Review of Safeway's 2009 Annual Shareholder Meeting

Safeway Inc. (SWY) held its 2009 annual meeting at its Pleasanton, California corporate headquarters. Shareholders were offered fruits and other food items on a large table. After the meeting, shareholders received a reusable bag with eco-friendly light bulbs and a box of tissues from Safeway's in-house brand, "Bright Green."

Safeway ran its meeting professionally--there were no glitches, and everyone knew exactly what to do and when to do it. One way to measure a well-run meeting is whether the company allows comments on shareholder proposals. (Google did not, causing problems at its meeting.) Safeway allowed shareholders to comment on various proposals prior to closing the polls. It limited comments on the proposals to two minutes.

General Counsel Robert Gordon handled the business portion of the meeting. He started off with some jokes about politicians and lawyers, drawing laughs. He then moved on to the shareholder proposals.

One shareholder submitted two proposals. The first dealt with cumulative voting. According to the SEC, "cumulative voting is a type of voting process that helps strengthen the ability of minority shareholders to elect a director." Put more simply, cumulative voting allows smaller shareholders more power by allowing them to concentrate their votes on a single candidate. For example, let's assume you own 100 shares, and there are two director vacancies. Ordinarily, you could only vote 100 shares for each director; with cumulative voting, however, you could combine your votes and vote 200 shares for one director. This proposal failed.

The second proposal was a shareholder "Bill of Rights":

1. Shareholder proposals should be binding, not merely advisory; after all, shareholders own the company and should be treated as owners, not advisory members.

2. Auditing firms should be rotated every five years, because long tenure tends to dilute independence and vigilance. (After several companies have restated results due to shoddy accounting practices, I sympathize with this idea. Who's the watching the watchmen?)

3. Institutional owners should not be able to vote blocks of shares without express approval from their shareholders. (Shareholder Shelton Ehrlich pointed out this might require shareholders who hold mutual funds to sift through hundreds of proposals each year. I've seen similar proposals, including one that required institutional owners to abstain from voting at all.) This proposal also failed.

The final proposal was submitted by Scott Adams (not related to Dilbert's Scott Adams) of the American Federation of State County and Municipal Employees Pension Plan Fund [AFSCME]. I've seen Mr. Adams make similar proposals, seeking to ban "golden coffins." He is very effective because he speaks clearly and entertains his audience with humor and visual props, such as a gold-plated nail. "Golden coffins," which AFSCME wants to ban, reward executives and upper management for dying. (You read that right.) Many CEOs, upper managers, and their families receive cash payments when they die. In this case, Safeway also pays former executives cash if they die during their retirement. (Again, you read that right.) The key sticking point is that death benefits are unrelated to executive performance and therefore amount to a giveaway of shareholder money. This proposal received 38% of the vote.

I agree with the proposal. If executives want death benefits, why can't they use their own ample salaries to buy themselves and their families life insurance policies? One would think after being paid millions of dollars, executives could afford a policy or an annuity. More important, there is no "pay for performance" element involved in this executive benefit. Companies offer it because other companies also offer it. It's never a good argument to do something because someone else happens to be doing it. Companies and their compensation committees need to understand that executive compensation has become a lightning rod for criticism. As a result, companies that offer excessive salaries and unnecessary benefits reveal how out-of-touch they are, and no one wants to invest in a company that's out-of-touch.

CEO Steve Burd handled the rest of the presentation. I've never met Mr. Burd before, but I became a huge fan. He doesn't avoid questions, knows his company inside-out, is focused, and projects professionalism and confidence without arrogance. I have no doubt that Safeway would be in much worse shape if not for him. During his tenure, Safeway introduced "O Organics" and handily caught the organic food wave. It is now trying to capture the "green" consumer wave with its "Bright Green" product line. Safeway also offers a line of "Eating Right" products to help consumers eat more healthy food. Safeway's other product lines, like "mom to mom" and "Waterfront Bistro," would benefit from more advertising and promotion, but in time, they may become as successful as "O."

It is easy to look back and admire the strength of Safeway's in-house products, but it is never easy to establish a brand. Under Mr. Burd, Safeway created its "O" brand in less than three years.

Mr. Burd was especially proud of how his company has managed healthcare expenses. He said Safeway had "flat-lined" healthcare costs, while its competitors had seen 38% increases in costs. Mr. Burd hasn't seemed to sacrifice quality, either. During the meeting, a Safeway employee and cancer survivor stood up and shared an emotional story about how Safeway helped her fight and beat cancer. Mr. Burd was recently invited to the White House to discuss his success in managing healthcare costs with President Obama.

