Safeway Inc. (SWY) is among the largest food and drug retailers in the U.S. The company has more than 400 stores in the U.S. and almost 220 stores in Canada. The company has been monetizing its assets, which will provide the company with large cash inflows that it plans to use to repay a portion of outstanding debt, repurchase shares and invest in growth opportunities. However, I recommend investors to stay on the sidelines when it comes to SWY, as the company is selling its assets, which will have a negative impact on the company's EBIT, and Safeway still has to provide plans where it will be directing its growth spending to grow its top and bottom line results.
SWY last week reported its financial performance for 3Q2013. The company registered total revenues of $8.6 billion for the quarter, up 1.1% year-on-year. An increase of almost 1% in total revenues for the quarter was mainly driven by an increase of 1.9% in same store sales, partially offset by lower fuel sales in the quarter. Total revenue for the quarter also beat analyst expectations of $8.4 billion. For the consecutive sixth quarter, the company experienced a share gain in the U.S. market, where its share was up 11bps in the supermarket channel. Also, sales volume for the company increased 0.8% in the quarter, as compared to flat U.S. sales volume in 2Q2013.
SWY reported an adjusted EPS of $0.10 for 3Q2013, down from $0.16 in the corresponding period last year, also missing analyst consensus estimates of $0.16 per share. Earnings for the quarter were adversely affected by lower gross margin and higher operating and administration expenses. Gross margin for the quarter dropped to 25.8%, a drop of 36bps as compared to 3Q2012, mainly due to shrink expenses. Also, operating and administration expenses increased to 24.87% of sales for 3Q2013, representing an increase of 7bps year-on-year.
Exiting Chicago Market and Related Benefits
An important takeaway from the recent quarter's earnings release was SWY's decision to exit from the Chicago market - SWY announced its withdraw from the Chicago market by early 2014. The company operates 72 Dominick's stores in Chicago. The company's decision to exit from the Chicago market will result in a tax loss of $400 million-$450 million, which can be used to offset some of the gains from asset selling in Canada. Due to its withdrawal from the Chicago market, the company will save multi-employer pension liability, which is generally paid evenly over 20 years, and have a present value of quarterly cash payments of up to $375 million and a tax benefit of up to $145 million. Exiting from the Chicago market makes sense and will be beneficial for the company, as losses in Chicago will offset gains in asset sales in Canada.
The potential tax savings from exiting the Chicago market are likely to increase net after tax proceeds from the sales of Canadian assets to $4.4 billion-$4.5 billion, as compared to previous estimates of $4 billion. The transaction is expected to close by the end of the ongoing quarter (Q42013). The proceeds that the company will generate from the sales of Canadian assets will be used to pay down $2 billion of debt. Also, the remaining proceeds of the sale will be used to buy back common shares outstanding and invest in available growth opportunities. The company has not yet disclosed any of its plans regarding available investments in available growth opportunities, and it's unclear what investing in the growth of business exactly means. However, I believe the company will target its investment spending toward changing its store layout and localizing the product assortment.
Currently, the company has total debt of $5.57 billion, and its outstanding debt will decrease by almost 35% if it decides to pay off $2 billion of its outstanding debt using a portion of proceeds from the sale of Canadian assets. Also, as the company intended to use a portion of proceeds to repurchase shares, it will have a positive impact on EPS and magnify the ROE.
In the near future, sale of assets will remain a focus for investors. Sale of assets will provide significant cash inflow, which the company can use to repay portion of its outstanding debt, repurchase part of its shares outstanding and invest in available growth opportunities. Also, SWY's plan to exit from the Chicago market will help the company focus on its key markets and result in potential tax savings of $400 million-$450 million. I believe for the long run, the company needs to devise a plan to effectively compete in the market and offset the pressures on its earnings from the growing competition from new discount stores entering markets. I recommend investors to stay on the sidelines on SWY, as the company is pulling off the sale of its assets in Canada and Chicago, and it will still have to table plans regarding its growth investment and how to address growing competition in the industry.