where to shop will continue to become increasingly compartmentalized in this shifting landscape, analysts say. Most REIT operators say the key to navigating these changes is to find the best grocers in any given market, with an eye toward those with strong regional identities. The grocers most likely to succeed are the ones that aren't competing directly with the discounters on price, but those that find a successful niche.
Customers can choose anything from the no-frills warehouse-type experience offered by Costco, Wal-Mart and Sam's Club to mid-range operators like Kroger and Safeway to high-end specialty and niche retailers, such as Whole Foods Market and Wild Oats Markets, which target more affluent consumers. In some regions, like Southern California and Florida, Hispanic grocers have found success. And in some areas, strong regional brands like Publix in Florida, have succeeded where others have failed. In such a climate, traditional food retailers looking to compete solely on price will have an uphill battle.
“You can have a Winn-Dixie on one side of the street and a Publix on the other; they're both grocers, both pay similar rent, but which will you want to own? The one that's generating the most traffic, every time,” Pharr says.
Stick with what works
The continued success of the strongest traditional grocers in spite of the ongoing price war is proof that there's room for a wide range of operators, observers say. So, how can a traditional store remain a player?
Take a close look at Publix Super Markets, the leader by far in Florida; 641 of its 876 stores are located in the Sunshine state, where it holds more than 41 percent of the market. The nation's eighth largest grocery retailer, with 2005 sales of more than $20 billion, Publix has held its own against Wal-Mart, thriving even as regional rival Winn-Dixie filed for bankruptcy protection. An attention to detail, high level of service and a loyal customer base makes Publix precisely the sort of grocery anchor smart landlords look for, says Moore.
An emphasis on quality goods and shopper-friendly services, rather than rock-bottom prices, has allowed Publix to grow faster than many other chains. One thing that makes Publix different is that it is privately held and therefore not dependent on the short-term expectations of Wall Street. It joins a handful of other highly regarded privately held operators, including Wegman's Food Markets Inc. in the northeast and the H. E. Butt Grocery Co. in Texas. Publix, first opened by the late George Jenkins in 1930 in Winter Haven, Fla., is still run by the founder's family, but employees hold a 30 percent stake in the company.
Another survivor, Cincinnati-based Kroger, the nation's No. 1 pure grocery chain has 2,500 supermarkets operating under a dozen banners in 31 states and recently reported a 4.7 percent increase in fourth-quarter, same-store sales.
“Surprisingly, I think Kroger's success speaks to their ability to tailor their stores to specific demographic niches,” says Charles Cerankosky, a retail analyst who covers grocers for KeyBanc. “Even though it's a chain of over 2,500 supermarkets, it's generating good sales figures, and it does it across a number of formats.” Fourth-quarter sales growth was the biggest since 1999.
It has focused on developing alternative formats, including its no-frills Food 4 Less stores, but much of its success has been attributed to the way it operates its national platform on a regional basis. Kroger leaves many merchandising decisions to division managers so they can be customized to local tastes, while maintaining consistency in how the stores look.
The No. 5 grocery retailer, Safeway, based in Pleasanton, Calif., takes more of a top-down approach to management of its 1,800 stores, and while it has posted losses for the last two quarters, it continues to hold its own. Safeway's same-store sales climbed 3.7 percent in the fourth quarter, though profit dropped. The decline in profit largely reflects the company's effort to close weaker stores and buy out older employees in an attempt to save money down the line. In the fourth quarter, Safeway incurred pretax charges of $55.5 million related to the closure of 26 stores in Texas and $37.5 million for employee buyouts.
Safeway is also spending millions to convert its stores into a “lifestyle” format, with more amenities, in the hopes of repositioning itself as an upscale grocer — an effort backed by the $100 million “Ingredients for Life” marketing push. This has helped Safeway stand out from the pack in some areas, including Southern California, where its Vons stores compete with Albertsons and the Kroger-owned Ralphs.
“They are putting a substantial amount of money into the stores … they look more like Whole Foods,” says Gwen MacKenzie, an investment broker who specializes in grocery-anchored centers for Sperry Van Ness in Los Angeles. “It's not just that it's shinier, it's better, newer, with a completely different look, from the lighting to the aisles to the produce bins, and they've supported that with a big marketing campaign.”
Safeway isn't the only operator giving its stores a makeover. The most successful supermarkets all look significantly different than they did a decade ago, or even five years ago. They're bigger, too, to accommodate more of the amenities customers have come to expect, says Terry Brown, CEO of Edens & Avant, a Columbia, S.C.-based developer with about 170 properties in almost 20 states.
