Foodstuffs stocks up for battle

Foodstuffs managing director Tony Carter is determined the group will not be swamped by competitors..

Tony Carter grins as if he is holding a Royal Flush. In some measure, the Foodstuffs Auckland managing director's demeanour is only natural. The Canterbury University chemical engineering graduate leads New Zealand's seventh-largest business and its only indigenous supermarket chain; last year he took home a salary of almost $1.3 million; he drives a nice car (an Audi estate); lives in fashionable Devonport on Auckland's North Shore and apparently enjoys a happy home life.

But at the same time he describes a brutal future for the chain, which operates the Pak 'N Save, New World and Four Square brands.

In his scenario:

* Australia's Woolworths, which recently took control of Foodstuffs' arch-rival Progressive, owner of the Countdown, Foodtown and Woolworths chains, will continue its squeeze on suppliers and pass on the savings in the form of cheaper groceries.

* In the longer term, an international giant such as Wal-Mart of the US, France's Carrefour or Britain's Tesco will make a takeover bid for Woolworths, attracted by its presence on both sides of the Tasman. This will further squeeze Foodstuffs' already tight margins as discounts the larger group negotiates with multinational suppliers such as Goodman Fielder, Nestle and Unilever are again passed on to consumers.

* German cut-price supermarket chain Aldi will set up shop in New Zealand once it has finished rolling out its stores in Australia, taking the grocery battle to another level.

Sitting in a cramped, windowless meeting room at the heart of Foodstuffs' rambling Mt Roskill HQ, Carter says: "I'm charged with ensuring we are not swamped by the wave of competition coming through, and we're determined we won't be."

The question is inevitable: Is his confidence just plain-pack corporate bluster or is Foodstuffs really holding a winning hand?

For most of Foodstuffs' 84-year history, such questions have largely been of interest to those owning the co-operative - the 631 Four Square, New World and Pak 'N Save store owners.

The co-op buys large so it gets discounts, which individual store owners can pass on to customers to buy and maintain loyalty. Any erosion of that buying power through more competition would hit the members' pockets.

But ever since Foodstuffs Auckland, with its sister co-operatives in Wellington and Christchurch, launched a lightning $150 million bid for 10 per cent of New Zealand's largest listed retailer, The Warehouse, the chain's future has also been exercising the minds of sharemarket investors.

At $5 a share, Foodstuffs' offer was more than 30 per cent above the previous day's close. But it still fell well short.

After shelling out $86 million, Foodstuffs was left with just 5.6 per cent of the company. (Sources say it has since picked up small parcels of shares, but that is not confirmed.)

Joint initiatives

Carter says The Warehouse was an attractive long-term investment prospect; Foodstuffs wants to be a supportive long-term shareholder and wants The Warehouse to consider joint initiatives.

Speaking on behalf of the three co-ops, Carter says: "[The Warehouse] is a well-run business in the retail sector, which we know and understand, and being New Zealand owned ... its culture is similar to ours."

He won't rule out Foodstuffs increasing its stake in the long term and says Foodstuffs "probably could afford to buy more".

"I don't think you can ever say never to anything, but it's certainly not our intent. We have board approval to purchase up to 10 per cent."

As it is, Foodstuffs holds only 5.6 per cent. Shares in The Warehouse closed at $4.96 last night, meaning Foodstuffs' investment has so far mostly held its value.

At Foodstuffs HQ this week, Carter was a little more forthcoming. The co-op saw "an opportunity" if Warehouse founder and 51 per cent shareholder Stephen Tindall were to sell.

"At some point they are going to be looking at options post Stephen Tindall."

But he says the media and observers have got it wrong.

"We see The Warehouse as a New Zealand company. We see ourselves as a New Zealand company. Everybody has tended to focus on the threat of groceries, but that is peripheral."

Instead he highlights the inevitable foreign takeover of Woolworths, calling it "when" rather than "if".

"That would give them scale no New Zealand retailer could get close to. One response is to try to get as much scale as we can in the New Zealand market, and that is it in a nutshell."

The Warehouse is an obvious partner in the longer term. Opportunities for an alliance could range from joint sourcing of goods to a full merger. But Carter insists Foodstuffs has no preference over the form of any alliance. He will seek talks with Tindall and The Warehouse "once the dust settles".

So that's a couple of points to the merger pundits.

Foodstuffs' bid came on the eve of The Warehouse unveiling its first hypermarket - the 12,500sq m Warehouse Extra at Sylvia Park in South Auckland.

However, Carter insists the launch had little to do with the timing of the raid and he doubts Foodstuffs has the financial firepower to make a full takeover which, at $5 a share, would amount to $1.5 billion.

"It's not our intention at this point to make a full takeover and, to be honest, it would be a stretch."

The co-operatives have sales of more than $6 billion and are relatively low geared, but, as co-ops, raising new equity is complicated. It would have to either demutualise the co-op or ask the members to fund the bid.

