Has Safeway Lost Its Way for Good?

Will Safeway make a recovery, or will it lose its way?

Feb 8, 2014 at 6:05PM

American supermarket chain Safeway (NYSE:SWY) recently posted a rather dull quarterly performance amid intense competition in the market. Can Safeway recover from this quarter, or has it lost its way? The answer remains to be seen. Let's have a look at the company and compare it to Roundy's (NYSE:RNDY) and SUPERVALU (NYSE:SVU).

Third-quarter earnings
Safeway reported mixed results for the third quarter. First, there was a 1.1% increase in sales to $8.6 billion compared to $8.5 billion in the third quarter of last year. Second, earnings per share slipped 58% to $0.27. The gross profit dipped by 36 basis points to 25.8%, while same-store sales grew by 1.9%. All in all, the company didn't do a bad job in terms of sales but struggled to earn sizable profits.

What is Safeway up to?
In November, the company sold its Canadian business to Sobeys for $5.8 billion in order to focus more on the US market. The move, however, has been met with great skepticism by many analysts, as the company's Canadian operations had been generating healthy profits for the past few years. According to the company, the proceeds from the deal will be used for a stock-buyback program and paying off debt.

At the end of the third quarter, Safeway announced that it wanted to exit the Chicago market by selling all its Dominick's locations in the region. The company has already sold 15 stores; four to New Albertsons and 11 to Roundy's. For the remaining 57 stores, Safeway is still looking for buyers.

Safeway is expecting a tax benefit of $400 million to $450 million by exiting the Chicago market. The net present value of these tax benefits is around $145 million, as estimated by the company. This cash will be used for the share-repurchase program and investing activities.

On the other hand, leaving the market is going to trigger a multi-employer pension withdrawal liability for Safeway, which is amortized for more than 20 years. Safeway estimates the present value of these payments to be around $375 million. For this reason, many analysts are of the view that exiting the Chicago market may not be a very judicious decision.

Safeway is facing intense competition from big players like Kroger, Whole Foods, Wal-Mart, and Target, which means that the company's margins aren't going to increase significantly, at least in the near future. Hence, the company will not be able to generate considerable profits, casting a shadow of doubt over its future prospects.

Safeway has also lowered its financial guidance for fiscal-year 2013. Now the company expects its earnings to be in the range of $0.93-$1.00 as opposed to prior earnings guidance of $1.02-$1.12.

According to Reuters, Safeway has become a buyout target after announcing that it wants to sell its Chicago business. Cerberus Capital Management, after buying five stores from SUPERVALU, is looking for a leveraged buyout of Safeway. As per the Reuters' report, the value of buyout could be around $8 billion, which would make it one of the largest leveraged buyouts since the financial crisis.

Safeway is adopting a "poison-pill"' strategy (plan to discourage a hostile takeover); therefore, the company has increased its stock-buyback authorization by $2 billion. This action was taken after Jana Partners, a hedge fund, acquired 6.2% position in the company.

Roundy's latest quarter wasn't a satisfactory result, as the company's earnings per share dropped to $0.07 from $0.20 in the comparable quarter last year. Same-store sales declined by 3.7%, while revenue grew by 1.1%. The earnings took a hit due to an increase in operating expenses, a weak economy, and new store openings.

Mariano's, a fast-growing upscale grocery chain owned by Roundy's, recently bought 11 Dominick's locations from Safeway. Considering Mariano's success in the market and its expansion plans, Roundy's is expected to get back on track. However, it would be prudent to further monitor the company before investing in it.

To keep a check on its operating expenses, SUPERVALU sold more than 900 stores to Cerberus for $3.3 billion. As a result, SUPERVALU reported adjusted earnings of $0.12 per share in its first quarter of fiscal-year 2014 compared to $0.08 per share in the year-ago quarter. Revenue, however, stood at $4 billion after a 1% dip. Save-A-Lot remained strong with positive identical-sales growth and revenue performance. The retail food and independent business segments also benefited from the company's cost-cutting initiatives, which could prove vital to SUPERVALU's future.

Final thoughts
Safeway's latest quarterly performance should be a worrying sign for investors. The outlook for the next year as portrayed by the company looks rather dim, as the management has revised its earnings downward. The company is facing massive competition both in the upscale and downscale markets, which is putting an enormous amount of pressure on margins. Furthermore, there are rumors going around regarding the possible buyout of the company. Considering all of this, I don't believe Safeway presents a valuable investment opportunity at this point in time.

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Zahid Waheed has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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