Safeway Vs. Whole Foods: Probing An Outrageous Valuation Disparity

Includes: SWY, WFM
by: Mark Krieger
The market is crazy when it comes to valuing supermarket operators these days. Case in point: Safeway (NYSE:SWY) is forecast to earn $652 million in 2012, while analysts think Whole Foods (NASDAQ:WFM) will garner $399 million (39% less). Now here’s where it gets weird. Wall Street loves WFM and loathes SWY as evidenced by its very generous placement of market value on WFM ($11.98 billion versus $5.68 billion) and its cheap appraisal of SWY. Conventional wisdom would dictate that the two valuations should be reversed, but Mr. Market these days seems to be more influenced by “fear and greed” than logic.
The math is simply outlandish here, because although SWY makes almost twice as much (63% more to be exact), its stock value is less than half of WFM’s. And when you compare their respective forward multiples, the disparity compounds, with SWY selling at 8.7 times its 2012 estimates of $1.86 and WFM selling at 30 times 2012 estimates of $2.25. In the end, WFM is almost four times costlier. It would take just 8.7 years to get your entire SWY investment returned, compared to waiting 30 long years for WFM to accumulate enough earnings to match its share price, assuming both companies earnings remain the same over time.
Reasons for the disparity: (1) SWY’s debt load of $5 billion must scare a lot of investors away compared to WFM’s debt free balance sheet; (2) WFM’s expected earnings growth rate of 17% is darn near twice SWY’s rate of 9.4%; (3) health food and organics are the rage; (4) everybody piles on a winner; (5) SWY is construed by many as a stodgy, out of touch retailer with no real focus.
The bottom line: WFM might not have any debt, but out of the 299 stores they operate, they do not own the land and buildings on a single one. Contrast that with SWY, which owns the real estate on 695 out of the 1,694 stores it operates. Add in the fact that SWY also owns 32 processing plants, 16 distribution centers, a 49% ownership in Casa Ley (Mexican chain of 299 stores) and Blackhawk Network (a gift card enterprise) and you have some compelling reasons to own its stock.
Is WFM a good investment? So far it has been top notch, but how long will they be able to execute flawlessly as they have? Their bar has risen to some very lofty heights and they will eventually disappoint. When they do, the MOMO investors will leave in droves, putting a big hole in the shares. Is SWY a good investment? So far it has been a horrible one, as any investor who has obtained shares in the last 20 years is underwater.
The good news is SWY does not have much room to fall and offers “sky’s the limit” upside potential, assuming one huge caveat: it is able to improve its operations. Obviously easier said than done and the prime reason for Wall Street’s persistent skeptical view.
The term "you get what you pay for" is a very relevant on Wall Street and in hindsight has been "right on" when comparing the history of these two grocery purveyors. However in this case, I am proclaiming that you "won't get what you paid for" when the future of these two organizations continue to unfold.
Disclosure: I am long SWY.