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Raining On Pathmark's Special Day

Posted: Sep 25, 2007 14:25 PM by Glenn Curtis

Tickers in this Article: COST, GAP, PTMK, TGT, WMT, WFMI

There's been a lot of talk over the past few months about the synergies that a marriage between grocer Great Atlantic & Pacific Tea Company (NYSE:GAP) and rival Pathmark (Nasdaq:PTMK) could bring.

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The pair inked a deal to merge back in March, but I have my doubts this is a match made in heaven. (For related reading, check out The Merger - What To Do What Companies Converge.)

Oh A&P, You Could Have Done So Much Better
Now, don't misunderstand me; I think that it makes sense for grocers to consolidate these days, especially because margins in that business can be very low. It's just that I don't think that Pathmark is much of a catch.

First, let's examine Pathmark's most recent second quarter results. In the period, the company posted a net loss of $18.8 million.

Although the bulk of that loss was caused by merger-related expenses and the company's withdrawal from a pension plan, its revenue was down 0.4% to $998.5 million, and its same store sales were down 0.2% during the period.

Put On A Brave Face
There are differing opinions of course. Let's first take a look at some of the positives that Wall Street sees in the deal:

1) Analysts are predicting that the combination will solidify the company’s presence in the U.S. northeast.
2) There is a presumption that the combined company could save on distribution costs/trucking because of the relative proximity of A&P and Pathmark locations particularly in the northeast region.
3) There will likely be a sizable amount of overlap at the corporate level, and so it is likely that we could see some personnel cuts and therefore a corresponding cut in salary expenses.
4) There is also the cost/time benefits of not having to run two public companies.
5) All told, it has been reported that the combination could generate annual cost savings of $150 million.

Ok, those are the positives, but here is why I am skeptical of how well the two companies will ultimately mesh:

The Bride Has Seen Better Days
A couple of weeks ago I visited a Pathmark and my feeling was that the place needed a good scrub down. It looked to be old, worn and run down. Also, it didn't carry anywhere near the selection that some of the "superstores" carry. In short, I suspect that A&P will have to put a lot of money into this and other similar stores to spruce them up.

Now, this is not to say that all of its stores are run down, but this was my experience and my conclusion after visiting three different locations over the last six months. I wonder how many other consumers share the same view? (To learn more on the value of making a personal visit before you invest, check out Analyzing Retail Stocks.)

Cannibal Wedding Crashers
While both companies enjoy a healthy presence in the U.S. northeast, this precess could be a double-edged sword. In other words, while there is the potential to achieve distribution savings, and maybe increase leverage over local suppliers, there is also the possibility of cannibalization of sales.

In fact, in a neighboring town where I live there is an A&P and a Pathmark. To me, they always seem to be fighting each other - if one sends out a flier full of coupons, it seems the others do too. You see what I mean here? In other words, in some instances they are going after the same customers rather than picking up new ones or going into untapped markets.

Living in a Tough Neighborhood
In the Northeast, where both companies have their focus, we don't have Piggly Wiggly, or Safeway. However, we do have Stop & Shop, Whole Foods (Nasdaq:WFMI), Foodtown, and Shop Rite. These stores fight for every customer. You also have to add in the discounters including Costco (Nasdaq:COST), Wal-Mart (NYSE:WMT) and Target (NYSE:TGT). While they are not grocers in the traditional sense, each seems to be offering a greater number of foodstuffs, and other goods that you normally find in a grocery store. In short, the competitive nature of the business could, in my opinion, be very detrimental particularly to Pathmark.

The Bottom Line
I like Great Atlantic & Pacific Tea Company, and more specifically its A&P trade name, but I think a marriage to Pathmark could end up being more trouble than it's worth.

Finally, the price of oil is up the $80 a barrel range and some say that this could lead to an increase at the pump of 20 cents per gallon! Grocers rely heavily on ground shipping. In short, this might not be a good time to invest in grocers at all!

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By Glenn Curtis

Glenn Curtis started his career in the 1990s as an equity analyst for a regional firm in New Jersey. There, he covered companies in the technology, entertainment, and gaming industries. Curtis has since worked as a financial writer at a series of both web and print publications, including TheStreet.com and Registered Rep Magazine. He has held his series 6,7,24, and 63 securities licenses.

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