After going through various slides, Mr. Burd opened the floor to questions. A shareholder asked about Safeway's pension and whether it was underfunded. Mr. Burd said that market conditions had reduced the pension's assets, but under a 2006 law, Safeway had time to correct underfunding and increase contributions. (The law is the Pension Protection Act of 2006, and it appears that companies have seven years to correct underfunding).

I asked questions about Safeway's relationship with its unions. I asked what percentage of the company was unionized (i.e., part of a bargaining unit). I also asked what made Safeway able to do so well while offering substantial employee benefits. I added that Safeway must have a special relationship with its unions because most unionized companies fail, or major tension exists between management and labor. One look at car companies (GM, Ford, Chrysler) and airline companies (Delta, Northwest, etc.) shows that unions tend to harm companies that rely on discretionary consumer spending. Safeway and other grocery companies seem to have dodged the union bullet.

Mr. Burd said 80 to 85% of Safeway's workforce is unionized, and Safeway had "very good" relations with Safeway's unions (he seemed to push back on my assumption that Safeway had a great or "special" relationship with its unions). He talked about having realistic expectations. He said that Safeway competes with several non-union companies, and this competition adds discipline [to negotiations]. He also mentioned Safeway's success in controlling healthcare costs. Having relatively fixed healthcare costs means there is more money for overall compensation. (From my angle, saving money on healthcare not only frees up more money for shareholders and employees, but it also results in a healthier and therefore happier workforce.)

I also asked Mr. Burd what he was most worried about in terms of competition. Mr. Burd said he wasn't a worrier. He said, "I worry about my kids [not Safeway]." Coming from anyone else, this response might have seemed flippant or arrogant, but when Mr. Burd said it, he sounded sincere. He said his concern was a variant of the real estate mantra of "location, location, location." In his case, however, it was "sales, sales, sales." He pointed out that Safeway was in a unique position--it could borrow money at "less than 1%."

After a few other shareholders asked questions, the meeting ended.

Before I go into my analysis of the stock, I want to commend Safeway's employees. Whenever I go into a Safeway, I receive excellent customer service. Every single time I've asked a question, a Safeway employee will go out of his or her way to help me. In an era where good customer service and just plain decent manners are declining, Safeway stands head and shoulders above most of its competition. I chatted with a Safeway employee on the way to the meeting, and he said he's worked for Albertson's before. He said Albertson's had a terrible relationship with its union and it semployees. I asked what made Safeway better. His response was classic: "Safeway treats me like a human being." Based on my own limited anecdotal evidence, I feel Safeway is doing exceptionally well when it comes to customer service and employee job satisfaction. The only other grocery store where I get a similar feeling is Nob Hill Foods, a Raley's division.

Even though I like shopping at Safeway, I don't own many Safeway shares, which are trading near a 52-week low. Despite having a great CEO and a decent dividend, Safeway shareholders may have a long road ahead. First, as Mr. Burd mentioned, 80 to 85% of Safeway's workforce is unionized. As a shareholder, it's difficult to justify investing in a company where 85% of its workforce, if unhappy, can strike and bring the company to a standstill. (Although Safeway is doing well overall in labor relations, just a few weeks ago, Safeway workers in Denver voted to go on strike.)

But Safeway's biggest problem may be what I call the "curse of the middle." In almost every business catering to Americans, the "middle" players have been crushed because of America's steadily declining middle class. In retail, for example, Neiman Marcus and Tiffany's (upscale players) have done reasonably well, as have Walmart (WMT), Ross (ROST), and Target (TGT) (cost-conscious players). Mid-level players, however, like Sears, Mervyn's, and Montgomery Wards, have gone bankrupt or are not major threats. The lesson to me seems simple--you either have to win on volume at the lower end of the scale, or on margin at the higher end.

Safeway is a middle-level company, in size and focus. It's much smaller than Walmart and Target, but bigger than Whole Foods Market (WFMI) and Trader Joe's. Its competition is focusing on specific customer niches to win market share, which may harm Safeway. For example, Walmart and Target are aggressively expanding their selection of food products. Safeway's products are generally priced higher than Walmart. If Walmart continues to expand its selection of food products, it could take business away from some of Safeway's cost-conscious consumers. Meanwhile, affluent consumers may already be going to Trader Joe's or Whole Foods Market instead of Safeway. Thus, Safeway is caught in the middle and may have to rely on cost-cutting to improve shareholder value. As great as Mr. Burd is, a company can only cut expenses so much, especially when it is heavily unionized.

