What Might Be in Store Under Kroger

Kroger Co., which plans to buy Ralphs Grocery parent Fred Meyer Inc., became the biggest U.S. supermarket chain after overcoming a massive debt burden it incurred a decade ago, and without making a major acquisition.

The story of how Cincinnati-based Kroger pulled off that feat offers a preview of the changes it probably will make at Ralphs, Food 4 Less and the other Fred Meyer operations after the $8-billion purchase is completed, which is expected early next year.

Most of the changes probably won’t be noticeable to Southern California shoppers--a whole new field of customers for Kroger, whose 2,200 grocery, drug and convenience stores and 212,000 employees are mostly east of the Rocky Mountains.

Ralphs and the others will probably keep their identities and local managements. The stores themselves--many of which already have gotten recent face lifts under Fred Meyer’s ownership--are unlikely to get another major overhaul under Kroger.

But there’s the prospect that shoppers of Ralphs and other Fred Meyer outlets will see more store-brand goods on the shelves, or find their stores adding more non-grocery sections, such as pharmacies, if they don’t have them already. Both features are Kroger specialties.

And because Kroger is an acknowledged leader in running supermarkets that are efficient, profitable and powerful in their markets, the buyout stands to make the California supermarket industry even more fiercely competitive.

Kroger declined to detail its strategy for Fred Meyer while the merger is pending. But in announcing the deal, Kroger said that it expects to leverage its expertise across Fred Meyer’s operations and that Fred Meyer will give it even bigger economies of scale that will help keep a lid on its costs and prices.

The merger isn’t without risks. Besides paying $8 billion in stock for Fred Meyer’s ownership, Kroger also will have to assume Fred Meyer’s nearly $5 billion of debt, which will lift Kroger’s total debt burden to $8 billion.

That’s a towering pile of credit in any business, but especially for one that earns only 3 or 4 cents for every dollar of sales--before taxes.

Moreover, Kroger will be assuming that extra debt at the same time supermarkets generally are being increasingly challenged by mass merchandisers, notably Wal-Mart Stores Inc., that are selling more groceries at discounted prices.

But if any supermarket chain knows how to drag along a heavy debt load and still prosper, it’s the 115-year-old Kroger chain.

It incurred a heavy debt in 1988, when the then-sleepy chain faced two hostile takeover bids. To fend off the threats, Kroger borrowed more than $5 billion to pay its stockholders a special dividend.

That ensured Kroger’s independence, but it also forced Kroger to sell marginal stores, close warehouses, slash capital spending and lay off more than 300 workers.

“We pulled our horns back,” said Kroger Treasurer Lawrence Turner. “If we were not No. 1 or No. 2 in a market, we sold it . . . and any marginal project did not get done.”

But by the early 1990s, Kroger had steadily whittled down its debt to the point where it was throwing off enough excess cash that it could start expanding again. Under the guidance of Joseph Pichler, its chief executive since 1990, Kroger aggressively opened new stores and poured cash into its infrastructure, including transportation, warehouse operations and in-store checkout and inventory technologies.

Look for Kroger to transfer its expertise in all those areas to Fred Meyer’s stores. Armed with Fred Meyer’s assets--which will boost Kroger’s annual sales to $43 billion--Kroger also will have a better chance of wrestling lower-cost terms from major food companies and its other suppliers.

Yet Kroger--named after Barney Kroger, who co-founded its first store in Cincinnati in 1883--also has built up its own manufacturing arm. Kroger makes more than 5,000 private-label items in 27 plants that include bakeries, dairies and beverage facilities. Its ability to control the flow of goods from the manufacturing plant to the checkout counter gives Kroger a cost-saving and efficiency edge over rivals.

To be sure, Ralphs and others also sell private-label items. But Kroger’s store brands account for nearly one-quarter of its shelf space, compared with 20% or less at most California chains.

Kroger also converted hundreds of its outlets to bigger “combination” stores, or supermarkets that house pharmacies and other specialty departments. That trend is also evident elsewhere--a Ralphs or Vons, for instance, typically sells flowers and has an in-store bakery--but the strategy could be aggressively expanded at Ralphs under Kroger’s leadership.

All of Kroger’s steps are aimed at lowering its operating costs so that Kroger can match or undercut rivals’ prices and still increase its earnings.

It’s been working. Kroger’s profit margins have slowly but steadily widened, and Kroger announced earlier this week that in the first nine months of this year, its earnings (before one-time charges) jumped 21% from a year earlier, to $359 million, even though sales edged up only 4%, to $21 billion.

That has caused Kroger’s stock to be a standout, having soared fivefold since 1993 while the benchmark Standard & Poor’s 500 index doubled in price. (Kroger’s stock jumped $3.13 a share Tuesday to close at $48.56 in composite trading on the New York Stock Exchange.)

But for all the changes Kroger might bring to Ralphs and the other Fred Meyer chains, Kroger doesn’t plan to shape them into mirror images of its own stores. As one Kroger executive put it: “Fred Meyer and its companies know their markets better than we ever will.”