Kroger's prototype has grown to about 69,000 square feet from about 55,000 square feet, and many include an on-site gas station. The average Stop & Shop Supermarket, owned by Ahold USA, has swollen to 70,000 square feet, up from 65,000 square feet. Safeway's newer stores are 57,000 square feet, up from 55,000 square feet five years ago.
“They're using that square footage much more effectively and efficiently,” Brown says. “They've got organic sections, prepared food, they've outsourced sections inside the stores to specialty retailers like Starbucks and Staples. They've done a much better job of merchandising the store to drive sales of profitable items.”
Size matters, and is another way for grocers to differentiate themselves from the discounters. There's a big difference between going to a 57,000-square-foot grocery and a 195,000-square-foot Wal-Mart — in terms of parking, ease of entry and convenience once inside.
While store improvements are likely to have a positive impact in the short-term, Safeway's strategy is not without risk, and some analysts doubt whether the massive capital investment will pay off over time. But in the current climate, it makes sense for operators to focus on the markets they're already in, says Michael Carroll, executive vice president of real estate operations at New Plan Excel Realty Trust Inc. in New York.
The trend toward upgrading existing stores has translated to less market expansion, Carroll says. Last year, Safeway, Albertsons and Kroger opened fewer than 125 new stores combined; a decade ago, it wouldn't have been unusual for each of them to open 125 new stores annually.
Eat or be eaten
The latest casualty in the grocery wars was No. 4 operator Albertsons Inc., broken up by a consortium of buyers led by Supervalu Inc. and CVS Corp. Once approved, the transaction will turn Supervalu into a bona fide supermarket behemoth, with more than 2,600 stores and projected sales of $44 billion, making it the nation's second-biggest pure grocery chain, behind Kroger. Though Wall Street has cheered the deal, which ended the suffering of a struggling operator and adds 1,124 above-average performing stores to Supervalu's lineup, it remains to be seen how successfully the two companies can integrate against such a competitive backdrop. (Another 655 weaker stores were absorbed by a consortium of five partners, including Kimco Realty Corp., who will recycle that space during the next few years.)
The deal's impact is likely to be muted for landlords, analysts and REIT professionals say, because most of the Albertsons stores acquired by Supervalu will continue operating. Albertsons greatest strength was in its regional banners, including Acme Markets, Jewel-Osco and Shaw's. Its weakness, it turns out, was failing to come up with a compelling strategy to win and keep customers.
“Albertsons, it seems, didn't know exactly what it wanted to be, and it poorly executed on the business model it did have,” says Rob Plaza, analyst at Zacks Investment Research. “It's really going back to being a retailer, getting the merchandise on the shelves that customers want at the right price. And they didn't do it as well as their competition. It's not profound. That's just what happened.”
The Albertsons story underscores the importance of delivering a consistent message to customers. By emphasizing, in turn, pricing, format and product mix, Albertsons lost focus. Escalating labor costs exacerbated its sagging fortunes, and in too many markets it was caught in the pinch between big-box discounters and the more upscale grocers. The upshot: very little room for inefficient operators.
Consolidation on this scale will almost certainly result in some vacancies, but REIT operators say the stores that wind up closing will likely be the least profitable ones.
New Plan is advising A&P Groceries in southeastern Michigan and northwestern Ohio, where some 35 stores have been closed as part of the Great Atlantic & Pacific Tea Co.'s ongoing turnaround. When a supermarket goes dark, another grocer is usually the best replacement, Carroll says; of the first 30 stores New Plan dealt with in this case, 20 were immediately leased to other grocery players in the market. But that's not always the right call.
“Oftentimes you'll find the not-so-good chains have made not-so-good real estate decisions,” Carroll says. “They will put a neighborhood grocery in what should be a regional shopping center. For example, you might find a Farmer Jack in a space that's much more appropriate for a Best Buy.”
In another example, New Plan is replacing a shuttered Winn-Dixie in North Lauderdale, Fla., with a Sedano's Supermarket, a specialty grocer based in Miami that caters to the Hispanic market, which it hopes will double the location's volume.
“In our mind, it's a tremendous upgrade, to take out a weaker operator and put in one that is stronger,” Carroll says. When there's consolidation, “You'll see some recycling of real estate … to other grocers and to other uses. But you're not going to see a lot of empty space.”
Ethnic grocers are growing, though less rapidly than other niche markets. Mexican retailer Grupo Gigante SA, is slowly expanding its presence in California, and Sedano's Management Inc. has a strong following in South Florida. Mainstream retailers are making the leap too. Publix has converted two Florida stores to a Hispanic-themed format, called Publix Sabor, and is set to open two more this year. And in another nod to the growing niche markets, Publix plans to open two GreenWise stores, its organic goods label, in 2007.
