Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Safeway (NYSE:SWY)

Q4 2010 Earnings Call

February 24, 2011 11:00 am ET

Executives

Melissa Plaisance - Senior Vice President of Finance & Investor Relations

Robert Edwards - Chief Financial Officer and Executive Vice President

Steven Burd - Executive Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Analysts

Edward Kelly - Crédit Suisse AG

Meredith Adler - Barclays Capital

John Heinbockel - Guggenheim Securities, LLC

Scott Mushkin - Jefferies & Company, Inc.

Adrianne Shapira - Goldman Sachs Group Inc.

Mark Wiltamuth - Morgan Stanley

Karen Short - BMO Capital Markets U.S.

Deborah Weinswig - Citigroup Inc

Robert Ohmes - BofA Merrill Lynch

Damian Witkowski - Gabelli & Company, Inc.

Andrew Wolf - BB&T Capital Markets

Charles Cerankosky - Northcoast Research

Operator

Welcome, and thank you for standing by, and welcome to the Safeway Fourth Quarter 2010 Conference Call. [Operator Instructions] I'll now turn the conference over to Ms. Melissa Plaisance, Safeway Senior Vice President of Finance. Please go ahead.

Melissa Plaisance

Good morning, everyone, and thank you for joining us for this Fourth Quarter and Full Year 2010 Earnings Conference Call. I'd like to remind you that management will make statements during this call that include forward-looking statements within the meaning of the federal securities laws.

Forward-looking statements contain information about future operating or financial performance. Forward-looking statements are based on our current expectations and assumptions and involve risks and uncertainties that could cause actual results or events to be materially different from those anticipated. However, we undertake no obligation to update or revise any such statements as a result of new information, future events or otherwise. For a list and description of those risks and uncertainties, please see our filings with the SEC.

And with that, I'd like to turn the call over to Steve Burd, our Chairman, President and Chief Executive Officer.

Steven Burd

Thank you, Melissa. Let me begin with net income. Net income for the quarter was $229.6 million. This compares with a goodwill adjusted income from the same quarter last year of $209.1 million. Expressed as earnings per share, we made $0.62 per share this quarter, contrasted with $0.53 per share last quarter, or an increase of 17%.

For starters, I would tell you that we're pleased with the results of the quarter, for the most part because all of our trends are improving and those trends have continued into the first quarter. We have some quick highlights. Q4 represents our second consecutive quarter of year-over-year EPS growth. We also had our best ID sales performance of the year in the fourth quarter.

Looking at operating margin, it improved with both gross margin rate and O&A expense ratios, excluding fuel, showing positive changes. Price per item, which had been negative all year, was flat when compared with Q4 of last year. While we had a benefit of $0.03 per share in terms of taxes, we also had lower fuel margins, which offset that, of $0.03 per share. And then just as I had indicated on the third quarter call, when we announced the closure of the British Columbia distribution center, it was going to cost us another $0.02 a share in the fourth quarter, and that in fact happened.

Turning to sales. Total sales for the quarter increased 0.9% over last year. The higher sales were largely the result of higher fuel prices and an increase in the Canadian exchange rate, offset by store closures and a decline in ID sales.

Looking at ID sales excluding fuel, they declined 0.8%. This decline was a combination of a negative 1.9% during the first eight weeks of the quarter, which represents that magic moment where we lapped last year's price investments. So in the back-half of this quarter, essentially weeks 45 through 52, we had a positive ID of 0.1%. Price per item was flat for the quarter, but comfortably positive in the second-half of the quarter just as we anticipated. Transaction and household changes were both positive and were the best results for 2010.

Equally important, our sales improvement is coming from our best customers, who were shopping more often. These positive trends have continued through the first seven and a half weeks of Q1. For seven and a half weeks, nine of 10 operating divisions are showing stronger IDs than they had in quarter four. Currently, seven of 10 operating divisions have positive IDs, again, excluding fuel. And much like the fourth quarter, our best customers are responsible for most of these sales increases showing us increased royalty.

Turning to gross margin. Our total gross margin rate declined 56 basis points from last year's fourth quarter. However, when you exclude fuel sales, the gross margin rate actually improved four basis points over last year's fourth quarter. As I indicated earlier, closing the distribution center in British Columbia, which will lower distribution expenses throughout 2011 and beyond and will free up a very valuable asset, actually reduced gross margin seven basis points in this quarter. The improvement in gross margin was largely the result of what I would call an extraordinary but planned effort to reduce shrink in Q4.

For the last several years, we've had a shrink target of $50 million per year, and we stepped that up beginning in the fourth quarter. We actually beat our $50 million target by $56 million on the year, with virtually all of that beating a target coming in the fourth quarter. The positive effects of shrink improvement were offset in part by investments in price that occurred in the first-half of the quarter, as we laid our mid-quarter anniversary of those investments from last year, the distribution center I already mentioned and then a smaller LIFO credit than we had last year. The great thing about the shrink effort is all of those benefits should be with us for the first three quarters of 2011.

Our O&A expenses were slightly lower in dollars on a year-over-year basis. When expressed as a percentage of total sales, O&A declined 44 basis points. Excluding fuel sales, the O&A expense ratio improved, or if you will, declined eight basis points. This improvement in O&A was driven by three factors: Larger gains on property disposals, lower general liability expense and lower non-labor store of expenses. They were offset in part by higher workers' comp expense and other miscellaneous expense increases.

The workers' compensation expense increase was really driven primarily by a decline in the interest rate used to discount the expenses. If you look at the underlying data, accidents were down some 15%, and the expensive accidents, what we call “paid time off claims”, were also down just a bit.

