Food Lion Parent Delhaize Faces Down the Big-Box Challenge

The Pro: Jonathan Matthews, manager of the T. Rowe Price International Growth & Income Fund.

The Fund: T. Rowe Price International Growth & Income Fund seeks out shares of large, under-priced companies around the world. Under Matthews' tenure, which began in 2010, the fund has beaten two-thirds of its peers over the past three years.

The Pick: Delhaize Group . Based in Belgium, the retailer operates grocery chains in eight countries. U.S. operations include more than 1,100 Food Lion stores, as well as smaller chains like Hannaford and Bottom Dollar Food.

With low margins and little customer loyalty, the grocery business has never been easy. Then add in a sluggish economy that’s hurt value-oriented consumers. Then toss in stiff competition from giant box stores such as Wal-Mart and Costco , and it's no surprise that Delhaize — whose U.S. operations make up about 60% of its $21 billion in annual sales — has been struggling of late.

In 2012, the company closed 126 U.S. stores and last year replaced its chief executive. The upheaval has taken a toll on its stock price. The grocer’s shares trade about 3% below their level five years ago. Meanwhile, the rest of the market has more than doubled.

Matthews is quick to acknowledge Delhaize’s woes. But he thinks investors may be overreacting.

Not in dire straits.

For starters, while some retailers — think Best Buy and Barnes & Noble — are fighting for their lives, that’s not an immediate concern for grocers like Food Lion.

Moreover, with the stock having logged such poor performance, a merely modest improvement in profits could boost the company's shares. “It’s priced for no growth,” Matthews says, “when two-thirds of the business” — Food Lion — “is underperforming its business model."

It's no secret that many types of retailers have been decimated by online players such as Amazon. But grocers are different. Unlike books and DVD players, groceries can’t be stored for months on end in remote warehouses. What’s more buyers are used to being able to inspect foodstuffs — squeezing the avocados and melons and feeling apples for bruises — before they buy. That means at least so far online grocery delivery has been largely a niche urban phenomenon. While prices can be competitive, inconveniences like annual membership fees and minimum order sizes remain. “It’s much harder to do food online, especially fresh food.” says Matthews.

Facing a big box challenge.

Still, grocers are facing that other big retail threat – the big box store. Wal-Mart is often cited as the nation’s largest grocer. Target, although less successful, has also gotten in on the act. While competition from those two would make life difficult for any chain of stores, grocers face the additional problem that big box stores don't necessarily need groceries to generate big profits on their own. These competitors might be happy just to have their food aisles lure customers in to buy other stuff.

So has Wal-Mart hurt Food Lion’s sales? Sure. But Wal-Mart has been at it for more than 20 years, and Food Lion is still here. While Matthews acknowledges it’s tough to match Wal-Mart's prices, Food Lion doesn’t necessarily need to. It’s 1,100 stores scattered across the Carolinas and Mid-Atlantic states tend to be more convenient than their big box rivals -- typically located close to downtowns, rather than out on the highway. That means Food Lion probably has lost shoppers who make a once-a-week trip to stock up.

On the other hand not everyone wants to drive half an hour every time they run out of butter or ketchup. Then they go to Food Lion, according to Matthews. “These are more convenience-store like,” he says. It's an advantage that Food Lion itself has sought to play up in clever television ads.

Leveraging its existing customer base.

Of course, merely holding the line against Wal-Mart won’t be enough. The company has to find a way to grow too. Matthews believes it can. The strategy won’t necessarily be opening new stores, but wringing more money out of its existing ones.

One of Food Lion’s problems, Matthews argues, is that during the 2000s, the company took too much money out of its U.S. stores, essentially milking them in order to invest in its overseas operations. Ultimately, the strategy didn’t generate the hoped-for profits, while the U.S. stores grew “stodgy,” in Matthew’s words.

“They have an old fashioned assortment, and they have far too many products. They need to modernize, and they need to focus on the products that actually sell well,” he says. But he’s optimistic. “The challenge is to get people to spend just a few more dollars in the store.” He says. “It’s not easy, but it’s not that difficult.”

Food Lion seems to have taken that kind of criticism to heart. According to one of Delhaize’s own recent investor presentations, sales per square foot in Food Lion stores amounted to $7.90 in 2013, up nearly 6% from $7.50 in 2010. But -- as if to underscore the room for improvement -- the company also pointed out that a group of rivals including Wal-Mart and Publix managed $10.20 of sales per square foot.

In May, Food Lion unveiled what it calls its “Easy, Fresh, and Affordable” initiative – essentially a plan to overhaul its stores, starting with 29 Wilmington, N.C., locations in 2014 and to improve its product line. These updates, according to the Charlotte Business Journal, will include a “fresh garden cooler,” grouping organic and gluten free products together, and focusing on trendier items like premium coffee and Greek yogurt.

Food Lion also tweaked its familiar logo (while keeping the distinctive old-timey lion) to provide “a more modern look for customers,” according the chief executive’s statement.

Of course, hurdles remain. Not least is Delhaizes's non-U.S. operations, where the turn-around strategy isn't as clear cut. The head of the company’s 850-store Belgium arm departed in May, followed in short order by an announcement that the company is considering shuttering 14 stores there and laying of 2,500 workers in an effort to cut costs. Meanwhile, Delhaize also recently sold its Bulgarian operations, and reached a deal to sell its 39 stores in Bosnia & Herzegovina.

With its stock at $16.65, Delhaize trades at a price/earnings ratio of 11.3, based on estimated 2015 profits. That compares to about 13.1 for Ahold, the Dutch supermarket company which owns Stop & Shop, and 14.7 for Wal-Mart.

Matthews doesn’t have a specific price target for Delhaize. But so long as management makes good on its plan to boost sales and profits, he thinks the stock could trade “towards the rest of the market.” A multiple of 15, inline with the S&P 500 index, suggest a price of $22.