Safeway: A Safe Way to Invest
Morgan Stanley is looking at the cup as half empty. Its recent downgrade of Safeway (SWY) from "equal weight to underweight, was due to analyst Mark Withamuth's perception that SWY's strategy to cater to the upscale market has not lived up to expectations.
Analyst concerns: SWY has spent the last five years remodeling its locations to appeal more to the high end consumer. According to Withamuth, the general softness in the economy has forced many of these consumers away from this,"price is no object category" to more of a "damage control" mentality. The analyst stressed that some SWY shoppers might be looking to economize, shifting some of their purchasing to Costco (COST), which has a footprint near 75% of SWY's locations.
I think the analyst's one year $22 price target is absurd and his analysis is flawed, being built on a worst case scenario. It will be a difficult endeavor for Costco to pick up many new customers as its selection is way too limited (usually just one item in each category available) and the stores lack convenience. It gets old, bagging your own groceries, waiting in long lines and walking through large parking lots and warehouses to find what you need. Time is money.
Management is optimistic: In last week's Goldman Sachs retail investment conference, Steve Burd, SWY's CEO, sounded a confident note to analysts. The CEO appeared extremely knowledgeable and was impressive in his delivery, despite being a bit too arrogant. He reiterated that the company still plans on achieving a 1-2% same store sales growth and is secure with its 2008 earnings guidance of $2.25-$2.35. He indicated that SWY's current strategy is working well and will not be changed. He is pleased with an improving sales mix, and stressed the sales of more company branded items and generic drugs are enhancing margins. He claimed the grocer and the industry is far better off than it was five years ago.
Burd stressed, "today's share price represents a good entry point, and patient investors will likely see a 40-50% return on their investment within the next 18-24 months". Burd's guidance assumes that the economy will not improve until 2010, although he was encouraged by the recent slide in oil and grain prices. The CEO also highlighted his objective to maintain a "perpetual cost reduction" strategy aimed at the company's supply chain and SG&A centers.
Second quarter earnings: Although SWY beat analyst expectations by a penny, the quarter was much more extraordinary than what appears on the surface. Sales increased 3% from $9.8 billion to $10 .1 billion and earnings were rose 8% from .49 to .53, despite a 20 basis point reduction in gross margin from 28.51% to 28.31%.
The company emphasized that it had some unexpected headwinds to contend with, putting a .11 cent dent into earnings: (1) Its income tax rate increased 150 basis points to 37%; (2) holiday Easter sales were lost for the period as they were shifted to the subsequent quarter; (3) an increase of $7 million in property impairment charges. If you exclude these headwinds, SWY would have earned an astounding .64 for the quarter - amounting to a 31% increase in earnings and a 12 cent blowout of analyst expectations. SWY's exceptional quarter was aided by an $8 million drop in interest expense, a 36 basis point slump in SG&A costs, from 24.21% to 23.85.% and a 6 million reduction in shares outstanding.
Gift card Division: Blackhawk Network is SWY's rising star. Its "gift card division" offers an opportunity for consumers to purchase gift cards of other retailers in over 63,000 locations. The gift card business is a $200 billion a year industry and SWY is aiming at nabbing about a 2% market share equating to $4 billion. SWY's commission rate ranges from 3-6% (the higher rate for its own stores) so if you do the math, it is crystal clear that Blackhawk will be a future earnings driver. SWY is contemplating selling a small portion of Blackhawk, simply to make a strong statement to the investment community of Blackhawk's true value, which management believes is not fully reflected in SWY's current share price.
Healthcare Division: Steve Burd indicated that the cost of healthcare for SWY's 200,000 employees has actually decreased 13% in the last 3 years versus a 30% average increase for most company health plans. The company has been successful at cutting health costs by adopting a behavioral approach. This system rewards employees by enabling them to lower their premiums by exercising, eating better and keeping on top of their health needs by being more informed, and taking an added "preventative" approach by being more diligent about annual tests and doctor visits.
The company is also an advocate of generic drugs through its Pharmacy Benefits Manager partner. The grocer has been so successful with managing its own health plans, it created its own subsidiary to aid other company's seeking to improve their overall healthcare costs. This division, just like Blackhawk offers substantial growth opportunities.
Share buyback and dividend boost: The company had a $4 billion stock buyback plan in effect and just increased that commitment an additional $ 1 billion to $5 billion. There is approximately $1.45 billion still available for further purchases. SWY also boosted its cash dividend 20% from .069 per quarter to .082 per quarter. The shares are selling at a meager 11 times 2008 estimates, which is lowest among its peers, with the exception of Supervalu selling at 8 times forward earnings.
Real estate owned and Mexican Investment: The company owns the land and buildings on 41% of the 1743 locations it operates. They also own the real estate on 32 food processing plants and distribution centers throughout the US and Canada. There is hidden value on the balance sheet due to these real estate holdings since the properties were acquired at prices significantly lower than today's market prices. The company also retains a 49% equity stake in Casa Ley, a 137 unit chain located in western Mexico.
Looking down the road: I expect that management's guidance is on the conservative side as they are likely cognizant of the "drill" of under promising in order to over deliver. The last four analyst actions have all been on the negative side, and although harmful in the short term, a possible blessing in disguise. The downgrades tend to push the shares down to unrealistic price levels as well as ratchet overall expectations lower to levels that can easily be beat. The shares are at five year lows and extremely oversold, representing a compelling value situation for those willing to take a contrarian investment approach. It is certainly an understatement to say that these shares present a "safe way" to invest.
Disclosure: Long: SWY.
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This article has 3 comments:
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adan
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303 Comments
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Sep 07 08:44 AMwe've shopped at safeway's randall's store for literally decades, and have seen and enjoyed an incredible improvement in look and selection, particualrly organic and natural food selections
recently they added gas pumps out front which has been super convenient for us
so for what it's worth, the store seems more crowded, cleaner, and we'll continue to shop there
just an opinion from that sector (retail consumer) that generates the business the company needs to survive :-)
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unimpressedpragmatist
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74 Comments
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Sep 07 03:08 PMSince June, Safeway has been on a toboggan ride to the bottom of the hill. As to crowded stores, I know in the very large market place of the San Francisco Bay Area, the SW stores are, mostly, empty of shoppers more than they are crowded.
Last Friday, SWY dropped 4% in the market. Morgan Stanley downgraded Safeway shares to "Underweight"... from "Equal-weight&quo... and set a price target of $22, saying the company is stuck with an upscale strategy in a trade-down economy. Since the beginning of the year, SWY has dropped its stock price, nearly, 24%!
To compound their problems, many Safeway stores are competing in COSTCO dominated areas. Under normal conditions, that’s a no-win situation. In a recession, it’s a sure loser!
Safeway went overboard on an unnecessary and recklessly expensive rehab of their stores (measured in $ billions) over the last several years. Then, to recapture this expense, they raised their, already, high prices even higher. The same products are available, elsewhere in the neighborhood, for a lot less money. Ergo, no shoppers are present in the Safeway stores. Look for a loss in the 3rd qtr. and a bigger one in quarter 4.
Don’t let agenda driven analysts influence your stock decisions. And, if you currently hold SWY, dump it before it goes, even, lower (see the Morgan Stanley evaluation, above).
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djlresearch
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5 Comments
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Sep 08 08:34 AM