In terms of interest expense, interest expense declined $7.8 million due to lower interest rates at lower average borrowing. Our average borrowing rate was lower by 18 basis points, declining from 6.17% to 5.99%. Our average debt outstanding was also lower by $274 million.

Looking forward, we have $500 million worth of 6 1/2% debt maturing on March 1 of this year. So we should have quite an interest rate saving coming up in 2011. We will initially replace this debt with commercial paper. Over the next several months, we intend to do a longer-term debt offering to replace the commercial paper. We continue to borrow in the commercial paper market at just under 40 basis points for overnight and sometimes one-month maturities. At year-end, we had no commercial paper outstanding due to the seasonal cash flow from gift cards.

Turning to capital expenditures. We opened seven new stores and completed 25 remodels in the quarter. For the year, we opened 14 new stores and completed 60 remodels. This brings our total Lifestyle store count to 1,440 stores or 85% of our store base. We closed 15 stores in quarter four and 45 stores during the year.

Turning to the full-year results. Net income was $589.8 million or $1.55 per share. Total sales increased 0.5% over last year, largely due to an increase in the Canadian exchange rate, an increase in fuel prices, offset by both negative IDs and store closures. Our gross margin rate, excluding fuel sales, was down seven basis points. Our O&A expense rate, excluding fuel, increased 43 basis points.

Almost all of this increase was the result of price-per-item decline, or what we've often termed deflation. Absent deflation, O&A would've been down 10 basis points instead of 43 basis points. In essence, we think we did a very good job this year managing costs, but it was hidden from view by deflation. At a 1% inflation rate, we would've leveraged O&A by 16 basis points, and with normal inflation, we would've leveraged it by 67 basis points.

Our free cash flow was strong at $1,058,000,000, essentially in the upper end of the range that we have given as our guidance. As a result, we've purchased 27.4 million shares at a total cost of $621 million. 7.5 million shares were purchased in the fourth quarter alone at a cost of $170 million. We also paid $168 million in dividends, and we reduced our debt outstanding by $65.5 million, and we increased our cash balances by year-end to $370 million.

Quick update on Blackhawk. The face value of card sales sold increased in quarter four 15%, giving us an increase of 18% for the total year. During the fourth quarter, Blackhawk added more than 5,000 distribution points in its international operations. Key retailers among those 5,000 distribution points included Tesco at 605 stores; Louis at 1,158 stores; Argos at 569 stores, all in the U.K.; and then we also added Coles supermarket, 726 points of distribution in Australia.

I'm not going to touch on guidance for 2011. We have our investor conference coming up, I believe, it's March 8. And so that's the moment at which we will address guidance for 2011. By way of a quick summary, we think we've made significant progress in 2010. ID sales improved each and every quarter. A deflation has now been replaced, just we expected, with some inflation. Shrink performance in Q4 was the highlight and as I indicated, that will continue to benefit us through the first three quarters of 2011. Free cash flow was very strong at $1,058,000,000. And we made some key marketing and IT investments that will allow us to continue to improve our results in 2011 and beyond. So with that, Melissa, I'm prepared for questions.

Melissa Plaisance

In addition to that, Robert Edwards, our Chief Financial Officer, is with us today to assist us with Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from John Heinbockel. You may ask your question and please state your company name.

John Heinbockel - Guggenheim Securities, LLC

Guggenheim. Steve, a couple of things. On the inflation topic, where is ASP or selling price per unit thus far in the first quarter? And how do you think you would tack price increases throughout the year? Maybe by category, or what's the thought process there in terms of -- I'm sure you don't want to be the leader necessarily, and together with that, is there a forward-buying opportunity here that can offset the negative impact of price pass-through to some degree?

Steven Burd

John, in terms of the first quarter, through about seven and a half weeks, inflation is running kind of in that 0.5%, 0.7% range. And that's been pretty consistent. It was actually a tad stronger in the back half, in the fourth quarter. But we continue to see inflation cost of goods. We pass those along to consumers, as we observe other retailers. But I would include price formats. You name it. We monitor their price increases. I would tell you that it's our observation that, virtually, all retailers are passing it along. You will occasionally find a geography where it's a little stickier than in other geographies, but at this juncture, no real difficulty in passing it along. I can only speculate that price inflation, since we're really just beginning to see the early signs of it, it's going to be stronger. I'd say it's clearly going to be north of 1%. A little early to tell, but wouldn’t surprise me if it hit 2%. I would not necessarily expect a complete return to normalcy, which is that 3% number. And then on the issue of leadership or not. Sometimes, depending on the item, we'll reflect it immediately. Milk is a good example. There was a time during the first half of 2009 where it was used as a very competitive draw item. And so even though we were getting cost increases, we weren't able to match that necessarily with a retail increase at the same magnitude. That changed in the fourth quarter. So today, if we get $0.15 a gallon increase in milk, the retail goes up $0.15. In the main and in the meat category, the produce category, center of store, we're typically protecting gross margins. And also very little delay, virtually, none in produce; virtually, none in center of the store in passing those along.

Robert Edwards

John, on your last point about forward buys. You’ll notice that inventory was up a bit in the fourth quarter. One of the reasons for that is we actually did do some investment buys on inventories. So given the inflation we're seeing and we expect we're looking for those opportunities and where it creates a positive rate of return, we're actually doing that. And that was one of the reasons inventory was up in the fourth quarter.

Steven Burd

Although I would caution, it's not the same kind of opportunity it was 10, 12 years ago.

John Heinbockel - Guggenheim Securities, LLC

Just a follow-up to that, the 2% you're talking about, that is your input cost increase, or that's shelf price inflation?

Steven Burd

That would be price-per-item. That would be shelf price, through the check stand. And so it's retail price-per-item. That's not what we're experiencing now. Just to clarify, I said that we were experiencing something in the 0.5% to 0.7% range that it's clearly going to break 1%. It wouldn't surprise me if it breaks 2%, sometime later in the year.

