We are reiterating our buy on Safeway inc. (SWY) and raising our year-end 2013 price target to $36.00. Gross profit margins have stabilized slightly below 26.5% and Safeway is also gaining unit volume from competitors, indicating sufficiently competitive price points. We note the probability that SWY will raise its dividend in May of 2013, from 70 cents to 75-82 cents after the May stockholders meeting. We highlight the company's real estate holdings, which have a purchase cost of $8.3 billion or $34.00 per share (land and buildings only). The increased price target is based on additional debt reduction and 5.8X 2013 EBITDA and 14.5 X our 2013 earnings of $2.46 per share. Safeway is expected to reduce borrowings by a further $900 million in the next three quarters through free cash flow and the proceeds from the Blackhawk IPO.
1st Quarter 2013 (not bad)
Overall we felt that the first-quarter earnings were fairly good. Safeway reported the strongest same-store sales growth since 2008. Revenues were impacted by two items outside of grocery; lower fuel sales and the seasonality of Blackhawk (gift cards). Same-store sales increased an average of $120,000 year over year. An increase of about 1.5% on an individual store basis. This compares favorably with Wal-Mart (WMT) (increase of 1.2% for fourth Q) and Target (guiding to 0% same-store growth for first Q). SWY Canadian operations had a better showing than Wal-Mart Canada posting 0% growth for the first Q compared with the (1.8%) comp for WMT. So overall we see that SWY is performing in line with most competitors and other formats. The gross margins of SWY were stable at slightly below 26.5%. So we did not see much of a reason for the negative reaction.
Since there have been as many as 80 million shares of SWY shorted at any given time we attribute most of the volatility to shorting. Short sellers lost over $750 million shorting SWY since July of 2012, through April of 2013. The general thesis that SWY was losing market share to other formats has been proven false and without the business failing, short sellers have become stranded in the shares.
We do not believe that there was anything wrong with Safeway's first-quarter 2013 earnings. The same-store growth was in line or better than the competition and the company gained market share. We believe that, at least in part, the reaction to the first-quarter earnings was the result of aggressive shorting on the bid.
Management has predicted that same-store sales will end the year at 2-3%. In the second half Safeway will roll out the Just For You program in Canada, which will positively affect Canadian sales. We believe that the key to substantial improvement for Safeway is a stronger economy.
We recommend the purchase of SWY shares and have moved our price target to $36.00 to reflect the lower 2013 year-end debt load projection. Our enterprise value is based on 5.8 X 2013 EBITDA and 14.5 X 2013 earnings. At this price the shares would be yielding 2.2% and be in line with the current S&P 500 dividend yield. The company has $8.3 billion in original cost real estate ($34.00 per share) and projected 2013 free cash flow of $3.73 per share. SWY is using free cash flow and the proceeds from the Blackhawk IPO to reduce debt from 5.7 billion to a projected 4.8 billion by year-end 2013.
Rev mix mm Q4 11 Q4 12 Q1 12 Q1 13
SWY Data mm Q1 13 Est. Q4 13
Financial Data mm______________
Comparable store sales% 4th Q 12 1st Q 13
Note: most of the above end 4th Q in Jan 2013. Safeway follows the calendar year.
Enterprise value mm_______________
Additional disclosure: Accounts of the RIA own the shares
Disclaimer: Broxton Capital Advisors is an investment advisor located in Westwood, California. The company manages the assets of individuals, corporations, retirement plans and sub advises accounts for registered investment advisors using the Primary Broxton Strategy or PBS. The strategy invests and reinvests portfolios with the objective of attaining long term capital gains and income. Individuals should consider the inherent risks before investing and this report should not be construed as advice tailored to an individual's investment criteria or objectives.