Zacks_Analysts' Blog : Safeway Stays Neutral - Analyst Blog

We reiterate our Neutral recommendation on Safeway Inc. (SWY) with a target price of $20.00.

Safeway reported EPS of 38 cents during the third quarter of fiscal 2011, surpassing the Zacks Consensus Estimate of 35 cents and bettering the year-ago earnings of 33 cents a share. The company reported sales of $10.1 billion during the quarter, exceeding both the Zacks Consensus Estimate of $9.8 billion and the year-ago level of $9.4 billion.

We note that the environment for retail industry is quite challenging. Consumer spending on durable products has been very weak. Also, riding on the economic uncertainty and price competition, the company has been witnessing sluggish revenue growth over the past few quarters.

However, the situation has improved considerably as reflected by the swell in identical-store (ID) sales, the best over the past nine quarters. During the reported quarter, Safeway registered a 7.1% increase in sales primarily driven by higher fuel sales, favorable Canadian exchange rate combined with a 1.5% increase in ID sales and the change in the Blackhawk revenue accounting. The significant improvement in fuel sales resulted from a 26% increase in pricing coupled with a 13% increase in volume. 

However, considering nearly 4% retail inflation, ID store sales effectively declined 2.5% year over year. On a sequential basis, ID store sales witnessed an effective decline of 100 bps. This induced the company to maintain or reiterate its 1% ID store sales guidance for 2011 despite an upside in overall ID store sales.

Inflation, which is hitting the entire retail industry (largely through food and fuel), will likely dampen the sales growth of the overall industry. Thus, we expect the impact on Safeway’s business to be nominal. Moreover, we are encouraged by Safeway’s constant effort to capture market share with its value-added offerings, which are expected to enhance its brand equity and reduce its dependency on price.

Safeway has undertaken cost reduction initiatives focused on cost of goods sold and supply chain efficiencies. The company is developing its distribution network in the US where some of its existing card content providers are becoming distributors, thereby reducing the number of retailers in the market.

Moreover, the company is focusing on shrink reduction, which will increase its inventory level. Safeway expects an improvement in pricing as well as volume through the year while shrink reduction is estimated to aid results till the third quarter of 2011.

Furthermore, Safeway is turning its attention to international market penetration. The company is expanding its overseas business especially in Canada, Australia and UK.

In addition, Safeway’s subsidiary, Blackhawk Network, which provides third-party gift cards, prepaid cards, telecom cards and sports and entertainment cards to a broad group of top North American retailers for sale to retail customers, is also contributing to the growth. Blackhawk also has gift card businesses in the United Kingdom and Australia.

However, retail inflation is rapidly gaining momentum and Safeway may find it difficult to pass on increased prices to its customers due to tough competition. This tough scenario has led certain consumers trading down to less expensive mix of products or searching for discounts on grocery items, which in turn have impacted Safeway's sales.

The company expects that these difficult economic conditions to remain for the time being. The company confronts a wide spectrum of competitive threats, especially from players like SUPERVALU Inc (SVU), The Kroger Co (KR) and Wal-Mart Stores (WMT).