John Heinbockel - Guggenheim Securities, LLC

So what if we end up 3%-plus, lets say, very late this year, early 2012? Is that problematic?

Steven Burd

I think if it's a graduated and the fourth quarter ends up a nudge over 3%, I think that's an absorbable amount by consumers. It's when inflation gets to 5% that you can have a demand-depressing result. It's not a clip. But I think that historically, since 3% has been normal, I would think you don't have a real issue up to 3%. And somewhere between 3% and 5%, you get an issue. But I would -- again, if we get 3% inflation, it will probably come in the back half. It will probably come in the fourth quarter.

John Heinbockel - Guggenheim Securities, LLC

How does inflation start to work into labor negotiations, i.e. if food's up, cotton's up, gas is up? Do we get to appoint -- and I think Southern California's, the contract there is coming up and I think it's March, or maybe gets extended, do we get the -- do conversations with the unions get more difficult in that wage increases have to pick up to cover the cost of living? Or you still think, give them more in wage and give them less in work rules or something else, you still end up okay?

Steven Burd

I think in terms of what you pay the employees in your store, it's driven more by competitive wage rates than any other factor. And I'm sure you've followed the numbers, there's been an extraordinary amount of market share taking over the last decade by non-union operators. So that becomes a discipline. To the extent that we can control healthcare costs, to the extent that we can modify work rules, that frees up money to be able to grant wage increases that would allow us: A, to be competitive; and B, to keep up, maybe, with some rising prices.

Operator

Our next question is from Scott Mushkin. You may ask your question and please state your company name.

Scott Mushkin - Jefferies & Company, Inc.

Jefferies. I wanted first to delve into a little bit the current trends. I think you said seven out of 10 divisions were running positive as far as IDs go. Just to clarify, is that expectation that 0.1 you were seeing the company overall is a little stronger now or how should we frame that?

Steven Burd

It is stronger. It's stronger through the first seven and a half weeks. I'm a little hesitant to give a specific number because then I'm going to have to explain for seven and a half weeks, last four and a half weeks. But it is running stronger. It’s certainly measurable on the Richter scale. And we're optimistic that, that will continue to build as we go through the quarter.

Scott Mushkin - Jefferies & Company, Inc.

Then I wanted to ask -- as we progress through 2011, I know everyone's talking about per-item inflation. I guess my thought is that there could end up being some retail-to-wholesale or wholesale-to-retail compression depending on where things move. Although, I think you said you're not seeing that. But what could offset that? Is any trade up activities you see from your customers going from ground beef to say sirloin? I was just wondering, what's your opinion on where customers are right now? And as we progress through '11, do you think trade up could trump any margin pressure you see per-item?

Steven Burd

I mean, I do think we are seeing some trade up. I think what you're seeing as I look around the landscape here, I think you're seeing a bifurcated recovery here. I think you're seeing the first people that felt comfortable and think we're getting better would be clearly in the upper income. Then I think we saw that migrate down to upper-middle income. And I think we haven't seen as much of a recovery in what you might call the lower income, maybe hourly jobs, to which there's still a lot of uncertainty. It's not like the economy has improved in any marked way. It's just that it clearly seems to have stabilized. And so we're seeing some confidence level returns. We'll show some numbers at the investor conference. The transaction increase among our best customers is nothing short of extraordinary. And remember that our best customers, our typical customer, is more of a middle, upper-middle income, higher income customer than virtually all of our conventional competitors. And probably is more like that, of some of the club formats, which tend to have a relatively high income customer. But as you look at some of the retail formats report their IDs, I think it will reinforce what I'm saying. Niche player operating in the high end, very high IDs. After having a tough couple of years, you see a constant improvement in our numbers then you see some of the price guys actually struggling. I think you're seeing what is a typical cyclical shift back over to conventional retailers, conveniently located, and we think we're going to benefit from that in a material way in 2011.

Scott Mushkin - Jefferies & Company, Inc.

Key fresh has been talked about a lot. I know you withstood that in California. Have any idea where that stands, the key fresh roll out in California, and when you'll cycle through most of it?

Steven Burd

They've made a substantial investment in Northern California. I think, Robert, you might be closer to these numbers. But I think the investment that we contemplate key fresh making in our markets in 2011 would be quite similar to 2010. But we'll show you some numbers again at the investor conference, so you can put into context the different retail formats and how they affect it because key fresh has a fractional effect, I mean, very minor effect, relative to a conventional store. And so we'll show you the competitive openings that are occurring in our market. We'll break that out by competitive format, and then you be able to see the effect. In essence, I would tell you that the competitive effects in 2011 certainly are not going to be any greater and might be a bit softer than 2010, which is the lowest competitive openings we had against us in more than a decade.

Operator

Our next question is from Karen Short. You may ask your question and please state your company name.

Karen Short - BMO Capital Markets U.S.

BMO Capital. Steve, wondering if you could give us some color on volumes, how volumes are trending in the fourth quarter, in both the U.S. and Canada, and how they're looking into the first quarter. If you did it, I missed that.

Steven Burd

I didn't give any volume numbers. I mean, I've talked about volume in the past. Volume was on the soft side in the fourth quarter and has really firmed up here in the first quarter. It's a bit of an imprecise measure because what we used is item count. And where you have significant changes in pack size and people attempt to trade up to maybe a larger pack size, for reasons of economy, it can be a little bit of a distortion. And it's kind of the reason that I shifted to looking at transactions and households, both of which were positive trends, to give you a better sense for what was going on. But using the item count measure, we were still negative in the fourth quarter. We're basically touch and go here in the first seven and a half weeks. And if I were to isolate -- I won't use weather as an excuse, but we had snow in one of our divisions last year that was 6x greater than normal. So they had extraordinary sales. And if I x them out of the equation, we have positive volume, positive transactions, positive households and nicely positive sales. And I think that trend will continue.

