Safeway Inc. (NYSE:SWY), with its vast range of grocery channels, stands as one of the leading retailers in the U.S. The company's flat top-line growth trend for the past few quarters is a result of its less competitive pricing policy, in comparison to competitive pricing policies offered by its peers. Moreover, increasing input costs have been shrinking the company's gross margins. However, despite its pressurized earnings base and shrunk margins, the stock has a lot to offer. SWY's merger with Albertson and significant remodeling of channels will prove to be major growth drivers for the company in the long run.
Over the years, growing competition among key retail chain sector players has led to an intense price war in the retail market. Whoever wins the price war, wins the game. SWY has been adversely affected by its inability to cater to the intense price competition among key players in the sector. The company's sales base has suffered due to competition; the company reported flat sales for the recent quarter. SWY's revenue increase of only 1% year-on-year in the recent quarter is lagging behind its close peers', Supervalu (NYSE:SVU) and Kroger (NYSE:KR), revenue increases of 1.4% and 2.4% year-on-year, respectively. Both SVU and KR are driving more consumer traffic by offering competitive prices to customers. SWY needs to reduce its prices to get more customers and drive up its revenues.
Moreover, the company's recent quarter's gross profit was down 64 basis points year-on-year, mainly caused by the escalated input costs for the company and the inability to fully pass on this inflation impact to consumers. Also, the rise in cost also weighed heavily on the company's bottom line results and the company's EPS once again missed analyst estimates by $0.12. However, the company is planning to pass on these higher input costs to consumers by further raising their product prices. The initiative to increase prices and pass on inflation to consumers will definitely increase margins and improve bottom line results for SWY. However, in the given competitive pricing environment, I fear the initiative to increase prices could lower store traffic and could continue to pressurize top line numbers.
Carving Out the Road to Success
Grocery retailers in the U.S. are continuously fighting to lead the market with a greater market presence. To increase their access to customers, grocers are continuously thriving to open new stores at new locations. At present, Wal-Mart (NYSE:WMT) leads the market with its 25% share and KR stands second with its 8% share. SWY is currently squeezed between these high-end grocers and I believe the company needs to put in a lot of efforts to effectively compete with its peers.
I believe that the company's decision to merge with Albertson will definitely help in addressing competition and expanding its presence. The company's merger worth $9.2billion is going to increase its market presence. The combination of two companies will create a company with 2,400 stores, along with 20 manufacturing plants and 27 distribution facilities; however, the combined new company with 2,400 stores will still be smaller in size than KR, which has 2,640 stores. The company not only expects this merger to result in the expansion of its market presence, but also plans on generating significant cost saving synergies. Also, I believe the combined new company will be able to generate stronger cash flows and grow its top line results.
Other than increasing the number of stores through the merger, SWY has carved out a plan to remodel its existing stores to get more customer traffic by making the store more attractive and easy to navigate. The company's Chief Executive Officer, Robert L. Edwards, recently said in the 1Q earnings release: "We will continue to drive sales momentum through our center of store remodels, as well as merchandising premium, Hispanic and Asian products to meet local demographic needs." I believe SWY's store remodeling program is going to help the company better its long pressurized top-line results in the near future.
SWY's current picture may look disturbing. But perhaps the company has successfully carved out its strategy for getting a promising stake among key retail grocers in the U.S. The company is planning well to grow its top-line results, with its plan of increasing its efficiency and improving its market share by increasing the number of stores through a merger. Moreover, I believe SWY will get more customer traffic directed in the near future, with its strenuous remodeling efforts for existing stores.
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