2005 Was Good for Big Retailers

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Big retailers got bigger, big food companies tried to get smaller and big tobacco had some big wins in 2005.

For 2006, investors will be watching as retailers integrate the deals, packaged food companies sell more assets and the biggest tobacco company, Altria Group Inc. (MO), considers whether the legal climate is clear enough to conduct its long-awaited breakup.

Two big retail mergers were completed in 2005 -- the $12.3 billion acquisition of Sears, Roebuck and Co. by Kmart Holding Corp. that formed Sears Holdings Corp. (SHLD) and the $11 billion purchase of May Department Stores by Federated Department Stores Inc. (FD), owner of Macy's and Bloomingdale's.

The Sears-Kmart deal was engineered by billionaire hedge fund manager Edward Lampert, who helped lift Kmart out of bankruptcy.

Shareholders have yet to see the big real estate sales that many had expected from Lampert, who built a hefty cash pile at Kmart by selling off chunks of stores to other retailers. Instead, he has cut store investment and eliminated profit-draining clearance sales to boost earnings -- often at the expense of sales growth.

In early December, Sears Holdings investors got a taste of the wheeling and dealing they expected from Lampert when the company offered to buy the rest of Sears Canada Inc. for about $719 million.

At Federated, starting in 2006, the company is slated to start divesting more than 80 "duplicate" stores -- stores where Macy's and May stores operate in the same mall or shopping center.

It will also convert all Marshall Field's stores to the Macy's nameplate in late 2006, a controversial move that eliminates a storied name in retail and which some analysts say could backfire.

"It would be like when Ford bought Jaguar a while ago and changing its name to Ford-England," said Craig Johnson, president of Customer Growth partners, a retail and consumer products consulting firm.

While retailers grew, many packaged food companies tried to shrink, selling off product lines in order to focus on core businesses.

One of the largest examples was Kraft Foods Inc.'s (KFT) $1.48 billion sale of the Life Savers and Altoids candy and mint lines to Wm. Wrigley Jr. Co. (WWY).

In 2006, analysts expect ConAgra Foods Inc. (CAG) to make similar sales after new Chief Executive Gary Rodkin announces plans for the company in March.

But the biggest overhaul of a food company is at Sara Lee Corp. (SLE), which this year announced plans to sell or spin off businesses representing 40 percent of its sales in order to focus on deli meat, baked goods, personal care products and its Senseo coffee pod business.

Sara Lee has already announced deals to sell its U.S. retail coffee business and its European bra and hosiery division, among other parts. But the market is still waiting for the company to spin off its U.S. apparel business.

Analysts expect Sara Lee CEO Brenda Barnes to have details on all the divestitures worked out in 2006.

"Operationally, there's a lot of risk on what she is trying to do because she is doing so many things at once," said Gregg Warren, analyst at Morningstar.

The year also saw food companies and other packaged goods makers get a double whammy from higher energy prices, which not only drove up costs for shipping but also the cost of packaging made from petroleum-based products.

"This year the real question is 'how do we streamline our operations so we don't get nailed so hard when these energy prices spike like they do'," Warren said.

One last food story to watch in 2006 could be the total spin-off of Kraft from parent Altria.

Spinning off Kraft became more likely after Altria and the tobacco industry scored two big wins in 2005.

The first came in February when a federal appeals court said that the tobacco industry could not be forced to forfeit $280 billion in past profits if it loses a racketeering lawsuit brought by the U.S. Department of Justice.

Then, in December, the Illinois Supreme Court overturned a $10.1 billion verdict against Altria's Philip Morris USA unit that had been issued by a trial judge who found that the company had defrauded smokers into thinking "light" cigarettes were safer than regular smokes.

Altria Chairman and CEO Louis Camilleri has said those were two of the major legal issues that had to be resolved before Altria was split up, separating Kraft from the Philip Morris USA and Philip Morris International businesses.

The company is still waiting for a decision from the Florida Supreme Court on whether to recertify a class action lawsuit that had resulted in a $145 billion jury award against the tobacco industry. A Florida appeals court later ruled that the case should not have been certified.

Some analysts say a favorable ruling in Florida will clear the way for the Altria split-up.

But others caution that there are other "light" cigarette lawsuits pending, including one in New York that could be certified as class action in 2006.

"I don't expect it to happen till the latter part of the year," Warren said. "I think there is a lot of wishful thinking out there that it will be the first part of the year."