At the same time, Safeway has many positive factors. Most consumers will not buy their produce or food from Target or Walmart. There seems to be a built-in bias right now against buying food at Target or Walmart. Also, Safeway will remain competitive because it offers better quality, convenience, and service than Walmart, Costco (COST), and Target.

I will continue to keep an eye on Safeway. If it maintains its dividend, it could represent a decent value play. Although Safeway stock probably won't ever be a large percentage of my portfolio, I will be rooting for Mr. Burd. At the very minimum, America can learn from Safeway's experience cutting healthcare costs.

Disclosure: I own less than 10 shares of Safeway (SWY).

Comments

[Matthew Rafat:]

A picture of what was given to shareholders at the meeting is here:

willworkforjustice.blo...

May 14 06:47 AM

[Backofroom:]

Interesting theory, but arguments based on comps in other businesses often miss the point. Safeway's operations are average, but its marketing is better - it's beating the crowd in developing new PL products that meet consumer needs, and that's what often provides a competitive in packaged goods. Watch for Safeway to beat analysts forecasts.

May 14 10:32 PM

[satyr:]

This is a very thoughtful piece and also well-written. I did not attend the meeting, but read the transcription and am quite familiar with Safeway and the grocery industry. There is more I could say, but will make observations on some points.

With respect to the proposal to rotate audit firms every 5 years, while I can see some merit, on the balance I disagree with the practice. I should disclose here that I was a CPA at a large firm that performed audits of public companies. I did this for 3 years before making a career change. What occurs when you audit the same company each year is that you begin to understand the nuances, which in turn tells you where you are likely to find "trouble". When a new auditor comes on board, they spend the first year just attempting to get the audit done on time and within budget. If I were a finance officer wanting to play accounting games, that is the year I would play them. While it is not a perfect analogy, it is not unlike taking a car to the same mechanic for regular service. Familiarity with the vehicle and access to history is likely more valuable than a fresh set of eyes. Keep in mind that the auditor gains nothing by doing a shoddy audit and has everything to lose. Also, the audit team does bring in some new members each year. So there are at least some fresh eyes in the process.

As for death benefits, I understand that "the other guys are doing it" is not good reason for most thing. But, a company does have to compete for talent. Good executives have a choice of where to work, and if Safeway is not offering a pay package that is on par with Kroger, Albertson's, or Supervalu, they are going to have a hard time getting or retaining the people they need. Compensation does not have to be apples to apples. But the total value cannot vary by significant amounts without leading to brain drain. That said, I do think that compensation for the top level executives in most US corporations has spiraled out of control. I just don't think this is a particularly effective way to deal with it.

Safeway's relationship with labor unions is on par with that of their competitors. It is not a cozy situation, because the short-term interests of management (and shareholders) are mostly in conflict what that of the union. While union members do not want their employer to go out of business, if Safeway made zero profit for the next 20 years and it allowed them to get 20% pay increases, they would be in favor of it. Unions will always push for whatever they can get, and management will always give them as little as they can. It's the nature of negotiation for anything in this culture. During the process, the union officials will make all sorts of disparaging remarks about the company because they have only one constituency. They will speak to the press often, while the company makes "no comment". And, of course, they will threaten with a strike much more often than they will actually begin one. It's sabre rattling, and it works well in good times, but less well when workers are grateful that they have employment. I suspect that you will not see a strike in Colorado, because Safeway could find replacement workers in a heartbeat. They could probably pay them less, too, given the job market. Mind you, this is not a good deal for Safeway, because it can create ill will in the community and with some shoppers. But, they do have to make financial decisions, and they are quite capable of enduring a strike longer than a union can finance one.

Having a unionized workforce does not necessarily mean that a company cannot be competitive. It does mean that they have to be quite diligent about managing all of their costs, and also very careful in the hiring process. No doubt, Safeway pays their employees much better than the non-unionized Wal-mart. But they are better quality workers, as well.

