For years, the Northeast seemed to be immune to the transformation of the grocery industry — where dominant regional players across the country have been giving way to national chains, wholesale players, Wal-Mart and Target supercenter concepts and, more recently, upscale operators like Whole Foods and Wild Oats.
Big boxes found the Northeast was a tough market to crack, in part because of the shortage in real estate, in part because it is the stronghold of the United Food and Commercial Workers, which has fought tooth and nail to keep the notoriously anti-union Wal-Mart out of the region. But with opportunities for growth dwindling elsewhere, the big boxes are making a new push. They are slowly gaining ground and eroding the sales of the former dominant regional players — the Great Atlantic & Pacific Tea Company (A&P) and the Dutch Royal Ahold N.V.'s brands including Giant Food Stores and Stop & Shop. That, in turn, has created vacancies for upscale players to move into, enabling Whole Foods, for example, to grow its footprint in the region.
All these changes are impacting the investment picture and pushing up prices on grocery-anchored centers in the Northeast, even while they are declining elsewhere. At the same time, regional supermarket operators are trying to switch gears any way they can, with some trying to recast themselves in the upscale grocers' image.
“The trends in the Northeast are very similar to the rest of the country — consumers are moving away from conventional supermarkets and going to extreme discount stores like Wal-Mart or upscale retailers like Whole Foods,” says David J. Livingston, a Pewaukee, Wis. — based supermarket consultant.
In the past, traditional grocers accounted for 90 percent of the food market, while discount wholesalers, drugstores and small convenience stores claimed the remaining market share. But now organic food grocers are coming into their own — the sector has been growing at the annual rate of 15 percent to 21 percent for the past decade, says the Organic Trade Association, a national business group.
Last year, organic sales in the United States totaled $13.8 billion, or 2.5 percent of the $552 billion food market. And the trend is going mainstream, with middle-income consumers willing to pay extra for quality products and enjoyable shopping experiences. Upscale organic chains often have food courts on their premises, in addition to brightly colored product displays and frequent food sampling offers.
“We used to think that the supermarket business was about the margins game, where the best thing to do was to have low prices,” says Kenneth C. Herbst, assistant professor of marketing at the College of William and Mary in Williamsburg, Va. “But many consumers will forgo saving $3 or $4 on an item if they can have fun while they shop.”
Meanwhile, 21.1 percent, or about 54.6 million, of all organic food consumers live in the Northeast, according to the Hartman Group, a Bellevue, Wash. — based market research firm, a number that leads other parts of the country by at least five percent.
The traditional grocers' struggles are reflected in the cap rates for supermarket-anchored properties in the Northeast. Last year, the average cap rate for such units in the region was 7.3 percent, up 0.2 percent over the national average. This year, the numbers are in sync at 7 percent.
Shopping centers anchored by Whole Foods trade at around 6 percent, according to Stephannie Mower, executive vice president of investment services with PM Realty Group, a national leasing and management firm. But a property with A&P as its main tenant will trade at 8.5 percent or 9 percent. “Something like Giant Food, which still has a strong name, may trade at 8 percent or a high 7 percent,” Mower notes.
In spite of Royal Ahold's troubles, its grocery chains are still well regarded and have a strong credit rating, according to Joseph French, senior vice president of institutional real estate sales with Sperry Van Ness, a national investment brokerage firm. “A Stop & Shop on Long Island or in a dense Westchester market would sell below a six cap,” he says.
Organic growth
The demographics in the Northeast fit the upscale grocery market to a tee — the region is home to five of the wealthiest states in the United States, according to the Census Bureau, including Connecticut, with the median household income of $56,409 a year, New Jersey with $56,356 and Massachusetts with $52,713, and has large concentrations of people who live alone.
“Single people are more willing to pay additional money for high-end products,” says Mower. The reasons vary — from psychology to the fact that families with children are more likely to benefit from buying in bulk at discount warehouses, but research confirms this. The Bureau of Labor Statistics estimates that a 3.5 person household with the annual income of $76,205 spends about $1,983 on food per capita. By contrast, a single person with the annual income of $37,806 makes about $2,427 in food purchases — a difference of more than 22.8 percent. One-person households make up approximately 27.2 percent of the 20.29 million households in the Northeast, compared with the 25.8 percent national average.
