Safeway (NYSE: SWY ) delivered a fantastically boring quarter Thursday. Almost all of its financial metrics were essentially unchanged from the year-ago quarter -- although net income ended down 4.7%. Earnings per share did increase slightly, mostly because of share buybacks during the quarter. The interesting bits were in the finer points, though.
The company had lower performance in various operational areas, but these tended to be offset by increased savings elsewhere. For example, identical-store sales decreased by about 2%, because of lowered prices, but this loss was offset by reduced spending on advertising and improved inventory control.
However, these offsets can only go so far before margins start to feel the pressure. Deflation was the main source of worry in the quarter, as Safeway sought to get an edge on other value-based competitors like Wal-Mart (NYSE: WMT ) and SUPERVALU (NYSE: SVU ) . While manufacturers such as Kraft (NYSE: KFT ) and Sara Lee (NYSE: SLE ) have raised prices on some of their goods, passing commodity price increases on to consumers, retailers have had to eat some of that cost to keep sales volume up.
Fortunately (for the retailers, not the consumer), Safeway believes its own price cuts have already given sales volume the spur it needed. The company believes that by 2011, wages will start to increase again and it will be able to pass any further cost increases on to consumers, without endangering demand.
Personally, I'm skeptical. CEO Steve Burd is expecting wage increases of 3% to 3.5%, but a recent report from the Social Security Trustees predicts only a 3.1% increase in 2010, followed by a 2.2% one in 2011 and a 2.4% increase in 2012. The report's predictions are already markedly worse than those in the Trustees' 2009 report. If wage increases fail to keep up with price increases, Safeway may have to continue eating higher costs to hold demand steady -- either that, or consumers will find a new source of pain as inflation hits their already weak earnings.
So how do you play this dilemma? My Foolish colleague Mike Pienciak has a few suggestions.
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