We reiterate our Neutral recommendation on Safeway Inc. (SWY) with a target price of $19.00.
Safeway reported an EPS of 41 cents in the second quarter of fiscal 2011, surpassing the Zacks Consensus Estimate of 39 cents and 10.8% higher than the year-ago figure of 37 cents. The company reported sales of $10.2 billion during the quarter, exceeding both the Zacks Consensus Estimate of $9.9 billion and the year-ago level of $9.5 billion.
We note that the environment for the retail industry is quite challenging. Consumer spending on durable products has been very weak. Also, on the back of economic uncertainty and price competition, the company has been witnessing sluggish revenue growth over the past few quarters.
However, the situation has improved considerably as reflected by the swell in identical-store (ID) sales, the best among the past nine quarters. During the reported quarter, Safeway recorded a 7.4% increase in sales primarily driven by higher fuel sales, favorable Canadian exchange rate combined with a 0.5% increase in ID sales. The significant improvement in fuel sales resulted from double-digit expansion in volume combined with a sharp 30% hike in fuel price. Besides, the occurrence of Easter during the quarter greatly benefited sales.
But considering the 2% retail inflation, ID store sales effectively declined 1.5% year over year, which indeed is alarming. This forced the company to lower its ID store sales guidance for 2011 to 1% from the previous outlook of 1.5%.
However, we are encouraged by Safeway’s constant effort to capture marketplace with its value-added offerings, thus enhancing its brand equity and reducing the company’s dependence on price.
Safeway has undertaken cost reduction initiatives focused on cost of goods sold and supply chain efficiencies. The company is building its distribution network in the US where some of its existing card content providers are becoming distributors, thereby reducing the number of retailers in the market.
Moreover, the company is focusing on shrink reduction, which will increase its inventory level. Safeway expects an improvement in pricing as well as volume through the year while shrink reduction is estimated to aid results till the third quarter of 2011.
Furthermore, Safeway is bringing to bear its attention on international market penetration. The company is expanding its overseas business especially in Canada, Australia and UK.In addition, Safeway’s subsidiary, Blackhawk Network, provides third-party gift cards, prepaid cards, telecom cards and sports and entertainment cards to a broad group of top North American retailers for sale to retail customers. Blackhawk also has gift card businesses in the United Kingdom and Australia.
However, retail inflation is rapidly catching on and Safeway may find it difficult to pass on increased prices to its customers due to tough competition. The company confronts a wide spectrum of competitive threats, especially from the likes of SUPERVALU Inc (SVU), The Kroger Co (KR) and Wal-Mart Stores (WMT). Food inflation combined with a weakening employment scenario is expected toreduce consumer spending and lead to a drag on its gross margin in the latter half of 2011.
KROGER CO (KR): Free Stock Analysis Report
SUPERVALU INC (SVU): Free Stock Analysis Report
SAFEWAY INC (SWY): Free Stock Analysis Report
WAL-MART STORES (WMT): Free Stock Analysis Report
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