Karen Short - BMO Capital Markets U.S.

And then wondering in terms of inflation. Obviously, you're saying you're not seeing that much of it right now, but any color on how the vendors are positioning themselves to help offset some price increases to the extent they come through?

Steven Burd

Well, I think that if you look at the underlying commodity cost increases, they're pretty extraordinary. At the same time, you need to keep in mind that, that doesn't necessarily mean that they get a 25% increase in ingredient costs, that the cost of the product goes up 25%. That's not the case. I think that the consumer packaged goods community is somewhat reluctant in raising cost of goods and is trying to find ways to offset that, but frankly, find themselves with no real good choices. And so they are raising the cost of goods because it's a matter of pure economics. But I think they're also making efforts to try to improve their efficiencies. But there really are no efficiencies at this juncture that can fully make up for the underlying commodity costs. And so I expect that by year-end, we will have experienced cost increases from virtually all vendors.

Karen Short - BMO Capital Markets U.S.

And then just wondering if you have an update on the potential to repatriate cash in Canada this year or next year?

Robert Edwards

Karen, we look at that on a regular basis. We're also monitoring discussions that might be going on in Washington on any tax policy change. So we monitor that on a regular basis.

Operator

Our next question is from Robbie Ohmes. You may ask your question and please state your company name.

Robert Ohmes - BofA Merrill Lynch

Robbie Ohmes from Bank of America Merrill Lynch. Steve, actually I had two quick questions. I was hoping you could maybe elaborate on sort of during the fourth quarter, what prompted the price investments that you guys mentioned in the press release that I guess you took in the first half? And maybe relate it to that in the inflation question that you're getting. Any color you can give on the perishables and periphery, the store outlook for inflation versus what's going on or what you think will go on in the center of store? And then the second question would just be a follow-up on the questions you're getting on input cost inflation and what that means for your Private Label business?

Steven Burd

In terms of the fourth quarter price investment that was mentioned in the press release, it wasn't really an investment that we made in the fourth quarter. It was a lowering of prices that we made a year ago, which then we cycled in week 45. So it wasn't new investments. But keep in mind that we constantly run promotions and stuff, but there was no new price investment. It was really just the anniversary-ing of that, that occurred in the first quarter. And that's what, in part, created the marked change in ID sales. If you were in on the first half of this call, I said we ran a negative 1.9 in the first eight weeks and then we ran a positive 0.1 in the last eight weeks. Part of that is the cycling and part of that is now an influx of genuine cost inflation, which we’re reflecting in retails. In terms of the kind of inflation that we're experiencing, it's pretty much across the board. We're seeing it in produce. But produce is often driven by weather conditions more than any other factor. And so you could have a commodity early in the year that would show inflation, and you could have that same commodity late in the year with an abundant supply that would actually show some deflation. So produce is in a little bit of a different category, although when energy costs go up, that is going to affect across the board in produce. There's been a long-term trend here in the cost inflation in the meat category, and then, of course, as you think about that as it affects beef, there's a lot of substitute products and therefore, some of the pressure comes off of beef and then goes into other categories. But some of those protein categories replenish themselves much quicker, like chicken than with beef. But we're seeing increases in beef produce, then a lot of the other commodities are driving cost increases in the other areas of the perimeter of the store, and then the center of the store. We're going to show some key commodity cost increases at the investor conference and maybe, Robert, it would be good to show an example of how that translates into an actual increase in product cost. And maybe what we'll do is we'll do that with one of our private label items. Now we don't feel -- we feel some cost pressure there, but remember, the national brands create a national pricing umbrella for us. So don't really expect any margin squeeze there. We had a brief period of time during 2010 where we actually made a bit more-than-normal margins in private label, but private label margins are sort of back to normalcy right now. Running up, your margin would run about 1,000 basis points higher than it would be on a national brand, and we don't see that diminishing even with cost inflation.

Operator

Our next question is from Mark Wiltamuth. You may ask your question and please state your company name.

Mark Wiltamuth - Morgan Stanley

Mark Wiltamuth from Morgan Stanley. Steve, during the first and second quarter of 2010, you did have some trouble passing through some of the commodity inflation in the meat, eggs and milk. What's making it different on this go-around as we get into inflation in 2011? And just give us a little update on how you're doing with sourcing the perishables right now because some of the stores out here on the East Coast, they even have signs up on the stores saying that the weather disruptions from freezes in Mexico and in Florida have disrupted supply.