The former option appears unlikely.

"The co-operative structure is our biggest advantage, because the people who run the stores are those who are focused on the needs of consumers," Carter says.

Foodstuffs had seen 10 per cent of The Warehouse as an "achievable" target that took out most of the retail shareholders.

"We are now the second-largest shareholder after Tindall."

However, for investors, the play was perplexing. In many ways it seemed the classic precursor to a takeover.

At the centre of the Warehouse Extra at Sylvia Park is a grocery offering. The Warehouse plans to spend more than $60 million in the next five years on the Extra format, potentially in around 15 stores.

Investors believed Foodstuffs was worried The Warehouse would eat its lunch. The Warehouse has a portfolio of sites - many in premium locations with plenty of parking and high traffic counts - that could easily be adapted to the hypermarket format.

It also made sense to make the bid now rather than later. Foodstuffs, with 57 per cent of the grocery market, would face Competition Commission scrutiny if it tried after The Warehouse had built a meaningful position in the grocery market.

By taking control now, Foodstuffs could legitimately claim the expansion into hypermarkets was simply a new way of increasing its market share.

Moreover, investors took the bid as confirmation Tindall was planning to sell his stake and even better, Foodstuffs - previously an outside player - was a contender in an auction sure to attract worldwide interest. Investors naturally sat on their hands.

But the raid didn't all add up as a 10 per cent stake would have given Foodstuffs few options. It would be enough to block Wal-Mart from obtaining sufficient shares to allow it to move to compulsory acquisition; furthermore, if a full takeover was its plan, it would have lowered the total cost of acquisition by eliminating the need to pay a premium.

But if these overseas predators convinced Tindall to sell, Foodstuffs would potentially be left with little leverage. Wal-Mart could introduce its systems, make savings from bulk buying and just wait for Foodstuffs to give up and sell.

In addition, Foodstuffs has not approached Tindall or The Warehouse management to discuss its interest in co-operation - a move most would have expected whether it was looking to make a takeover or saw opportunities for other forms of co-operation.

Investors say if co-operation was the object of the proposal, Foodstuffs should have been able to convince The Warehouse on the merits of co-operation alone.

If a full takeover was the plan, convincing Tindall to sell would have been the most constructive course.

Carter is not convinced hyper-markets will succeed here as they have in some countries because New Zealand's population is spread across a wide area and roading capacity hampers developments. Typically, hypermarkets serve a population of 2 million in a 32km radius from the store. New Zealand's population is not so concentrated. Overseas, hypermarkets are destinations because they can offer significantly lower prices.

Moreover, gaining scale can also bring disadvantages. It forces standardisation and, as a result, the new, larger grouping is less attuned to local conditions. At the same time innovation is stifled by bureaucracy.

"Consumers will decide," says Carter. "Don't assume they will necessarily work."

The Warehouse's strength is in general merchandise, which makes up only 3 per cent of Foodstuffs' sales.

"The overlap between the two organisations is relatively small. Most of our product is grocery and most of theirs is general merchandise."

That is several marks against a merger.

It may be that Carter is simply reluctant to show what's in his cart, but Foodstuffs strategy from here seems uncertain. Just one thing stands out: The Warehouse appears to be in play and Foodstuffs is just one of several doing the shopping.


GOVERNANCE

Chairman: Glenn Miller, owner of Pak'nSave Hamilton

Managing director: Tony Carter

NATIONAL CO-OPERATION

The three co-operatives jointly own Foodstuffs NZ, which acts as their federation body.

Foodstuffs NZ owns the intellectual property in Foodstuffs' brand names, but does not trade in its own right and is not a holding company.

It co-ordinates policy and national activities and represents the collective interests of the co-ops.

HISTORY

The first Foodstuffs buying co-op was formed in 1922, from members of the Auckland Master Grocers Association.

It expanded in 1925 with Four Square branding on member stores. Co-ops were set up in Wellington in 1922, Christchurch in 1928 and Dunedin in 1948.

They adopted the name Foodstuffs in 1935. There are now three co-ops: Foodstuffs Auckland, Foodstuffs Wellington and Foodstuffs South Island. Each operates independently.

SUBSIDIARIES

* Cash and Carry operations for the small Foodstuffs franchises.

* James Gilmour & Co, subsidiary of Foodstuffs Auckland.

* Toops Wholesale, subsidiary of Foodstuffs Wellington.

* Trents Wholesale, subsidiary of Foodstuffs South Island.

* Superbank was launched in February 2003 and is the trading name of St George Bank of NZ, a joint venture between Foodstuffs and St George Bank of Australia.

OWN LABELS

Pam's, Budget, and the Fresh Express labels.


PILING THEM HIGH

631 stores including:

128 full service New World supermarkets

39 Pak'N Save and five Write Price food warehouses

279 Four Square convenience stores

180 On the Spot convenience stores in the South Island.