On Oct. 10, Safeway (NYSE:SWY) announced its third-quarter results. Along with the results, the grocery store chain revealed a series of cash-generating initiatives. Included in these initiatives were details for Safeway to undergo an aggressive stock buyback plan. Investors greeted these details with applause, sending the company's stock up to new five-year highs.
Back in June 2013, Safeway announced it was selling its Canadian operations for net after-tax cash proceeds of around $4 billion. The book value of these operations is around $1.84 billion, giving Safeway a large one-time profit of $2.16 billion. It plans to use the money to pay down $2 billion of debt, "with the majority of the remainder to be used to buy back stock."
Safeway is going to exit the Chicago market, where it has 72 unprofitable Dominick's stores. Exiting will bring in $400-$450 million in cash to the bottom line in the short term and boost its earnings-per-share outlook by 12%-15%. It will also save on pension liability and taxes over the long term, carrying a present value of $520 million. Safeway said this extra cash would also be used for stock buybacks and company growth on top of the "majority" of $2 billion already slated to buy back stock.
Reduced interest expense
Safeway guided for adjusted non-Chicago EPS of $1.05 to $1.12. Absent from this guidance is any benefit from the sale proceeds of its Canadian operations. Those numbers aren't insignificant. Its average interest rate on its debt is 4.7%, which means paying off $2 billion of it saves it $97 million annually in interest expenses. This comes out to over $0.40 per diluted share, which is a large increase to the 2013 guided run rate.
Safeway has a market cap of around $8 billion. With over $2 billion coming available for share buy backs, the next question might be if that's the best move for shareholders. One the one hand, at current prices it would boost the EPS significantly by retiring a lot of shares, up to 25% of them. On the other hand, the stock it would be buying back would have an annual EPS run rate of around $1.50. With the stock price at around $34, that's a price-to-earnings ratio of around 23.
Other grocery chains
Compare that P/E of 23 to other grocery chains. Kroger (NYSE:KR) has an analyst-estimated $2.81 EPS for this year and $3.13 EPS for next year. At a stock price of $42 per share, that puts the P/E at between 13 and 15. Kroger is expected to grow sales by 5% next year.
Next, Casey's General Stores (NASDAQ:CASY) has analyst-estimated EPS of $3.70 this year and $3.96 next year. At a stock price of $74, that puts the P/E at between 18 and 20. Casey is expected to grow sales by 8% next year.
Finally, SUPERVALU (NYSE:SVU) may be the best comparison of the three to Safeway since analysts expect both SUPERVALU and Safeway to increase their sales by 1% next year. SUPERVALU has analyst-estimated EPS of $0.46 this year and $0.63 next year. At a stock price of $8, that puts the P/E at between 13 and 18. As measured by P/E, Safeway appears to be the priciest of the group and without the expected sales growth to justify it.
Foolish final thoughts
Safeway's trimdown is leaving it with less debt, fewer interest expenses, and more cash than it knows what to do with – possibly literally. It is prepared to use its soon-to-be lean, cash-rich self to return a lot of cash back to shareholders in the form of buybacks. A better use of that cash might be to increase its quarterly dividend or pay a large one-time special dividend instead, especially given that its stock is a bit pricey in comparison to others in the grocery industry.
Investors should watch Safeway for possible pullbacks in share price. If the stock price pulls back enough so that its P/E ratio comes in line with its peers, the coming aggressive buyback would have much more meaning and value. Not only would a dip mean that the company was buying back stock at cheaper P/E ratios, but the number of shares it can retire would increase as well, which would further increase the long-term EPS.
Nickey Friedman 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.