Safeway: A Safe Bet Indeed

Since the last time I wrote about SWY (over a year ago), the stock price has taken a huge turn for the worst, dropping more than 25% since I listed the attributes of buying it in Sept of 2008. I thought it was a relatively safe bet, but in hindsight, I was wrong, very wrong . Hopefully this time around I can make amends for the errors of my ways.

It is now a safer bet: The lower the price gets, the better the value becomes, and at this juncture I don’t see much downside left. The company is much leaner and stronger than it was last year and even a more compelling buy.

Second quarter sales were a disappointment: Although SWY reported a decrease in sales for its second quarter of 6.5% from $10.1 billion to $9.5 billion, it was still able to improve its gross profit margin 56 basis points to 28.87% and produce an 8% increase in earnings from .53 to .57 per share. Helping matters were a 4% drop in shares outstanding (SWY repurchased 9.5 million shares in the quarter) coupled with a $5 million decrease in interest expense. The company’s Selling, General and Administrative costs fell nearly 2%, but rose 124 basis points to 25.09% of sales due to the drop in the top line.

Guidance lowered: management lowered its identical stores guidance to - 1% to -1.7% and earnings to $1.70-$1.90. Even if you use the low end of estimates to calculate a forward multiple, you still obtain a very reasonable P/E of 11.70, and chances are management has sandbagged their guidance in an attempt to under promise to over deliver.

Dividend growing: SWY recently increased its cash dividend 20% to 40 cents per annum-that equates to a decent dividend yield of 2% . The dividend is more than safe as it represents less than 25% of earnings.

Rich in Real estate: The company owns the real estate on 41% of the 1735 locations they operate. This real estate is on the books at acquisition cost and has seen substantial appreciation. This hidden value could be monetized in the future to fund an acquisition, a special cash dividend or other corporate need.

Third party gift card business and Mexican division: SWY’s Blackhawk Network division specializes in selling gift cards. This division could capture sales of $4 billion a year in its $200 billion market. SWY could spin it off at any time to enhance shareholder value. SWY also is a 50% joint owner of a 149 unit chain in Mexico called Casa Ley.

Bottom line: The company is slated to report its third quarter results on Oct, 15^th. Sales estimates of $9.46 billion and earnings of 30 cents are on the conservative side and there is a very good chance SWY will handily beat these expectations. A blowout (earnings north of 32 cents) would certainly send the shorts into a buying frenzy as they frantically cover to avoid a major squeeze. The end result could be a one day, 10-20% spike in the share price. A safe bet indeed.