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California price war hurts Ralphs parent Kroger

The owner of Ralphs Grocery Co. is paying the price for helping to launch Southern California’s supermarket price wars.

Kroger Co., the largest U.S. grocer, said Tuesday that it would take a $1.05-billion write-down in the value of Ralphs as the division contends with cautious consumers, rampant unemployment in the chain’s core market and the slumping value of the real estate where its stores are located.

The company’s problems, including an $875-million quarterly loss, doesn’t bode well for its Christmas season. Already Ralphs’ shoppers in Southern California and Kroger shoppers nationwide spent less on the Thanksgiving holiday than the company expected.

“I am not bullish as to where Christmas will come in for the industry. We are being realistic,” said David Dillon, Kroger’s chief executive. Shoppers, he said, were “more disciplined in their spending” and were trading down to less expensive goods.

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“Others are holding back altogether on purchases because they simply don’t have the money to spend,” Dillon said.

Food stamp redemptions at Kroger chains, he said, were higher in the last three months than in any other period he could recall. “The [economic] environment is a new game. I have never seen anything like this.”

Mike Scholtman, Kroger’s chief financial officer, said that more than two-thirds of the record 12.5% of Californians who are unemployed live in Southern California, where Ralphs operates.

On Tuesday, the Cincinnati company cut its full-year profit forecast and reported a third-quarter loss of $874.9 million, or $1.35 a share, compared with a profit of $237.7 million, or 36 cents, a year earlier. Sales inched up nearly 1% to $17.7 billion. Kroger shares fell $2.72, or 12%, to $20.13.

Ralphs has slashed prices this year, setting off stiff competition with rivals Vons and Albertsons. That in turn has squeezed its profit margins.

Despite the problems at Ralphs and Kroger’s giant write-down in the unit’s value, Dillon believes that Ralphs’ long-term prospects are strong and that the 263-store chain has grabbed market share in the last six months. That leaves it well positioned to grow once the economy improves, he said.

Analysts agreed.

“Kroger has a strong balance sheet that works to their advantage. . . . They are well positioned to ride this out,” said B. Craig Hutson of Gimme Credit, an independent financial research firm in Chicago.

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Kroger acquired Ralphs as part of its merger with Fred Meyer Stores 10 years ago and set the value of the company at a time when the region’s economy was strong.

But changes in the local economy since then prompted Kroger to take another look at how it valued the chain on its books. Many companies have written down the value of tangible assets such as real estate, reflecting declines in the value of a business’ trade because of the recession.

To cut expenses, Kroger reduced spending on new stores and on the remodeling of existing stores by $1 billion, or 33%, and now plans $2 billion in such expenditures over the next three years.

Kroger also is dealing with the negative effects of food price deflation. The grocery industry operates on a more narrow profit margin than other businesses. For example, if it makes 5 cents on a $1 item, and the price drops to 90 cents, its profit drops to 4.5 cents.

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“Last year at this time we had estimated inflation of 6%. This year we estimate deflation to be negative 0.8%. Deflation was particularly acute in categories such as milk, produce and meat. We certainly sold more units -- as any associate who stocked dairy or produce departments can attest -- but at much lower retail prices,” Dillon said.

The pace of food deflation should slow in the first quarter of next year and turn into a touch of inflation in the second quarter, said Andrew Wolf, an analyst at BB&T Capital Markets in Richmond, Va.

“That should help a lot. It will take longer for the consumer to come around, and the competitive environment remains the biggest issue for the industry,” Wolf said.

For the near term, Kroger is ratcheting back its earnings expectations.

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Full-year earnings should total $1.60 to $1.70 a share, excluding the write-down, the grocer forecast. Kroger previously pegged its annual profit to reach as high as $2 a share.

Dillon expects the difficult economic conditions to extend through the first half of 2010.

jerry.hirsch@latimes.com

twitter.com/latimesjerry

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