The argument about being in the middle is an interesting one. I think that the examples given are compelling, but I'm not convinced that it goes beyond current circumstances. In fact, many high end retailers are now suffering greatly due to the tough economic times. Whole Foods is doing horribly, with sales down in double digits. Wal-mart was doing poorly a couple years ago when people were feeling flush. Yes, they have low prices. But the quality of merchandise tends to be poor and shopping location inconvenient. People endure that during hard times, but in normal to better times, a certain percentage of the customer base will defect and go back to shopping somewhere that is easier and provides better quality.

If you look at other industries, there are many examples where the mid-range company or item has done quite well. Take a look at the best selling automobiles, regardless of make, and they have been mid-range (camry, accord, taurus, etc.). I'm sure we can find a number of examples, and it all comes down to providing consumers with something that makes sense at a particular price point.

The important thing for a retailer, or for that matter any company, is to define a viable market and shape operations and offerings to it. In the case of Safeway, I would say it is the shopper who values convenience and quality over price, but is not willing or able to be extravagant. They are not willing to tolerate the negative experience of going to a Wal-mart, nor pay Whole Foods prices. These are the same people who might shop at some of the Kroger or Supervalu stores. That means that Safeway has to be conscious of price and offer something that seems better than the discount retailer (selection, quality, shopping experience).

This is not to say that Safeway is a good stock to buy - just that I think there is a big place in the market for a player like Safeway and they have proven that for several years. How the stock performs will depend on both the economy and the rest of the market. It is a defensive sector, so if the S&P falls over the next 24 months, I'd expect Safeway to fall less. But if it rises significantly, Safeway will rise, but not as much. There are not that many surprises in grocery.

I have talked about areas where I disagree, because there is not a lot of value here in having a discussion about points where we do agree. But, as I started out, I do think many of your points are valid and I enjoyed reading the piece. I particularly agree that Steve Burd is a very good operator and a decent human being, as well.

May 14 10:46 PM

[buyforeclos...:]

who in gods name buys 10 shares of anything? hardly worth the commission...also Costco's quality is AWESOME! what planet are u on? I love their stuff

May 16 11:31 PM

[RWCMom:]

You buy 10 shares so that you can attend shareholder meetings or make shareholder proposals. There is nothing illegal about it.

What Safeway has to offer is broad inventory, quality house brands and locations. I have close access to Target, Trader Joe & Whole Foods (across from Safeway) and shop at each of them for different items. I can depend on Safeway for branded products my family demands and one-stop shopping when time is at a premium.

Although I commend Safeway for entering the organic and green markets, they are charging too much of a premium for those products; I can pay the same price and get better selection of meats and specialty organics at Whole Foods. I can get better priced recycled paper products and quirky selection at Trader Joe. However,for working moms, the premium may be worth the convenience.

May 18 03:47 PM

[Joe Gabriel:]

I agree with your comment on charging too much of a premium on Organics. We supply Whole Foods, Trader Joes, and Safeway with Organic Fruit and one of the reasons the product sits on their shelves, unlike their competitors, is their pricing structure and how they market the product. They negotiate very low buying prices and charge triple what their competitors charge for the same product you can buy across the street.


On May 18 03:47 PM RWCMom wrote:

> You buy 10 shares so that you can attend shareholder meetings or
> make shareholder proposals. There is nothing illegal about it.<br/>
>
> What Safeway has to offer is broad inventory, quality house brands
> and locations. I have close access to Target, Trader Joe &amp; Whole
> Foods (across from Safeway) and shop at each of them for different
> items. I can depend on Safeway for branded products my family demands
> and one-stop shopping when time is at a premium.
>
> Although I commend Safeway for entering the organic and green markets,
> they are charging too much of a premium for those products; I can
> pay the same price and get better selection of meats and specialty
> organics at Whole Foods. I can get better priced recycled paper products
> and quirky selection at Trader Joe. However,for working moms, the
> premium may be worth the convenience.

Jul 05 11:22 AM

[usc_graduat...:]

So What does this article do to help the stock price? I have been holding since 2000 because Steve said our price was cheap and told my manager we deserved a 30x multipule when EPS was around $1.98 to $2.45 per share. You truly were spellbounded by Burd's ability to tell a story! You realize that Al ( The Chainsaw) Dunlap use to mesmerize men and woman too with his great story telling. Just use the 10k's and 10Q's a bit a stock research and you don't have to have egg thrown in your eye! Safeway is heading towards a new low and you are feeling the hangover of Steve's purple Kool-aid! Sorry Charly, next time try Whole Foods!

Aug 04 09:50 PM