Union Fight May Sully Grocers - TheStreet

Union Fight May Sully Grocers

A new dispute in California could again slam profits and prevent a rumored buyout.
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Supermarkets have been in the news lately amid reports that

Kroger

(KR) - Get Report

could be the target of a leveraged buyout. But such a deal's not going to happen as long as a potentially ugly labor situation in Southern California is unsettled.

No buyer in his right mind would get involved with the grocer when the last labor strife in the same market just three years ago cost the industry an estimated $2 billion in sales.

Kroger and

Safeway

(SWY)

estimate they each lost over $300 million in profits as a result of a four-month strike that began in October 2003. Albertson's, now owned by

SuperValu

(SVU)

, also was involved.

Now, the supermarkets and the union are back at the bargaining table over many of the same issues, and the situation is beginning to look eerily familiar.

Equal Pay Demands

The supermarkets' management and the United Food & Commercial Workers union are at odds over a two-tier wage system. New employees are paid at a lower rate and, perhaps more importantly, must wait months or years to obtain benefits. The system, part of a concession the companies won in the last dispute, makes it more difficult for the unions to recruit new members.

The companies claim that with increased competition from

Wal-Mart

(WMT) - Get Report

,

Costco

(COST) - Get Report

,

Target

(TGT) - Get Report

and incoming British grocer Tesco, the supermarkets need to keep costs contained in order to stay competitive and save jobs.

The union believes that argument is garbage. For starters, the UFCW claims that Wal-Mart has just a 0.7% market share in Southern California, while Costco's share has tumbled from 14% to 7%. Costco didn't return calls seeking confirmation of those figures, while Wal-Mart said it doesn't comment on market share.

Furthermore, UFCW spokesman Mike Shimpock says that the reason consumers most often cite for shopping at Albertson's, Kroger's Ralph's chain and Safeway's Von's is customer service. In other words, it's the employees that are attracting the shoppers.

But the grocers are fast losing these employees, the union maintains. Shimpock says that the employee turnover rate in the second and lower tier is 85%.

Game of Chicken

During negotiations in 2003, Kroger, Safeway and Albertson's banded together in a "mutual aid" package where if the union struck against one company, the other two would lock out workers. Additionally, Kroger paid Safeway and Albertson's $146 million to compensate for damages suffered as a result of this pact.

Last week, as talks were taking place, the three supermarkets announced they entered into a similar deal that would lock out employees if the union struck against any of them individually. This information was revealed in the press and not at the bargaining table, which infuriated the union. A cooling off period was ordered and the two parties are expected to be back at the table next week, if not sooner.

So what are the odds of an actual work stoppage? Not good. Both sides were hurt badly last time. Although the companies lost hundreds of millions of dollars, their selling, general and administrative margins have returned to prestrike levels, while employees have had to pay more for health care.

Labor consultant Bill Adams, of consulting firm Adams, Nash, Haskell & Sheridan, believes there is no chance of a strike this time.

"The employees got beat up and didn't get anything," he says. "Everybody loses in a strike but the union members really took it in the shorts."

Union spokesman Shimpock doesn't want to see a walk-out. "A strike makes very little sense for us," he admits. "But if they want to play chicken, they just have to look at the recent overwhelming vote to approve a strike against Albertson's." Union members voted March 25 to authorize a strike at a future date.

The Bottom Line

It's unlikely that the situation will turn into the fiasco that occurred in 2003-2004. However, just to see what's at stake, consider that if Kroger were to lose another $339 million as it did last time, it would translate to reduced earnings per share of roughly 47 cents -- quite a haircut from the earnings of $1.66 a share that analysts currently expect for 2007.

Safeway, which is more heavily concentrated in California, would suffer a more devastating impact of 80 cents a share off the current $1.98 full-year projection.

Ultimately, while there likely will be nasty fights, a deal should get done. No one wants a repeat of the previous episode. I suspect that management maintains the upper hand and will not have to give up too much to get the contract settled. Operating margin likely will be hurt, but not to the same degree as it was last time, when Safeway saw SG&A as a percentage of sales up roughly 170 basis points in 2004 compared with 2002.

And while management may be in a favorable position, it did have to spend a lot of money to buy back market share. Some of that was done through rebranding efforts to enhance the shopper experience. This initiative is a big part of the supermarkets' new-found success.

However, if supermarkets were to lose market share due to a work stoppage, they would need another trick up their sleeve to lure customers back.

No Go on the LBO

There has been a lot of speculation that Kroger is the target of a leveraged buyout, despite the company's insistence that it is not interested. How the companies negotiate with the unions may be a good indication of whether management is being truthful.

If the chains do not bargain in good faith and try to squeeze every last dime out of the union, that may be a signal that they're trying to keep costs as low as possible in the short term in order to appear more attractive for a sale. If they appear to be bargaining toward a long-term solution that will ensure the health of the business for years to come, that would tell me they are truly not interested in a buyout.

Despite potential for acrimony in the labor dispute, I

continue to be bullish on the grocery sector. Margins are improving and customers like new initiatives and store remodels. I hope an amicable agreement can be hammered out so that management, employees and investors can focus on merchandising, customer service and same-store sales, rather than rhetoric and picket lines.

In keeping with TSC's editorial policy, Lichtenfeld doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.

Marc Lichtenfeld was previously an analyst at Avalon Research Group and The Weiss Group and a trader at Carlin Equities. He holds NASD 86, 87, 7 and 63 licenses. His prior journalism experience includes being a reporter/anchor for On24 in San Francisco and a managing editor of InvestorsObserver, a personal finance Web site. He is a graduate of the State University of New York at Albany. He appreciates your feedback;

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