This Grocer Is Heading in the Right Direction

Safeway (NYSE: SWY  ) is the second largest supermarket operator in the U.S. after Kroger (NYSE: KR  ) , and primarily operates as a food and drug retailer. It has many brands of its own such as Safeway, O Organics, Eating Right, Open Nature, Bright Green, etc. The stock has appreciated a commendable ~48% (as compared to a ~17% uptick in the S&P 500) year-to-date.

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Looking forward

It is estimated that the food retail market will grow at CAGR of 5.5% globally for the period of 2011-2016, as compared to 5.7% for 2007-2011. Grocery stores are facing stiff competition and price wars are common as they all look to attract more customers. Companies are doing this by focusing on strategies like expansion, restructuring and store remodeling, all in order to control the $7 trillion grocery market. In the second quarter, Safeway managed to do $8.7 billion in revenue and fell short of consensus estimates of $10.3 billion in the second quarter. The uptick in identical-stores sales saved the company from posting a still-lower figure.

Safeway is making efforts to increase sales by introducing various loyalty programs and fuel programs. Additionally, it is also remodeling its existing stores and pushing private labels in a bid to increase profitability. Different private label brands add an additional 1,200 basis points to its gross margin, as private label products are much more profitable than the same item from another brand.

Just for U has been a success with customers. Safeway has successfully implemented this program based on data collected with respect to customers' taste, preferences, likes, and dislikes. It is estimated that about 5.4 million customers have benefited from this loyalty program. These customers have started visiting the stores more often according to the company and in fact, about 50% of the top line is being attributed to these shoppers.

Safeway made an investment of $928 million last year for nine new or replacement stores, four lifestyle remodels, and eight other projects. It expects to spend anywhere between $1 and $1.1 billion this year. It is clustering its stores into what it calls premium, mainstream and value categories. The premium segment is addressing the needs of higher income customers, whereas the value segment is dealing with affordable products for the lower income group.

As a part of the restructuring, Safeway disposed off it's Canadian operations this June for $5.7 billion. To cash in on the Washington, D.C. area boom, Safeway is expanding it's D.C. presence . Safeway, along with its real estate wing, Property Development Centers, got a solid response after testing local developer interest in building housing above the new locations. As a result, they are also expanding on this model, and a new Safeway in Wheaton, with 486 apartments on top, will be complete in October. The new Petworth store, with 220 apartments, is expected to open next summer.

Looking around

Other grocery stores in same league as Safeway are Kroger and Supervalu (NYSE: SVU  ) .

Kroger operates under two dozen banners, including Kroger, City Market, Dillons, Jay C, Food 4 Less, Fred Meyer, Frys, King Soopers, QFC, Ralphs, and Smiths. As of Feb. 2, 2013, it operated 2,424 supermarkets and multi-department stores. Of these stores 1,169 had fuel centers.

Kroger has increased its market share in 9 out of 17 markets, despite facing tough competition from Wal-Mart. It believes customers who are digitally engaged with the company are more loyal, so it has been spending to try and connect with them digitally and this effort seems to be paying off well. It is also supporting fishery and seafood initiatives in order to gain consumer confidence and improve its fresh image.

Kroger is also buying upscale chain Harris Teeter Supermarkets in a deal worth $2.44 billion in order to expand its reach in the Southeast and Mid-Atlantic U.S. This is being touted as biggest takeover bid by Kroger since 1998, when it bought Fred Meyer for $12 billion. This deal would give the Cincinnati-based retailer 212 fairly new stores that wouldn't need any remodeling, expanding its presence in more markets.

Supervalu has done well after selling off a number of its store brands. The company recently sold close to 900 assets as a part of restructuring exercise, for a value of $3.3 billion. This has enabled it to achieve diminished infrastructure costs and allows Supervalu to focus more effectively on a leaner business. A lower cost structure and simplified business model as a result of divestment has also helped it revive its margins.

Looking forward, Supervalu is focusing on various moves like better merchandise arrangement and weekly newspaper inserts to push sales higher. But the stock has run up more than 200% this year, so investors should tread cautiously and look for more signs of a turnaround.

Conclusion

Safeway has done really well this year, and it can do even better in the future. As the company is looking to focus on its core business, it should perform more efficiently. And with a trailing P/E ratio of just 12 (lower than both Kroger and Wal-Mart) and a juicy dividend yield of 3.2%, investors should think of adding this stock to their portfolio.

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  • Report this Comment On September 14, 2013, at 6:56 AM, TMFWillSommers wrote:

    Hi ANUP -

    Interesting take. I'd be interested in your thoughts on the following issues as regards to Safeway "heading in the right direction."

    1. Margins have declined for four years in a row and will definitely decline this year because of the sale of the Canadian operations

    2. Liabilities are huge if you look at its debt, leases and pension obligations

    3. It's culture is toxic. Employees hate working there, they hate the managers, they are surly to the customers, and they're 80% unionized. At the same time, managers have done nothing to inspire or motivate employees.

    4. The traditional grocery channel is in secular decline because of competition from Walmart, Target, Costco, pharmacies and dollar stores.

    5. Within the grocery channel, Wegman's, Trader Joe's, and Whole Foods Market are rapidly taking share at the expense of companies like Safeway.

    Thanks for your article, and I'm eager to hear your thoughts.

    Best Regards,

    Brendan

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