As a result, organic chains in the region are expanding faster than mid-market grocers and the latter's popularity is waning. Texas-born Whole Foods Market already has 45 stores in the Northeast, representing 24 percent of its portfolio, and is planning to open another 15 in the next year. Wild Oats Markets, out of Boulder, Colo., has seven stores, or about 6 percent of its locations, in the Northeast, and is looking to build up its holdings, according to Chuck Lanyard, principal and director of brokerage services with the New Jersey-based brokerage firm the Goldstein Group. Rochester, N.Y. — based Wegmans Food Markets opened its 69th Northeast store last year. In addition, Whole Foods has started edging toward middle-income areas in New Jersey, a departure from its usual strategy, to test its appeal to the average American.
“They have now gone on the fringe of higher-end areas, such as the new location they have in Union, N.J.,” says Lanyard.
Whole Foods was the only retailer with properties in the Northeast to get a five-star rating on Morningstar's five-star scale from supermarket analyst Mitchell P. Corwin. Its annual sales, currently at $5.431 billion, are projected to increase by an average of 22 percent over the next five years, while square footage will grow by 20 percent in 2007 and 2008. Sales for Wild Oats Markets, which now bring in $1.156 billion a year, will grow about 11 percent over the next five years, Corwin says.
At the same time, A&P, Pathmark and Royal Ahold, which owns Stop & Shop and Giant Food Stores, have been struggling. A&P got a one-star rating from Corwin, who expects the company's $7.484 billion in annual sales to grow by a modest 3 percent until 2010. That's assuming that A&P survives. “That's a chain that's been losing money and investors are concerned,” says French. A&P owns 314 stores in the Northeast, in A&P, Waldbaum's, the Food Emporium and Food Basics USA formats.
Pathmark, with 141 locations in inner cities, is an expert in its niche, but has “no economic moat,” in Corwin's opinion. There is a possibility that the investment firm Yucaipa Companies, which owns 40 percent of the chain's stock, will sell it to a larger operator.
Royal Ahold is also posting a mediocre performance. The company's sales, now at $55.719 billion, are expected to average 3.5 percent to 4 percent in growth over the next five years, short of its five percent annual goal. In November, Royal Ahold announced that it will sell its U.S. Foodservice business, which distributes food to restaurants and institutions, to concentrate on retail operations, including Giant-Carlisle, Stop & Shop and Giant-Landover stores. Royal Ahold also plans to sell its Tops chain, which posted a decline in net sales last year, and is currently in talks with another Dutch operator, the Delhaize Group, about a possible merger. Ahold owns 563 supermarkets in the United States. Delhaize has more than 1,500 stores. In the Northeast, Delhaize operates Food Lion and Hannaford.
Catching up to Whole Foods
Aware of their problems, Pathmark and A&P have launched revamping efforts. Pathmark has been removing clutter from its stores, increasing selection of fresh foods, fruits and vegetables and adding new merchandise categories in toys and books. Corwin believes that this strategy will push annual sales growth to 3 percent from the current 1 percent. Pathmark now brings in $3.975 billion a year.
A&P plans to spend more than $500 million on remodeling over the next two years, abandoning its middle market approach and going after the discount and up-market segments. Some locations will be turned into Food Basics stores and will target the low-income demographic with affordable prices, while others will become A&P Fresh Markets. A&P Fresh Markets, introduced in 2004, put the emphasis on organic foods and feature elaborate product displays similar to Whole Foods'. The Food Basics stores are based on a concept introduced by A&P Canada in 1995. The remodeling will affect 75 percent of the company's portfolio.
But the revamping may not save this grocer. “A&P's efforts to turn itself around after years of underperformance are likely to lead, at best, to minimal profits,” writes Corwin.
Buyouts on horizon
If two or three mid-market grocery chains do go out of business in the Northeast, real estate brokers are not worried. Their prime real estate will attract a Whole Foods or, perhaps, a Wal-Mart, or a private equity investor eager to capitalize on the space.
“Entry into the Northeast is very difficult and real estate is hard to come by, so it would be a good way for a new retailer to enter the market,” says Mower. “I think that Food Lion is a likely candidate — over the next 18 months you might see some movement.”