Regional grocer Safeway's (UNKNOWN:SWY.DL) stock price has been on fire lately, up almost 100% over the past year, as investors expect a more valuable company to emerge from its restructuring activities. Management has been busy offloading non-core assets, including the pending sale of its Canadian operations and a public offering of its Blackhawk prepaid card subsidiary.
However, some investors expect more upside ahead, with activist investment firm Jana Partners upping its stake in the company recently, leading to management's initiation of a stockholder rights' plan. So, should investors bet on this retailer?
What's the value?
Safeway is a vertically integrated grocer with strong operating positions on the West Coast and in the Chicago metro area, primarily through its Safeway, Vons, and Dominick's chains. The company keeps its format simple, offering traditional grocery-store outlets, while avoiding the complications of warehouse, superstore, and combination-store variations. Like category-king Kroger, Safeway has been slowly increasing its fuel center outlets, currently positioned at 25% of its stores, in order to drive customer visits, despite the low margin of the fuel-reselling segment.
In fiscal year 2013, Safeway's top-line growth has been absent due to the company's continued paring of its store network. It enjoyed higher comparable-store sales, however, up 1.5% for non-fuel categories, as it drove more customer purchases with enhanced private-label offerings, including its fast-growing Open Nature all-natural brand. More important, Safeway has enhanced its cash flow by closing or selling underperforming stores, like its Genuardi's unit, which has allowed it to reinvest in product development and loyalty programs.
Looking ahead, though, future growth seems limited, given management's plans to continue consolidating its network. Indeed, the company intends to use the proceeds from the pending sale of its Canadian operations to pay down related debt and repurchase a significant portion of its shares. As such, Safeway seems to be in the same mind-set as fellow regional competitor SUPERVALU (NYSE:SVU), which has been going through its own business rightsizing process.
In March, SUPERVALU sold off the vast majority of its traditional grocery-store banners, choosing to focus on its discount Save-A-Lot chain as well as a group of strategically located niche grocers in profitable markets, like Cub Foods in Minnesota and Farm Fresh in Virginia. The transaction eliminated almost $4 billion of its debt load and brought a well-heeled financial partner in investment firm Cerberus, which took a 21% stake in the company. Despite continued weakness in comparable-store sales across its remaining segments, SUPERVALU's early returns are promising, as cost savings from the downsizing process led to a big pickup in operating profitability in its first post-transaction fiscal quarter.
Like SUPERVALU, Safeway may get a bump from a recapitalization. Long-term growth, however, depends on its ability to drive more customers into its existing store network and encourage trading up to its premium-priced products, like its O organic brand.
The company's gross margin of 26.4% in fiscal year 2013 is in line with its peers, but pales in comparison to organic king Whole Foods Market's (NASDAQ:WFM) gross margin of 35.9% in fiscal year 2013.
Whole Foods' ability to create a community shopping experience and a very loyal customer base through its stated mission of providing quality, wholesome products allows it to charge premium prices across its product mix, leading to favorable financial dividends.
In fiscal year 2013, Whole Foods has continued delivering on its growth ambitions, with double-digit increases in revenue and operating income aided by a solid 7.2% increase in comparable-store sales. More important, the company's strong profitability and cash flow allow it to operate essentially debt-free and fund its expansion activities internally.
With a development pipeline of 94 stores, versus a current base of 355 stores, and a forecast of double-digit sales growth in fiscal year 2014, Whole Foods looks set to further its expansion in coming years, a strong contrast to Safeway's current business plans.
The bottom line
Safeway will certainly get a short-term boost if it buys back a large contingent of shares with its Canadian sale proceeds. Long-term value creation, however, will require an improvement in its gross margin through improved customer traffic and higher average product pricing.
While the company has been making strides in that direction, especially with its Just for U digital loyalty program, it has work to do to catch Whole Foods' well-oiled machine. As such, I feel investors would be better off sticking with the sector's best-of-breed player, Whole Foods.
Fool contributor Robert Hanley owns shares of SUPERVALU and Whole Foods Market. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. 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.