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Safeway (SWY), a leading food and drug retailer in North America, is scheduled to report its fourth quarter and fiscal 2011 results on Thursday, February 23 before the opening bell. The current Zacks Consensus Estimate for revenues and earnings per share for the quarter are pegged at $13.5 billion and 64 cents, respectively. For fiscal 2011, earnings are expected to be $1.72 on revenues of $43.45 billion, according to the Zacks Consensus Estimate.

Third Quarter Highlights

Safeway reported earnings of 38 cents a share in the third quarter, surpassing the Zacks Consensus Estimate of 35 cents as well as the year-ago earnings of 33 cents.

The company reported sales of $10.1 billion in the third quarter, exceeding both the Zacks Consensus Estimate of $9.8 billion and the year-ago sales of $9.4 billion. The upside in sales was attributable to higher fuel sales, a 1.5% increase in identical-store sales (excluding fuel) and higher Canadian exchange rate along with the impact of reporting Blackhawk commissions on a gross basis.

Safeway reaffirmed its EPS and free cash flow guidance for fiscal 2011. The company expects to deliver EPS in the range of $1.45-$1.65, including a 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 fourth quarter depict a mixed sentiment among the analysts. Out of the 15 analysts covering the stock, one analyst has increased his/her estimate over the past 7 days while one moved in the opposite direction. A somewhat similar trend is observed over the past 30 days when 2 analysts have made upward estimate revisions with two reverse movements.

However, for fiscal 2011, 2 out of the 16 analysts covering the stock reduced their estimates over the last 30 days while only one revised the estimate upward during this period. For the past 7 days, one analyst has made a downward revision to the estimate with no movements in the opposite direction.

The mixed sentiment clearly reflects the prevailing weak macroeconomic 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 increased food cost inflation in the first three quarters of 2011 and made consumers more price-sensitive. Retail inflation is rapidly taking place and Safeway may find it difficult to pass on increased prices to its customers due to the tough competition. This tough scenario has resulted in certain consumers trading down to less expensive mix of products or searching for discounters for grocery items, all of which have impacted Safeway's sales. These difficult economic conditions are likely to continue for the time being. We expect further clarity from the company on this front, as declining margins remain one of the key challenges for the company.

However, the analysts are to some extent, encouraged by the company’s gradual improvement in non-fuel Identical Store (ID) sales. They also anticipate further shrink improvement in the fourth quarter which completes 15 months of the company’s 18-month goal to reduce shrink by $350 million.

Additionally, in an attempt to control operating expenses and increase focus on areas with a strong presence, Safeway recently entered into agreements to sell its Genuardi's stores in Pennsylvania and the greater Philadelphia area. Moreover, the company has closed its distribution centers in British Columbia and Vancouver to lower its operating expenses further. We expect all these strategies to bode well for the company’s cost reduction initiative. The current Zacks Consensus Estimate of $1.72 in EPS for fiscal 2011 is above the company’s guidance.

Magnitude

The magnitude of estimate revisions is insignificant over the past one month. Overall, estimates for the fourth quarter remained unchanged at 64 cents per share in the last 7 and 30 days. However, for fiscal 2011, the Zacks Consensus Estimate has gone down by a cent to $1.72 a share over the last 30 days.

Surprise

Safeway has exceeded expectations in all the past four quarters. The company has delivered an average positive earnings surprise of 6.04% over the past four quarters, implying that it has beaten the Zacks Consensus Estimate by that measure.

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 is likely to improve margins further. Moreover, Safeway intends to strengthen its presence in 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. (SVU), The Kroger Co. (KR) and Wal-Mart Stores (WMT).

Safeway currently retains a Zacks #3 Rank (short-term ‘Hold’ rating). Over the long term, we are Neutral on the stock.

KROGER CO: Free Stock Analysis Report

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SAFEWAY INC: Free Stock Analysis Report

Source: Safeway: Earnings Preview