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Safeway (NYSE:SWY), a leading food and drug retailer in North America, is scheduled to report its first quarter of fiscal 2012 results on Thursday, April 26 before the opening bell. The current Zacks Consensus Estimate for revenues and earnings per share are pegged at $10.08 billion and 30 cents, respectively, for the first quarter of 2012.

Fourth Quarter Highlights

Safeway reported EPS of 67 cents in the fourth quarter of fiscal 2011, surpassing the Zacks Consensus Estimate of 64 cents as well as the year-ago earnings of 62 cents. For the full year, adjusting for a tax charge of 29 cents per share related to the Canadian dividend paid in the first half of 2011, adjusted EPS came in at $1.78, ahead of the Zacks Consensus Estimate of $1.72 and was up 20.6% year over year.

The company reported total sales of $13.6 billion during the reported quarter, exceeding both the Zacks Consensus Estimate of $13.5 billion and the year-ago level of $12.8 billion. The upside in sales was attributable to higher fuel sales, a 1.5% increase in identical-store sales (excluding fuel) along with the impact of reporting Blackhawk commissions on a gross basis. Total sales stood at $43.6 billion for fiscal 2011, up 6.2% year over year and ahead of the Zacks Consensus Estimate of $43.4 billion.

On March 6, 2012 Safewaydeclared its fiscal 2012 financial guidance. The company expects to earn $1.90–$2.10 per share in 2012, surpassing the Zacks Consensus Estimate of $1.83. Notwithstanding the prevailing difficult macroeconomic condition leading to anticipated decline in sales volume, the high EPS expectation was on the back of several cost-reduction initiatives on the company’s part, which may lead to operating margin improvement. Also, the company expects increased repurchase activity in 2012 that will likely lead to bottom-line improvement.

For 2012, the company expects identical-store sales, excluding fuel, to rise in the range of 1–2%. Operating profit margin change, excluding fuel, is expected to range from positive to negative 5 bps. The company also expects around $900 million in capital expenditure in 2012 with free cash flow in the range of $0.85–0.95 billion.

Estimate Revision Trends

Agreement

The estimate revision trend for the first quarter has been static so far. Out of the 15 analysts covering the stock during the quarter, only one analyst made an upward estimate revision over the past 30 days, while none moved downward. A somewhat similar trend was witnessed for fiscal 2012 with no analyst (out of 16) changing their estimates over the past 7 or 30 days.

Although there was improvement in identical-store (ID) sales, considering the nearly 4.7% retail inflation during the fourth quarter 2011, ID store sales effectively declined 3.2% year over year. Accordingly, the company’s ID store sales guidance of an increase of 1–2% for fiscal 2012 was moderate. The analysts believe that the inflation, which is hitting the entire retail industry (largely through food and fuel), will likely dampen sales growth of the overall industry. As a result, Safeway may find it difficult to pass on increased prices to its customers due to tough competition. Amid such economic uncertainty and price competition, the analysts expect further clarity from the company on this front.

However, the analysts remain encouraged by Safeway’s constant efforts to capture market share with its value-added offerings, which are expected to enhance its brand equity and reduce its dependency on price.

Additionally, in order to improve its bottom line in a recessionary environment, Safeway has stepped up efforts to reduce cost, which the analysts believe will improve its margins in the upcoming quarters. The company has closed its distribution centers in British Columbia and Vancouver, which resulted in a property gain of $68 million in 2011 ($42 million of the gain was from British Columbia).

Moreover, Safeway decided to exit the greater Philadelphia market to control its operating expenses and to focus on areas where it has a strong presence. Also the company entered into an agreement with Giant Food Stores (a division of Ahold, US) to sell 16 of its Genuardi's stores in the greater Philadelphia area. The company also plans to close 3 Genuardi's stores in Pennsylvania.

Further, the company is focusing on shrink reduction, which will increase its inventory level. Safeway expects an improvement in pricing as well as volume as the year progresses and expects to be benefited from the shrink reduction in the upcoming quarters. The analysts remain encouraged with all these cost-cut initiatives and are waiting for more light in this regard.

Magnitude

The magnitude of estimate revisions is insignificant over the past one month. Overall, estimates for the first quarter remained unchanged at 30 cents per share in the last 7 and 30 days. However, for fiscal 2012, the Zacks Consensus Estimate has gone down by 3 cents to $1.95 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 5.49% over the past four quarters compared to the Zacks Consensus Estimate.

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. (NYSE:SVU), The Kroger Co. (NYSE:KR) and Wal-Mart Stores (NYSE:WMT).

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

Source: Safeway: Earnings Preview

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