Steven Burd

On the issue of inflation recovery, your memory is correct that in the first half of 2010, particularly in the milk category, we broke stride with a 18-year history. And I think that -- as I attempted to explain earlier, I think that was driven by the fact that it's a traffic builder, and people chose to be a little bit slow with the price increases there in an effort to try to build traffic. We saw it increasingly in the first half of 2010 on the front page of peoples’ ads. So it was promoted more than probably at any time in my recent memory. And I think what's changed is the sector can only take so much of that. And as you try to build sales through one technique or another using this category or that category, certain levels of promotion, if it doesn't work, you back off and try to do something else. Now I think that deflation has been really devastating to the P&Ls of, virtually, all retailers, particularly those suffering ID sales decline. And I'm not going to rattle off the financial position of various retailers, but it's been a struggle. We've been unique in our ability to control costs, cut expenses more recently after, I think, having the best shrink numbers in our business essentially took another set of objectives to cut another $300 million out on an annual basis and got our first installment in the fourth quarter. So that stayed the course for us. But I think, just like in the CPG world, you hold off, you hold off and then finally enough is enough. I said on one of those earlier calls, probably in the third quarter, that I thought that you would see price increases at retail even if you did not see cost increases from the CPG world, simply because it had just been too long, and retailers were suffering. And they've got to do what's in their best interest. So it's following a pattern that I expected. So I would tell you that the fourth quarter was a very normal quarter. In terms of cost inflation, I mean, still on the low side, but in terms of passing it along, it was normal for us. Again, I'll address this at the investor conference, hopefully we'll get a large crowd. But what I'm going to show you is how we monitor what we and others are doing through our price checks. And I will demonstrate that we are not the only one passing along cost increases, and it is not confined supermarket industry. And it's called preservation. It's called, after two years of defining price-per-item, you have to take some risk and pass it along. We're passing it along, and we're not seeing a demand-depressing effect. And the reason is because consumers, in the main, particularly our consumers, are feeling better off than they were a year ago. They're feeling more comfortable, and they're getting wage increases themselves.

Mark Wiltamuth - Morgan Stanley

The packaged food companies, many of them are talking about seeing their costs up in the 8% to 10% range, and they're going to be asking for price increases for the grocery industry. So what magnitude are they asking for when they come through and ask for an increase?

Steven Burd

It varies a lot. It varies really by the item. Let's take something like coffee. I mean, coffee is -- there it is. It's all coffee, and it's in a paper bag. And so that's going to be a much bigger effect just as milk would in a plastic gallon. Now if you were to take some of the more processed products where the ingredients cost might not loom as large because they got heavy marketing budgets in advertising and brand-building, that commodity element is going to be a lower percentage. So an 8% increase in commodity cost could translate into as little as a 3% to 5% increase in cost of goods. But a 20% increase in the cost of coffee beans is going to come across pretty much as a 20% increase in the cost of coffee.

Mark Wiltamuth - Morgan Stanley

And how are you doing outsourcing on the perishables given the supply disruptions?

Steven Burd

If there's one unit of the company that does this every day -- produce is an exciting area because it's a constant scramble. I used to work in the railroad business and I think that the operating guys used to love it when there was a snowstorm or a derailment so they could go to work and solve that problem. The produce guys are solving supply problems, virtually everyday. When you get a major freeze or something, you could lose an entire crop. We could actually have that crop in the ads. And so what we do is we scramble to try to get some other product that we think would be a good substitute, get that in the stores, put it at a sharp price even though it wasn't really in the ad. So it happens, virtually all the time. And some times are more extreme than others. And some of our products come out of the East Coast. This time of year you're talking about Chile, Mexico. It comes from all over the world. But produce is so much more predictable in the spring and the summer, although some crops are going to get affected by rain. So I don't think we're looking at extraordinary times here. I think we have a couple extraordinary events, and they will pass, and they'll pass fairly quickly.

Operator

Our next question is from Adrianne Shapira. You may ask your question and please state your company name.

Adrianne Shapira - Goldman Sachs Group Inc.

Goldman Sachs. I'm wondering. Given how much fuel impacted margins, can you help us think about going forward, is that an opportunity?

Steven Burd

I think fuel -- just to refresh, when the price of oil and therefore fuel is rising, our margins get squeezed. When the price stabilizes, our margins return to normal. And when the price goes down, our margin's widen. And the dominant explanation for that is that we typically sell about 3x the quantity in our own fueling station that a typical branded retailer would sell. As a result of that, we turn our inventory at a much faster rate, virtually 3x the rate. So when we get a price increase, because it's competitive, we don't immediately pass that along because our retail has to be competitive with those that haven't experienced that inventory pop. And just a reverse of that happens in a decline. So what I would tell you is in the -- if I look over the last 10 years, the margin has probably been within $0.02 per gallon on a year. This particular year, our actual fuel margins were up a little bit on the year, but they were down in the quarter, affecting us a full $0.03. That is the most commodity-driven business that we happen to be in. And prices are basically driven by market conditions, and we're competing with people that haven't experienced a higher cost inventory. So I think it'll always move around in the quarter. So since costs are going up this quarter, the first quarter in all likelihood will be a below normal margin. As soon as that stabilizes, we'll become normal. And at some point, we all like to think that those costs will come down and margins will thicken up.

Adrianne Shapira - Goldman Sachs Group Inc.

And just staying on the cost of discussion, share with us any OG&A initiatives that you might be working on to drive incremental leverage other than sales lift.

Steven Burd

We're always working on things that drive cost reduction. And again, we'll address that at the investor conference. In the last couple years, the numbers have been pretty extraordinary. I didn't commit them all to memory, but we had a year at around, I think, we did over $400 million in 2008, $900 million in 2009 and close to $400 million in 2010. Now that's not all SG&A or O&A. It's a combination of things that we do to improve profitability of the business. The biggest single thing that will affect margins in 2011 will be the shrink effort that I talked about earlier. Because now were at a new, lower-level of shrink. I still think we'll make progress beyond that, but it will be very good for this company just to stay at the level that we finished [indiscernible] '13. But in addition to that, we've got things lined up on the O&A side, and we'll talk about those, again, on March 8.

Operator

Our next question is from Chuck Cerankosky. You may ask your question and please state your company name.

Charles Cerankosky - Northcoast Research

Northcoast Research. Steve, can you go back to Blackhawk a little bit? I'm just wondering why the face value growth rate slowed in the fourth quarter versus the entire year.

