Belgium-based retailer Delhaize Group is to offload its Sweetbay, Harveys and Reid’s chains in the US to Winn-Dixie owner Bi-Lo. The move could reduce earnings in the short term but should provide the group with the opportunity to improve its balance sheet and help position its US operations for long-term growth. Katy Askew reports.

Belgium retailer Delhaize is grappling with a number of challenges in the US, a market that generates around 65% of group revenues.

During 2012, the company stepped up its investment levels in the US market in a bid to create a tourniquet to stem haemorrhaging sales and market share trends. Price cuts were implemented across Delhaize’s network of stores and the group revamped 500 outlets to try attract shoppers with an improved shopping experience.

The company simultaniously invested in the development of a discount banner, Bottom Dollar, to extend its appeal to value conscious consumers. Since its inception, Delhaize has opened 56 Bottom Dollar stores in the US.

Success in rejuvenating the top line has been modest but steady: during 2012 US total sales were down 2.2% and same-store sales were down 0.8%. Top line progress was made throughout the year and, during the fourth quarter the tide changed direction and Delhaize was actually able to grow comparable sales. Gains have continued into fiscal 2013, when the company reported same-store US sales were up 1.9% – the largest gain for six quarters.

But investment in improving the group’s offer and broadening its appeal in the US have placed Delhaize’s operating margin in the market under sustained pressure. The group has worked to offset the drag investments are having on operating margins by stripping costs out of its US operations.

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The firm has moved to progressively stabilise margins in the country through job cuts and store closures. Last year Delhaize closed 126 under performing stores and, during the first quarter of this year, the group shut an additional 36 outlets.

Delhaize may be getting its house in order in the US, but store closures have come at quite a considerable cost. Indeed, closures and impairment charges caused net profit to plummet by 73.7% in fiscal 2012, the group revealed in March.

So, yesterday’s (29 March) news that Delhaize has sold 165 outlets (including the leases of ten stores that had already been shut) to US supermarket operator Bi-Lo will likely provide some welcome respite for the bottom line.

The stores being sold off generated sales of around US$1.8bn in 2012, representing a fairly hefty 10% of US revenue. Through the deal the group will offloaded its loss-making Sweetbay banner in Florida, where it has already closed a number of its worst performing stores over the past year, as well as its less problematic Harveys and Reid’s chains.

And Delhaize was able to secure the sale at a reasonable price: at 15% of sales generated by the stores, excluding leases, the transaction value of US$265m was a figure that beat expectations.

Nevertheless, Petercam analyst Fernand de Boer said the transaction will likely result in a “small book loss”.

Boer added: “Delhaize was not willing to comment on the net profit contribution of the stores. However, assuming a small positive EBIT contribution, EBITDA margin of 3% and negligible income on the cash proceeds, the deal is marginally EPS dilutive in the short term.”

This must be viewed as highly preferable to the alternative, had a buyer not been found, of further costly store closures. Through the disposal, the group will also reduce its lease expenses by a little over $30m.

De Boer suggests proceeds from the sale, which is expected to close in the fourth quarter of this year, will allow Delhaize to deleverage its balance sheet, strengthening its balance of debt and lowering interest costs.

Citi research analyst Alastair Johnston agreed the cash could ultimately result in a “considerable reduction in net debt”.

He said: “We were already expecting net debt to fall from EUR2.06bn last year to EUR1.70bn by year end 2013. With this deal Delhaize might be able to reduce net debt 25% to EUR1.5bn (versus estimated 2013 EBITDA of EUR1.4bn).”

However, Johnston emphasised the short-term impact on the balance sheet could be muted. “It is unclear what Delhaize will do with the cash as there are few bond maturities in the near future: we expect the company to run a somewhat inefficient balance sheet for the foreseeable future.”

In addition to the financial logic behind the divestment can be added the strategic rationale. By further streamlining its US business, Delhaize’s local management will be far better placed to focus on driving growth at its key banners: Food Lion, Hannaford and Bottom Dollar.

This factor could prove particularly significant given the uncertainty surrounding economic recovery in the US. If economic momentum is lost in the country, retailers could once again see the grocery sector slumping. However, on the upside, continued economic improvements also have the potential to lift sales and margins. Whatever the future holds in store, Delhaize will be better prepared to face it thanks to the greater focus and improved balance sheet the divestment is likely to bring.