Seeking Alpha
Profile| Send Message| ()  

We are reiterating our buy rating and our 2013 year-end price target for Safeway (SWY) of $36 per share. The recently announced sale of Safeway's Canadian operations will provide the company with a significant deleveraging. The transaction could ultimately lead to an acquisition of the domestic operations as well. The remaining company consists of the 1,419 domestic supermarkets and support facilities, and has LTM EBITDA of $1,755 million. Adjusted for the transaction the company is currently trading at roughly 3.5x the last 12 months, or LTM EBITDA.

Safeway owns about 78% of gift card company Blackhawk (HAWK). Safeway-owned shares of HAWK have a value of roughly 1 billion, or $4 per share. We value the remaining company at roughly $ 9 billion, or $36 per share, including the value of HAWK. Our price target is based on a discounted EBITDA multiple of 5.1x. This is reasonable considering that Canada was sold for 11x EBITDA. The remaining company is also trading at a significant discount to its real estate value, which we value at $11-$12 billion. We believe that the remaining company should trade at over 5x EBITDA, which is a discount to its peer group and historical multiple.

Post-transaction, year-end 2013 net debt and pension liability will fall below $300 million. The forecast cash at year-end is comprised of cash on hand ($295 million), proceeds from the HAWK IPO ($220 million), net proceeds from the Canadian operations ($4,000 million), and projected free cash flow ($700 million). We project total cash on hand and cash generation for 2013 to total $ 5,215 million.

Operations Are Trending Higher

The same-store sales of SWY could trend higher after the sale of the Canadian operations. In the most recent quarter, SWY Canadian same-store sales were stagnant and domestic sales were 1.73% higher, leading to a blended comparison of 1.5%. Domestic same-store sales are projected to exceed 2% in the third quarter. This would be a new post-2008 high in same-store sales for the recovering supermarket chain. We believe that general economic improvement is the key to pricing power and improvement for the chain.

EPS

There are three variables for projecting the future EPS of the remaining company: debt pay down, share repurchase, and reduced operating margin (due to the higher Canadian operating margins). Since the company has indicated that it will pay down debt and purchase shares with proceeds, we have used the following scenario:

  • Operating Profit of 2.1% -- this incorporates a reduction of 60 basis points for the loss of the higher-margin operations and an improvement of 20 basis points to account for other improvements.
  • Interest expense of $140 million.
  • Raised tax rate to 33% from 30%.
  • Shares outstanding of 160 million; this incorporates a buyback of 80 million shares.

The tables below are shown for possible outcomes only; actual results will depend on the number of repurchased shares and debt reduced.

Conclusion

We view the sale transaction as a positive event because it allows Safeway to realize the next 15 to 20 years of Canadian dividends currently and reduces the net debt of the company. We value the remaining company at $36.00, or roughly 5.1x LTM EBITDA. This is also equal to an 11 to 14 range possible 2014 projected-earnings multiple.

Projected Financial Data for Remaining Company

LTM EBITDA Domestic SWY

The chart below shows the EBITDA calculation for the remaining company (in millions as of March 31, 2013):

LTM EBITDA

2,397

Canada LTM EBITDA

(544)

LTM Domestic EBITDA

1853

Blackhawk LTM EBITDA

(98)

SWY Domestic LTM EBITDA

1,755

2014 pro forma EBITDA

1,850

SWY Year-End 2013 Data (in Millions Est.)

Debt LT & ST

(5,731)

2013 YE Cash

5,215

Pension

(800)

Hawk Value

$26/sh

1,040

Totals

(276)

Shares Out

241 mm

Equity Value

X $24.3

5,856

Enterprise $

6,132

EV/EBITDA

3.48

Pro Forma 2013

Sales

38443.00

Number of stores

1419

Cost of goods sold

28313.27

% COGS

0.7365

Gross profit

10129.73

O & A expense

9322.43

% O & A

0.2425

Operating profit

807.30

% operating profit

0.02100

Interest expense

-140.00

Other income, net

25.00

Inc before taxes

692.30

Income taxes

-228.46

% Tax

-0.33

Income net of tax

463.84

Net income

463.84

NC interest

-10.00

Net income

453.84

Shares

160.00

NI/ share

2.84

Pro Forma 2014

Sales

39596.00

Number of stores

1419

Cost of goods sold

29142.66

% COGS

0.7360

Gross profit

10129.73

O & A expense

9562.43

% O & A

0.2415

Operating profit

890.91

% operating profit

0.02250

Interest expense

-140.00

Other income, net

25.00

Inc before taxes

775.91

Income taxes

-256.05

% Tax

-0.33

Income net of tax

519.86

Net income

519.86

NC interest

-10.00

Net income

509.86

shares

160.00

NI/ share

3.19

Disclaimer: Broxton Capital Advisors is an investment advisor located in Westwood, Calif. The company manages the assets of individuals, corporations, retirement plans and sub advises accounts for registered investment advisors. 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.

Source: Safeway Update: After Canadian Sale, The Remaining Company Is Undervalued