Steven Burd

The only explanation I could give you, I mean, it is a -- we've had a soft economy. They're not totally unaffected by that. Obviously, retailers in general had a better Christmas this year, as most of us predicted, than last year. 15% growth at a bad economy, to me, is still a pretty good number. 18% on the year is a very good number. And quarter-to-date, we're running 18%. So I think one of the challenges in that business -- we built the distribution network in the United States, and so there aren't a lot of new retailers to add. We are taking some of our card content providers, and they're becoming distributors themselves. And so that's actually very helpful. And the international business is also building at a pretty fast rate right now. Very strong numbers in Canada. Very strong increases in Australia. Really, just getting up to speed in the U.K. And so I think that we expect more growth out of the international operations in the next, say, three or four years, and we will make efforts to introduce some new products in the North American market to maintain good, strong sales growth there. But I don't think any -- I wouldn't point to any particular issue in the business. If I try to break it down, we're expanding our presence in telecom, creating more real estate at store level for that. As we piloted some additional space, we saw those numbers improve pretty dramatically. So that gives us an opportunity to do that. And then we've got some opportunities on the open loop side because we have members of the distribution channel that still don't carry the open loop card. I think that -- I don't see that any issues at Blackhawk, and frankly I'm not that embarrassed by the 18% growth rate, and it does leverage your P&L.

Charles Cerankosky - Northcoast Research

Switching over to gasoline, Steve. How would you characterize the promotional, or the response to, the promotional use of gasoline? And what was the year-over-year change in average price-per-gallon sold?

Steven Burd

I don't have the year-over-year change. Robert might be digging for it.

Robert Edwards

You talking about Q4, Chuck, or for the full year?

Charles Cerankosky - Northcoast Research

For the fourth quarter.

Robert Edwards

Change was about 8%.

Steven Burd

And that’s price, right?

Robert Edwards

Right, price. Retail price-per-gallon.

Steven Burd

And then I think, if I understood your first part of your question, the fourth quarter, I think we made some promotional changes in fuel in the third quarter. No real change in the fourth quarter. And some markets are much more responsive to that than others. And so we don't do exactly the same thing in all markets.

Charles Cerankosky - Northcoast Research

Do you anticipate selling that British Columbia distribution center? And what might be the cash generation potential from that? And also, what's the cost savings going forward?

Steven Burd

The cost savings we gave on the third quarter call, it's a little lumpy. But it should be worth about $0.04 a share on a go-forward basis.

Charles Cerankosky - Northcoast Research

Annually?

Steven Burd

Annually, yes. And then we are freeing up a significant asset sitting on over 50 acres, near Vancouver. And there will be a gain for that. It's like -- a real estate gain on the year are usually pretty predictable. But that could happen in 2011 or it could happen in '12. Because one of the things you try to do before transferring the asset is try to entitle the real estate for an alternative use. If you can entitle that, then you capture that value. If you just sell it, then somebody else has to entitle it, and they capture the value. But the reason we did, we did it because we free up a lot of cash, and we have ongoing operating savings. But as you know in Q3, Q4, we took an earnings hit to affect that.

Operator

Our next question is from Deborah Weinswig. You may ask your question and please state your company name.

Deborah Weinswig - Citigroup Inc

Citigroup. What percentage of your business, of your produce SKUs are currently globally sourced, and what do you think the opportunity is there?

Steven Burd

Can you repeat the question?

Deborah Weinswig - Citigroup Inc

So what percentage of your produce or your SKUs are currently globally sourced, and what do you think the opportunity is there? We're hearing from a lot of retailers, especially on the food side, that they’re increasing what they're globally sourcing in terms of potential gross margin improvements and just wanted to see what your opportunity was there.

Steven Burd

If I understand the question right, produce is going to run as a percentage of store sales between probably 11% and 13% seasonally. It's going to be higher in the summer, but 11% is probably a pretty good number, sort of all in. Now some stores are going to be higher than that, some stores are going to be lower. And then I think you had -- another part of your question was about global sourcing, and we've been sourcing produce globally for as long as I can remember. If you were to go back, when I was a kid, retailers didn't do that. And so you didn't have produce like we have today that's available year-round. And so global sourcing is a big piece of what the produce organization does.

Deborah Weinswig - Citigroup Inc

Is there any opportunity to globally source other products that you're selling or are you pretty much at full penetration there?

Steven Burd

I'm not sure I understand the question. Is there an opportunity to do more of it and save money, is that the question?

Deborah Weinswig - Citigroup Inc

Correct.

Steven Burd

I mean, I think that we do -- we're looking for quality product at a good cost position. And everything now kind of operates in a world market. In the summer, when we have abundant produce, we probably give a little favor to locally-grown product because our consumers like the idea that it was grown just a short distance away, and there was less energy and transportation costs involved and so on and so forth. So the global sourcing is more of a seasonal requirement, than it is -- it's not a big piece of what we do in the summer. And I think that to the extent that it was available globally, we'd have to trade that off against what we think our consumers want to see in terms of local product.

Deborah Weinswig - Citigroup Inc

And then what have you seen in recent weeks in the competitive environment? Not to be short-term oriented, but I just want to focus on the response to your answer to Karen Short's question earlier in the call, where volumes seem to have improved thus far in the first quarter.

Steven Burd

The competitive environment is -- there's nothing unusual about today's competitive landscape. I think trying to figure how many of these calls I've done, maybe 60 of them, and only twice have I said, "Hey, it's abnormal. It's really more competitive than I've ever seen it”. I would say that things are pretty normal right now, however you want to measure the competitive landscape. I think that -- I don't see any irrational behavior. I see people trying to win market share. I see us trying to win market share. Nothing really unusual going on. And I think it's just normal business?

Deborah Weinswig - Citigroup Inc

But it does seems like your business has improved between the fourth and the first quarter.

