High Prices, High Costs and Heavy Debt Weigh on Israel’s No. 2 Supermarket Chain

A shrinking Mega has few options as its struggles to compete with discount food retailers

Moti Milrod

For Mega, Israel’s struggling No. 2 supermarket chain, it looked this week like the vultures were circling.

Avigdor Kaplan, CEO of the retailer’s parent company Alon Group, made remarks at a University of Haifa conference set off alarms about the Mega’s ability to survive. Dun & Bradstreet, the credit monitor, recommended to clients to accept payment from Eden Teva Market, Mega’s 51%-owned organic-food supermarket chain, in cash or with collateral.

Kaplan, who joined Alon after trying to put out the financial crisis at Hadassah University Hospital, said his remarks at the conference, which was about leadership and crisis, were misunderstood and denied that he said the heavily indebted Alon Group will be broken up or that Mega is close to collapse.

“Alon Group is a large and stable group – there’s no risk to its survivability. We’re working to reduce its leveraging and improve its [business performance],” he told TheMarker.

“Mega has problems but I believe we will exit from the crisis,” he said. “To do it everyone has to roll up their shirtsleeves, increase sales and reduce costs. If I thought that Mega couldn’t overcome its current losses, I wouldn’t invest so many resources.”

Mega, whose blue-and-green logo graces shopping malls and downtowns across Israel, has had a rough few years, losing market share and posting losses over the last two years. The downfall was rapid: In 2011, the retailer had an operating profit of 38 million shekels ($9.8 million); by 2014 it had an operating loss of 155 million.

Mega has 400 million shekels in bank debt, three quarters of it to Bank Hapoalim. So far, Mega has made repayments on time, thanks to financial support from its parent company, publicly traded Alon Blue Square Israel.

Hapoalim’s exposure to the group’s woes is bigger than just Mega. All told, the bank has at least 700 million shekels in loans to the group’s combined retail businesses. Alon Retail owes between 400 million and 450 million shekels, much of that backed by Mega shares as collateral, which today is worth nothing.

Mega’s biggest problem is its image as a high-price supermarket at a time when shoppers are hungry for bargains. It was compounded by a branding strategy in perpetual flux as it sought to find a place at the discount end of the market, changing the name of its low-price sub-brand from Mega to Mega Bul, then to You, all while sales kept falling.

The depth of the problem is attested to by the fact that in many cases the retail space that Mega gave up saw sales grow sharply when it was taken over by a rival chain. For instance, at the Hutzot Hamifratz Mall in Haifa, after Super Shuk Yohananoff replaced a Mega outlet two years ago sales grew to 15 million shekels a month from 3.5 million.

By closing stores, Mega has improved its sales per square meter by about 10% in the last two years, but at 19,000 shekels in 2014, that is still just 76% what discount-supermarket king Rami Levy gets at his stores.

Mega’s cost structure makes it hard to compete on price. Its workforce is a relatively old average of 45, and 5,000 of its 6.500 employees are employed under long-term collective labor agreements. Average salaries at Mega are 50% higher than at rival chains, which adds up to 150 million shekels a year in extra labor costs.

Mega often pays higher rent than its competitors. Its real-estate assets, including 73 stores, were spun off into a separate publicly traded company, Blue Square Real Estate, nine years ago. The contracts under which Mega rents back the stores until 2019 are structured in a way that, except in the most high-demand spots, Mega is paying rent tens of percent higher than nearby retailers.

Any recovery program demands a big investment in expanding floor space at branches, inventory and customer credit, all of which cuts deeply into cash flow. That was the painful experience at Super-Sol, Mega’s larger rival, last year.

In any case, between debt and earnings before interest, taxes, depreciation and amortization of just 6 million shekels last year, Mega won’t be able to finance a turnaround on its own. Alon Blue Square doesn’t have the cash resources to help, having paid out 1.5 billion shekels in dividends in 2006-11.

Mega’s downsizing – it closed 22 stores last year alone – complicates any recovery by imposing higher overheads, like logistics centers, on a smaller sales base.

In fact, Alon Blue Square has been trying for some time to try and sell the supermarket chain, but given Mega’s dire financial state there hasn’t been much interest. Rami Levy, Victory and other chains have offered to buy certain stores, but not the company.

Instead, Mega’s fate hinges on Alon Blue Square injecting new capital into the company in the hundreds of millions of shekels, writing off bank debt and further branch closings to cut 60 million to 70 million in annual costs.

Unions will have to surrender some pay and benefits to save another 50 million to 60 million shekels, but talks to that effect have progressed slowly.