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A leading food and drug retailer in North America, Safeway (NYSE:SWY) is scheduled to report its second quarter 2011 results on Thursday, July 21.. The company is expected to report EPS of 39 cents on revenues of $9.9 billion during the quarter, according to Zacks Consensus Estimates.

Barring the first quarter of fiscal 2011, Safeway has exceeded the expectations in three out of the trailing four quarters. The company’s average earnings surprise is positive 5.19%.

Previous Quarter Highlights

Safeway reported EPS of 7 cents during the first quarter of fiscal 2011. However, repatriation of $1.1 billion from Safeway's Canadian subsidiary resulted in $80.2 million tax charge (22 cents per share) during the quarter. After adjusting for this charge, the company’s adjusted EPS stood at 29 cents, edging out the Zacks Consensus Estimate of 28 cents and 16% higher than the year-ago quarter earnings of 26 cents.

The company reported sales of $9.8 billion during the quarter, exceeding both the Zacks Consensus Estimate of $9.4 billion and the year-ago level of $9.3 billion. The upside in sales was attributable to higher fuel sales, higher Canadian exchange rate, and a 0.4% rise in identical-store sales (excluding fuel), partially offset by several store closures. After several quarters of declining identical-store sales (excluding fuel), the positive growth in the reported quarter was encouraging.

Safeway reaffirmed its guidance for fiscal 2011. The company expects EPS in the range of $1.45 to $1.65, including the negative impact of approximately 15 cents per share related to the Canadian dividend. In addition, the company anticipates identical-store sales growth between 1% and 1.5%.

Agreement of analysts and magnitude of estimate revisions

Out of 16 analysts covering the stock, one analyst raised the estimate over the past seven days. The same trend was noticed during the past 30 days while none revised estimates in the reverse. Similarly, for fiscal 2011, one out the 17 analysts covering the stock increased the estimates over the last seven days and the same was noted during the last 30 days. None moved in the opposite direction.

Safeway registered a 5.4% increase in sales during the first quarter primarily due to higher identical-store (ID) sales. During the quarter, the company witnessed the highest ID store sales in the past eight quarters. A consistent growth in ID sales over five consecutive quarters was also observed. Maintaining the trend, we expect ID sales to improve further.

With the Lifestyle transformation program nearing completion, we believe that the company’s capital expenditure will decline going ahead. This is evident from the $7.5 million reduction in capital expenditures for the 12 weeks ended March 2011. We estimate Safeway’s cash position to improve further, thereby enabling the company to pay dividends, repurchase shares and reduce its $4.8 billion of debt.

Moreover, as retail food price inflation is gradually taking pace, we strongly expect further price acceleration, which indicates positive earning implications going forward. However, food inflation coupled with reduced consumer spending could pressure its gross margin. We expect further clarity from the company on this front, as declining margins remain one of the key challenges for the company.

The magnitude of revision has been insignificant over the last one month. Overall, estimates for the second quarter have remained unchanged over the last seven days and 30 days at 39 cents per share. For fiscal 2011, estimates have decreased by a penny to the current level of $1.72 per share over the past seven days.

Recommendation

Safeway witnessed sluggish revenue growth primarily due to unemployment, deflation and price competition, which make budget-conscious shoppers all the more alert.

However, the company expects the scenario to improve going ahead, aided by better volume and pricing. We are also encouraged by the company’s cost-saving activities, which is likely to improve margins further.

Moreover, Safeway intends to strengthen its presence in the international markets. The company is expanding its international business, especially in Canada, Australia and the UK.

However, increased competition and tough industry conditions are major headwinds for the company. The company confronts a wide spectrum of competitive threats, especially from the likes of Supervalu Inc. (NYSE:SVU), The Kroger Co. (NYSE:KR) and Wal-Mart Stores (NYSE:WMT).

Source: Safeway Earnings Preview