Safeway Earnings Preview

Oct.12.11 | About: Safeway Inc. (SWY)

Safeway (NYSE:SWY), a leading food and drug retailer in North America, is scheduled to report its third quarter 2011 results on Thursday, October 13. The current Zacks Consensus Estimate for revenue and earnings per share for the quarter are $9.8 billion and 35 cents, respectively.

Safeway has exceeded expectations in all the past four quarters. The company has delivered an average positive earnings surprise of 7.13% over the past four quarters, implying that it has beaten the Zacks Consensus Estimate by that measure.

Second Quarter Highlights

Safeway reported earnings of 41 cents a share in the second quarter, surpassing the Zacks Consensus Estimate of 39 cents and topping the year-ago earnings of 37 cents.

The company reported sales of $10.2 billion in the reported quarter, exceeding both the Zacks Consensus Estimate of $9.9 billion and the year-ago sales of $9.5 billion. The upside in sales was attributable to higher fuel sales, higher Canadian exchange rate combined with a 0.5% spike in identical-store (ID) sales (excluding fuel).

The significant improvement in fuel sales resulted from the double-digit growth in quantity combined with 30% hike in fuel price. Moreover, sales during the quarter were favorably impacted by Easter occurring in that period. Besides, during the quarter, the company witnessed maximum ID store sales over the past nine quarters. A consistent growth in this field across five consecutive quarters was also witnessed.

However, after considering 2% retail inflation, ID store sales effectively declined 1.5% year over year. On a sequential basis, ID store sales recorded effective decline of 190 basis points (bps). This has forced the company to lower its ID store sales guidance for 2011 to 1% from the previous outlook of 1.5%.

Safeway reaffirmed its guidance for fiscal 2011. The company expects to deliver EPS of $1.45-$1.65, including the negative impact of 15 cents related to the Canadian dividend. In addition, the company estimates identical-store (excluding fuel) growth of 1% and free cash flow in the range of $0.75–$0.85 billion for 2011.

Estimate Revision Trends

Agreement

Estimate revision trends for the third quarter depict a negative sentiment among the analysts. Out of the 14 analysts covering the stock, one analyst has reduced his/her estimate over the past 7 days with none moving in the opposite direction. A somewhat similar trend is observed over the past 30 days with 2 analysts lowering their estimates with no reverse movements.

Similarly, for fiscal 2011, 2 out the 15 analysts covering the stock reduced their estimates over the last 7 and 30 days while none revised their estimates upward during these periods.

The bearish sentiment clearly reflects the prevailing weak macro conditions and the impact on the company’s Lifestyle strategy. The macro environment of U.S. and Canada is taking a toll on consumers. Wealth destruction from the equity markets, uncertainties and the decline in the housing market and falling consumer confidence are forcing consumers to opt for cheaper substitutes or cut back on overall spending.

The present economic scenario has made consumers more price-sensitive. The magnitude of retail pricing continues to be the deciding factor for Safeway. Food inflation, combined with weakening employment scenario is expected to lower consumer spending and lead to a deteriorating gross margin in the second half of 2011.

Consumers are now choosing less expensive products and this has impacted Safeway. Retail inflation is rapidly taking place and Safeway may find it difficult to pass on increased prices to its customers owing to the tough competition. We expect further clarity from the company on this front, as declining margins remain one of the key challenges for the company.

Magnitude

The Zacks Consensus Estimate for the third quarter has not changed over the last 7 days. However, the estimate for the quarter has reduced by a cent to 35 cents a share over the last 30 days. For fiscal 2011, estimate has moved down by a penny and a couple of cents over the past week and month, respectively, to $1.69 a share.

Our Recommendation

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

However, the company expects the scenario to improve going forward, aided by better volume and pricing. We are also encouraged by the company’s cost-saving activities, which are 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 SUPERVALU Inc. (NYSE:SVU), The Kroger Co. (NYSE:KR) and Wal-Mart Stores (NYSE:WMT).

However, inflation, which is affecting the entire retail industry (largely through food and fuel), will likely dampen the sales growth of the whole industry. As such, we expect the marginal impact on Safeway’s business to be insignificant. Moreover, we are encouraged by Safeway’s constant effort to capture market share with its value-added offerings, which is expected to enhance the company’s brand equity and reduce its dependency on price.