Safeway Brings Home the Bacon

I don't think investors can fault Safeway (NYSE: SWY  ) for lack of effort in a notoriously difficult marketplace. With competitors ranging from peers Kroger (NYSE: KR  ) and SUPERVALU (NYSE: SVU  ) , which recently bought out Albertson's, as well as more general retailers like Wal-Mart (NYSE: WMT  ) and Costco (NYSE: COST  ) , there are not too many niches left where a plain-Jane grocery store chain can put its focus.

Granted, a "niche" is somewhat relative when discussing a retailer with $39 billion in sales last year, but with competition besetting Safeway on all sides, it had to do something to try and differentiate itself. Safeway chose to go with what it calls a "lifestyle branding" initiative, to update its image to something a wee bit more upscale, with an almost Whole Foods (Nasdaq: WFMI  ) feel.

Third-quarter results show that the updating is bearing some fruit for the company's coffers. Profits were up to $173.5 million, up almost 42% year over year, and were largely driven by obtaining operating costs leverage through good expense control. Sales were up 5.3% over the same time frame, to $9.4 billion. However, capital expenditures were up significantly to $1.1 billion this year, as the firm remodeled existing stores to fit the lifestyle format, as well as opening new lifestyle stores.

While the lifestyle branding is helping the company now, the problem is that it is not a source of long-term competitive advantage. Safeway and others in the industry are faced with a similar situation to that of Warren Buffett and the textile business in the mid-1980s. Warren realized he could invest millions of dollars in the textile business, but he wouldn't gain any edge over his rivals, as they would be investing in the same opportunities. The perceived benefits from his investments were largely illusionary, as they quickly became a cost of doing business in the industry, rather than a source of competitive advantage.

Safeway's perceived advantage now as a lifestyle brand will be eroded over time as Whole Foods and other national competitors -- as well as regional operations, such as Aldi, Stater Bros., and Trader Joe's -- all fight for the same grocery shopper. Larger and larger capital expenditures, as we're seeing this year, will be required to remain relevant in the space.

While values may show up in the industry from time to time -- at current levels, Kroger may possibly be one -- investors might be best served by looking elsewhere to invest their hard-earned dollars. Safeway, while well managed, just does not look that attractive with a P/E in the mid-teens in an industry with difficult fundamentals.

More goodies for foodies:

Wal-Mart is aMotley Fool Inside Valuerecommendation. Costco and Whole Foods areStock Advisorselections. You can try either newsletter free for 30 days.

Fool contributorStephen Ellis doesn't hold shares in any companies mentioned. You can see his holdings foryourself. The Motley Fool serves only genuine spray cheese with itsdisclosure policy.


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