Steven Burd

Well, it has, and there are a couple good reasons for that. First of all, we've been working very hard on trying to build the business and tailor our stores and our operations to satisfy customers better than our competition. And we have a relatively large-scale targeted marketing effort underway, which we think is unique and is bringing us value. And then it goes without saying that we're starting to see the benefits of moderate inflation. So I think those three things in tandem. I'd like to think that our results are improving not because the economy is getting better -- we're still at 9.4% unemployment -- but because we are appearing to be a much better choice for the consumers in our marketplace.

Operator

Our next question is from Ed Kelly. You may ask your question and please state your company name.

Edward Kelly - Crédit Suisse AG

Credit Suisse. Question for you on just back on this inflation topic, but a little bit broader. How should we be thinking about gas prices in this whole equation? So let's just assume that we are in an environment where you're seeing private cost inflation north of 3%. Based on what the vendors are saying, it seems like we could be there. And we are seeing a spike in gas prices because of what's going on today with oil. How much more difficult is it going to be for you to pass those price increases through in an environment like that?

Steven Burd

I think the -- we don't know where fuel prices are going. They'd certainly been at these levels before. I think the last time we saw retail fuel hit $4 a gallon, we actually saw people not wanting to venture that far from home. And we actually were a beneficiary, from a shopper’s standpoint, of high fuel expenses. And also I think we saw an effort to consolidate trips. I know it doesn't -- it seems like if that store is five miles away, how could it possibly have that effect? But I would say it's very similar to the effect that if we have turkeys priced at Thanksgiving that are $0.03 lower than our competition per pound, which is going to be $0.36 on the entire bird, we'll win that business. And fuels sort of fits into that can. So there's an emotional reaction to fuel that, I think, as fuel costs to up, strangely enough we'll be a beneficiary of that. We were the last time we saw that kind of increase. Now it does affect our cost of doing business. I mentioned earlier all the things that we are doing to lower costs. There are a whole host of things that cause costs to go up, including the fact that we signed labor agreements a year and two years ago, and we have pension costs and other things go up. So it will be a bit of a challenge, but I don't sit here and worry that rising energy costs are going to blunt our ability to generate good results in 2011. I think we'll be just fine.

Edward Kelly - Crédit Suisse AG

And where do you stand today on store labor? I know you've done a lot of work over the last couple of years as sales have been softer. Are you comfortable with current levels? Do you feel that they are appropriate for what you are looking to accomplish longer term within your business model?

Steven Burd

I think that when you talk about sort of labor content, we have these elaborate standards and they're broken down just ultimately by the task. And we schedule in 15-minute increments and we look at our history in terms of what parts of the day the business will flow. And we try to have as many jobs as possible that can do double-duty, so they can move from check stand to somewhere else in the store. They can move from deli to Starbucks and that kind of thing. At the same time, I would tell you that every year we find opportunities to be more efficient, and oftentimes, it's as simple as looking at a group of stores that seem to operate at a higher level of efficiency and productivity than all other stores at equivalent volume of sales, equivalent mix of the business. And you sit down and you learn from what they're doing, and then you apply that to the rest of the stores. But if you look at, in terms of what we call “the targeted labor content”, our targeted labor content using our scheduling system has been essentially the same for at least a decade. Now that doesn't mean there's as much labor in the store as there was 10 years ago. A bakery is a good example, where we bring in a lot of product that we finish off and some product that we just put out. And so that takes labor content out of the stores. So it's a constant look for better ways to do things, as well as it is to stay on top of how well people manage that labor content, week to week, store to store.

Operator

Our next question is from Meredith Adler. You may ask your question and please state your company name.

Meredith Adler - Barclays Capital

Barclays Capital. First, about Easter, you didn't mention it. I'm presuming it's because you have a 12-week first quarter, and so you're going to see Easter from last year and this year will both fall into the second quarter, is that right?

Steven Burd

Yes. Well, it's a 12-week quarter for sure. I actually haven't even looked at the calendar to tell you whether or not it falls into the same quarter or not.

Meredith Adler - Barclays Capital

Yes, I guess it's actually the week before. That would be the most import. That's what I looked at quickly so maybe -- because Easter's a big holiday for you. Right?

Steven Burd

It's a very big holiday. So that -- you're correct that if the shopping week prior to Easter Sunday is in the first quarter, that's going to be very strong. If it's in the second quarter, then we'll be soft in the first and strong in the second.

Meredith Adler - Barclays Capital

And then I wanted to talk a little bit about new store plans. I think I read something that said that you were taking a hard look at finding opportunities in northern California for a new locations. I was wondering whether that's something that's going to move ahead quickly? Does it take a long time? Does that impact capital spending going forward and free cash flow? Or is it kind of all well in the future?

Robert Edwards

Meredith, I think at the investor conference, we'll talk a bit about the components of CapEx and how many new stores versus remodels. So I think we've got a number of slides set up to cover that here in just a couple weeks.

Meredith Adler - Barclays Capital

About Blackhawk, I was wondering if there is an initial cost when you bring on all the stores for Tesco or something. Is there an initial cost when you set up those stores? And then have you guys ever disclosed -- I think it would be of interest to people -- what the growth on a same-store basis is? Or is most of your growth right now just coming from new distribution points?

Steven Burd

Yes, we have disclosed that in the past at investor conferences. In fact, I've detailed, in the past, how much is going to come from existing stores and how much might come from new card content or new distribution. The distribution points, as I indicated in the North American market, grew very little in 2010. And that is the dominant piece of our business today. And so in the main, that would represent same-store sales growth, if you will. And it would be a double-digit number. And then there is an initial cost in hooking up a retailer. It's not an overly burdensome number. It's more burdensome to open a country than it is to add a retailer. But there is -- sometimes, it take some time to get somebody up and running because we have to integrate our IT systems with their IT systems. So it's more of a time factor than it is a cost factor.