Meanwhile, all eyes are on the superdiscounters. “If Wal-Mart continues to build supercenters and Costco continues to build stores, selling food is a zero-sum game,” says Mitchell Corwin, an equity analyst at Morningstar Inc. in Chicago. “Supermarkets are going to have to continue to fight to maintain market share … and market share is key because margins are thin. It's a tough business.”
TOP 10 GROCERS, 2005 SALES
|Company Name||Number of stores||2005 sales|
|1. Wal-Mart Stores, Inc.||3,808 stores||$317.3 billion (est.)|
|2. Kroger Co.||4,296 stores||$59.9 billion (est.)|
|3. Costco Wholesale Corp.||433 stores||$51.9 billion (actual)|
|4. Albertsons Inc.||2,674 stores||$41.3 billion (est.)|
|5. Safeway Inc.||1,802 stores||$38.6 billion (est.)|
|6. Loblaw Cos.||1,058 stores||$24 billion (est.)|
|7. Ahold USA Retail||1,048 stores||$22.6 billion (est.)|
|8. Publix Super Markets||875 stores||$20.1 billion (est.)|
|9. Supervalu||1,553 stores||$19.9 billion (est.)|
|10. Delhaize America||1,542 stores||$16.6 billion (actual)|
|Source: Supermarket News|
Cheers and Konichiwa
Eager to meet the needs of time-pressed shoppers, some foreign operators are experimenting with smaller formats focused on prepared food. In California, the American brand of Japanese retailer Family Mart has opened three Famima stores, marketed as a combination upscale neighborhood deli, quick-service restaurant and premium grocer with an international flair. The chain's expansion plan calls for 30 stores by the end of 2006, and 250 by 2009.
And Tesco PLC, the largest food retailer in the U.K. — in spite of a price-slashing attack by Wal-Mart's British subsidiary ASDA Group Ltd. — recently announced plans to launch a chain of convenience stores on the West Coast. Tesco Express, already operating in a number of markets around the globe, sells meats, produce, frozen food and bakery items. It has committed $435 million annually to the U.S. expansion, and expects to open the first stores in 2007. This is one to watch, industry experts say, especially since Tesco is considering expanding to larger stores in the U.S..
“I think Tesco will clearly be a player,” says Terry Brown, CEO OF Edens & Avant. “They have Wal-Mart's knack for efficiency and a market like Target. They do a great job in terms of business efficiencies, and they deliver a very strong value proposition.”
The grocery business convulsed in a wave of consolidations during the latter part of the 1990s, with national chains snapping up regional banners to broaden their reach as Wal-Mart gobbled up market share. Kroger purchased Western chain Fred Meyer; Albertsons acquired Acme Markets and top Chicago food retailer Jewel-Osco purchased American Stores; Safeway bought Dominick's Finer Foods in Chicago, Randall's Markets in Texas and Vons Cos. in Southern California; and in New England, Ahold USA acquired Stop & Shop and Delhaize America purchased Hannaford Bros. Co. The consolidation continued with Albertson's 2004 acquisition of Shaw's Supermarkets from U.K.-based J. Sainsbury, and the more recent deal in which Supervalu purchased a thousand Albertsons stores.
Not all of the last decade's deals led to profits, however. Labor disputes and tough competition from discounters have complicated matters for traditional food retailers, forcing them to lead, innovate or risk annihilation. Dominick's has lost significant market share since it was acquired by Safeway, as has Randall's in Texas, where the operator has closed some 26 stores, sparking rumors it may flee the Lone Star state altogether.
Weaker players continue to fight for survival. Since filing for bankruptcy protection in early 2005, Winn-Dixie Stores Inc. has sold or shuttered more than 360 stores, leaving it with about 585 stores in five Southern states and the Bahamas. The Great Atlantic & Pacific Tea Co., once one of the nation's grocery leaders, is a shadow of its former self; in the midst of its second restructuring in three years, A&P sold its Canadian operation — more than 230 stores — in 2005, and has put its Farmer Jack chain in southeast Michigan and Ohio up for sale. And Fresh Brands Inc., which operates nearly 100 stores, was acquired by Certified Grocers Midwest Inc., a wholesale cooperative based in Chicago, in a $100 million deal that closed in February.
Delhaize America, the Belgian-owned operator of Food Lion and New England's Hannaford Bros. grocery chain is in the process of converting its Kash n' Karry Food Stores in Florida to a more upscale format under the name Sweetbay Supermarkets, to better compete with Publix.
And more consolidation appears to lie ahead: Wild Oats, the No. 3 natural food retailer behind Whole Foods and Trader Joe's, is rumored to be a target for acquisition.