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Shares of Safeway (SWY) have been continuously down for months now, and today is no different despite pre-market futures at times indicating a potential +7% opening on earnings surpassing expectations. In the past week and a half, Safeway has declined in total nearly 15%. First, it faced a loss in confidence leading to an approximate 10% loss due to peer SUPERVALU's (SVU) complete earnings miss last week. Now, it has declined as much as 10% at times following its own earnings results. A closer inspection of earnings, despite the beat, reveals why the stock has been facing so much pressure lately.

On the top line, revenues reached $10.39 billion and beat average expectations by $30 million. Margins have faced pressure as the company faced a decline of 73 basis points to gross profit. While fuel sales account for over half of this decline, the rest of the decline relates to increased advertising and other costs related to the just for U loyalty program, accounting for 26 basis points. Importantly, operating income declined a significant 11%, from $146.0 million in Q2 2011 to $121.7 million in Q2 2012. Despite the decreased margins, EPS gained a boost from share buybacks: Safeway repurchased 11.6 million shares of its common stocks, drawing down its outstanding share count by 4.6% to 240.4 million shares.

What is really weighing on the stock: identical store sales growing a mere .8%, below consensus estimates. Identical store sales are indicative of revenue growth; identical store sales are defined as "sales of stores that have been open for a year or more". This metric basically shows what portion of growth comes from sales growth and not opening new stores. Particularly for Safeway, same store sales must increase as it's been remodeling stores for that exact purpose. The chain has set its goal to between 1% and 2% for identical same store sales.

The push to reach this goal is two-fold: the just for U service for returning customers using the web and apps to get deals on items, and updating stores to the Lifestyle format. However, in the conference call, CEO Steve Burd did not indicate how many customers are actually registered to just for U nor did he break out how actively customers are utilizing the service. For something that is surely a key aspect of the business going forward, it is hard for investors to develop a strong (or positive) thesis on such vague details. On the Lifestyle format: "net cash flow used by investing activities increased to $464.9 million in the first 24 weeks of 2012 from $405.3 million in the first 24 weeks of 2011 primarily due to higher capital expenditures". $219.2 million was spent in Q2 2012, opening one new Lifestyle store and completing one Lifestyle remodel. "For the year, Safeway expects to invest approximately $900 million in capital expenditures to open approximately 10 new Lifestyle stores, complete approximately 10 Lifestyle remodels, refurbish in-store pharmacies and develop properties through our wholly owned subsidiary, Property Development Centers LLC".

Overall, margins are destined to continue to see pressure as the industry vies for market share. The stock trades at a P/E of 9 and has an annualized dividend yield of over 4%. The real question investors must ask themselves is: Are the measures that Safeway is taking (just for U, Lifestyle) going to fuel identical store sales growth, or will increasing competition force profits down as the stock's chart suggests? Given that it must average 2-3% identical store sales growth to average out the first half's .8% to reach its goal, Safeway has an uphill battle ahead of it (and that is surely evidenced by the pressure on the price and the short interest).

Source: Safeway Under Pressure Despite Earnings Beat

Additional disclosure: I took a small position in SWY ahead of earnings.