Safeway's Asset Sales Need to Yield Results in Stores

Supermarket chain Safeway (NYSE: SWY  ) released an earnings report last Friday of last week that would normally send the stock into a dive, but the market resisted the urge to jump at headline numbers. Investors and analysts were assuaged at the idea of a slimmer Safeway, since management announced that it would be exiting the Chicago market and taking a nice cash tax benefit. The company has had a few challenges in recent years, both internal and from competitors, not to mention macroeconomic concerns. Safeway's Chicago departure follows an even bigger one last June, when the company sold its Canadian business for nearly $6 billion. Will Safeway's asset sales keep the stock moving in the future?

Sales up, income down
Though Safeway was able to push its top-line sales up 1% to $8.6 billion, the bottom end of the income statement did not fare well. Adjusted profit plummeted 58% to $0.10 per share. The Street was expecting $0.06 better, yet the market was forgiving.

The company also lowered full-year guidance from $1.02-$1.12 per share to $0.93-$1 per share.

Operationally, the company is not seeing much of a pickup in terms of cash flows or margin enhancement. Cash flow, at least, won't be too much of a problem given that the Chicago store sales could net as much as $450 million in addition to the billions from the Canadian stores.

Bet on the assets?
Management is clearly trying to focus on its remaining profitable grocery business and shed the rest. This is a great strategy -- if there is a profitable grocery business. Safeway can only sell so many of its assets to cover up the operational pitfalls, and at some point it will run out of "poor-performing assets."

Still, some analysts see the stock going much further up based on the encouraging asset sales.

With the major cash influx come new opportunities for capital allocation. The company can, and will, buy back stock. As many a Fool knows, stock buybacks are not the cure-all strategy they try to be, but it may be a smart move for the slimmer Safeway. Additionally, the company could double down investments on improving the stores, steering customers toward a better product mix and thus bumping up margins.

The asset sales, while good in the short term, are the easy part of the equation for management (and investors). The most important aspect to focus on is where the cash goes and what kind of ROIC it achieves -- whether that be in store renovations, new store openings, or merchandise level. In coming quarters, keep a close eye on these factors and watch same-store sales as well as sales per square foot.

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