Safeway Should Cool Down Before Investors Purchase Shares

| About: Safeway Inc. (SWY)

Peter Lynch wrote in his book One Up on Wall Street (2000) that sometimes, the best investment opportunities are in companies and products that surround us on a daily basis, right under our nose. Mr. Lynch, however, was more specifically referring to new, up and coming companies, rather than established giants such as Safeway Incorporated (NYSE:SWY). The company has much good news ahead, but with shares approaching $34 as of November 21, 2013, representing a near 101% increase from lows of $16 a year ago, investors may be better off waiting for a dip in price before buying stock.

The Good News

To understand why the stock has reached its current price over the past year, we must first look at the good news responsible for such gains. Most recently, on November 4th, 2013, the company completed a sale of its Canadian series of supermarkets to Sobeys Incorporated for $5.8 billion Canadian dollars (roughly $5.5 billion USD). This news come shortly after the company initiated a sale of all seventy-two Dominick's labeled supermarkets in the Chicago, IL area, to be completed by early 2014, ending the poorly-performing markets' 2013 losing streak of nearly $35.2 million as of October 2013. The proceeds from both sales will be used to pay off nearly $2 billion in company debt, with the rest going towards buying back shares. The company also reports that any excess money may be used for "growth opportunities," although the company did not specify details. With the stock repurchases already approved by the Board of Directors on October 18, 2013, the move reflects strongly on management's commitment to ensuring shareholder value and long-term gains. Excellent news for investors and the company in general.

Looking further back, the company increased its dividend by 14% in May 2013 and cut its operating expense in the second quarter of 2013 by approximately 25% to $161.4 million (compared to $211 million in 2012). Additionally, the company received $237.9 million from Class-A stock sales for the initial public offering of Blackhawk Network Holdings, Inc. (NASDAQ:HAWK), a gift card production company that Safeway owns approximately 73% of. The company also enjoyed increased numbers across the board for the second quarter earnings, including increased profit margins, income, and profit per share.

This all explains why the company has doubled in price over the past year. However, new investors to the company may have missed the boat, as it appears all of the good news has already been priced in.

The Party is Over

Looking beyond the Canada and Chicago store sales, as well as the other good news stated above, the financial picture of Safeway should be of particular concern to a potential shareholder. On October 10th, 2013, the company reported earnings per share that were slightly under half of their 2012 equivalents. While increasing earnings over the past year have boosted the stock price, the earnings have now taken a downturn. Consider the following table:

Time Period: Diluted Adjusted Earnings Per Share:
3rd Quarter, 2013 $0.10
2nd Quarter, '13 $0.51
1st Quarter, '13 $0.49
4th Quarter, 2012 $0.94
3rd Quarter '12 $0.66
2nd Quarter '12 $0.51
1st Quarter '12 $0.27

The stock price appears to have risen in line with the earnings, as the stock gained 35.02% between April 26, 2012 (the day 1Q '12 earnings were reported) and April 24, 2013 (the day before 1Q '13 earnings were announced).

SWY Chart

SWY data by YCharts

The stock then dropped almost 17.5% in the two days after reporting 1Q '13 earnings that were roughly half of the prior quarter's earnings. The stock ultimately recovered and gained 32% between the day after 1Q '13 earnings and the day prior to the most recent earnings, the 3rd quarter of 2013.

SWY Chart

SWY data by YCharts

After losing 5% due to the disappointing 3Q '13 earnings on October 10, 2013, the stock has gained to its current $33.90 share price, as of November 21, 2013. This is largely due to the excitement of the company's Canada and Chicago sales, which will be used to buy back stock and cut out unprofitable stores. However, the earnings simply do not justify the price at a recent adjusted earnings per share of only $0.10 cents/share. Even at times of higher earnings, such as during most of 2012, the stock was in the low twenties, a more fair price considering the stock also pays an eighty-cent annual dividend.

Of note is the company's struggle to gain market share in face of competitors such as Whole Foods Market (NASDAQ:WFM) and Target (NYSE:TGT). CEO Robert Edwards stated on the 3Q '13 earnings conference call:

"Our U.S. market share, as measured by Nielsen group for the sixth consecutive quarter, even when we adjust Nielsen's numbers downward for the sale of Genuardi's, we gained 11 basis points in the supermarket channel and were essentially flat in the all-outlet channel."

While the company has completed competitive initiatives to gain customers, such as through the "Just for U" coupon program and partnering with Chevron to provide gasoline services, the company still struggles with securing significant market share as addressed in the conference call. There is no clear indicator that Safeway has the overall advantage, and judging by earnings, I still feel concerned regarding Safeway's ability to attract and secure market share.

Bottom Line

The company's stock has had an impressive run over the past year. Yet, in light of disappointingly low earnings, a lack of competitive superiority, and the final completion of the stock's significant driver--the sale of the Canada and Chicago markets--, I believe investors should wait for the share price to decline and management to address future initiatives regarding the company's growth. I cannot reasonably see a solid basis for the share price to continue to increase significantly at this point, yet I believe the company may be a more attractive investment at a cheaper price with optimistic, solid guidance.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.