Melissa Plaisance

And we have time for two more questions.

Operator

Our next question is from Damian Witkowski. You may ask your question and please state your company name.

Damian Witkowski - Gabelli & Company, Inc.

Damian Witkowski with Gabelli & Company. Just a quick question on what's going on with private label versus branded. If I look at the basket increasing and volume is down, should I assume that branded is not growing faster than private label?

Steven Burd

No. Private label continues to grow at a pace much stronger than national brand. And not as strong as it was maybe a year ago, but it's more than 500 basis points stronger than national brand growth.

Damian Witkowski - Gabelli & Company, Inc.

And are you talking units or...

Steven Burd

When I give you that number I'm thinking of sales. The only hesitation I have on the unit question is the volatility of milk is such that, if I x out milk, then I think you would see the units in sales growing at roughly the same rate. And I really expect that to continue no matter how robust the economy becomes, because we're really doing some innovative things in our private brands area and creating a lot of brands recently that cut across commodity groups. O Organics is either the first or second largest organic package brand in North America. And Eating Right is also a very strong brand. And we've opened up some additional brands recently, Open Nature, which is a natural brand, which we have great expectations for. And so I think that we’re creating some unique brand that really cut across business cycles. And they will do well in good times and in bad.

Damian Witkowski - Gabelli & Company, Inc.

And then, Steve, just on the fuel. Based on historical perspective in your markets, when price-per-gallon is going up as fast as it probably is currently, do you typically have a hard time keeping your penny-per-gallon margins? Or it does it really affect it?

Steven Burd

No, they get squeezed. They get squeezed on the way up.

Damian Witkowski - Gabelli & Company, Inc.

But again, is it based on -- forgetting the timing of you turning a lot more volume more quickly and thus reflect in the current costs in your station versus competitors. But if you look at -- what's the competitive response? If it goes from $3 to $4 per gallon, do you typically see competitors saying, "Okay, volumes start dropping," and so they cut their own prices as well?

Steven Burd

No. I would tell you that I think that the retail fuel business is probably the best example of what economists would refer to as the most purest competition you could ever imagine. Because of the vast majority of retail outlets, even the branded guys or franchisees who own that franchise, that one unit. And so it's a cash flow business for them. And they don't think about squeezing margin in order to take market share. They're trying to buy groceries at the end of the week. And so it's the most pure form of competition, probably, I've seen in my business career. And so it doesn't really matter what the cost of fuel is. I think over the course of the year, the margins will be very consistent, whether the retail price is $2, $3 or $4. Those margins will be consistent, virtually, across all brands.

Damian Witkowski - Gabelli & Company, Inc.

And then just lastly, should we expect to hear more detail on Blackhawk in March?

Steven Burd

You'll get a bit more detail, but it's not going to dominate our presentation.

Melissa Plaisance

And last question?

Operator

Our final question is from Andrew Wolf. You may ask your question and please state your company name.

Andrew Wolf - BB&T Capital Markets

BB&T Capital Markets. Steve, on the shrink positive variance, just want to double check my takeaway. I mean, can we just take our estimate of that, you're over-budget number for Q4, and kind of straight-line it into the next three quarters basically as an addition to earnings or are there some costs in and out of there that these processes or what have you costing any incremental labor or perhaps even technology costs or capital costs?

Steven Burd

I think we do expect you to basically get that benefit multiplied times three. At the same time, you can't just add that to earnings. It does stand on its own. It does have that effect on earnings. But there are a whole host of things that are causing costs to go up next year. And so we need things like that to offset some of that. But in terms of its pure incremental effect, you're gauging it correctly.

Andrew Wolf - BB&T Capital Markets

To get to gross margin -- if you take out, again, my estimate based on what you said about most of the shrink upside being in the fourth quarter, looks like selling gross margin for the fourth quarter contracted. What I really want to get to is did the selling gross margin in the quarter, and here into the current quarter, did it follow the same pattern as pricing, unit pricing? And if you’re willing to talk about it, is selling gross margin going to trend from down to up currently?

Steven Burd

Only occasionally do I actually make the calculation on selling gross margin because one of our competitors kind of uses that term. I haven't made it in preparation for this call. What I would tell you is -- remember, the gross margin number is a comparison to last year. And so once we reach week 45, we cycled our investment from last year. And so you can logically think that the gross margin comparison in weeks 45 through 52 would have been much more favorable than it would've been in the first eight weeks of the quarter. And then, of course, having this material effect as a result of completely re-engineering our approach to shrink. So I do think that, that bodes well for next year's gross margin. No question about it.

Andrew Wolf - BB&T Capital Markets

Lastly, can you just remind us. I mean, I think the Canadian pricing is still, that's still affecting gross margin, right? And that doesn't cycle until midyear or...

Steven Burd

Yes, it cycles in Q2.

Andrew Wolf - BB&T Capital Markets

I mean, what is that three of the divisions? So it's having -- is it a material effect in gross margin or it’s a measurable effect, I would assume?

Steven Burd

There are about -- think of it this way, there were about 15% of total sales. But remember, now what's happening, which did not happen to us as we went through that one year of cycling, is we had deflation during that period. And Canada is now seeing some price-per-item inflation. And so that'll actually help them. They came into deflation a couple quarters later, and they're recovering quite fast. And the pricing changes made in Canada actually created a greater near-term response that even in the U.S.

Melissa Plaisance

All right. Well, thank you, everyone, for participating in the call. If there are any follow-up questions, Christiane Pelz and I will be available the balance of the today. Thank you.

Operator

Thank you. This does conclude today's conference. Thank you for participating. You may disconnect at this time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Safeway's CEO Discusses Q4 2010 Results - Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts