Safeway Profits Up, Stock Down

PLEASANTON, Calif. — The stock market took a “show me” attitude to Safeway's fourth-quarter financial results last week — driving the share price down in an apparent demonstration of dissatisfaction that the company's price investments have not shown up strongly enough on the top line, analysts told SN.

While earnings were up 12.3% to $338 million for the fourth quarter, which ended Jan. 3, sales rose 3.4% to $13.8 billion for the 17-week quarter and comparable-store sales, excluding fuel, were up 0.5%. For the 53-week year, net income increased 8.7% to $965.3 million, while sales rose 4.3% to $44.1 billion and comps, excluding fuel, rose 0.9%.

“We expect 2009 to be a good year for sales,” Steve Burd, chairman, president and chief executive officer, said in a conference call with analysts, with Safeway investing more in everyday prices than in promotions.

However, Safeway's stock price fell more than 10% in the hours after the numbers were released — a reaction one analyst said “indicated investor concerns over what the economy will do to food retailers in general and questions they have about the impact of reducing costs and investing in lower prices to drive more traffic.”

Burd said store traffic was down in the fourth quarter but has turned positive — with gains approaching 2% — in the first few weeks of the first quarter, “though if you adjust first-quarter sales for deflation in some commodities, we're at essentially the same run-rate as in the fourth quarter.

“We're seeing the economy softening and an acceleration of trading down, which are taking away from top-line sales. But we're also seeing early signs of deflation in commodities like dairy and produce, and that's a good thing because it should lead to higher volume.”

He said it's too early to quantify the rate of deflation. “It was modest in the fourth quarter, but quite measurable in the first quarter,” he noted.

Safeway expects to see ongoing increases in corporate-brand sales at the expense of national brands, Burd told analysts.

“Although some national-brand vendors have rolled back prices, others have said they will hold the line. Those are the companies that are selling less product, and they will keep selling less as long as their cost of goods is at that level, and they'll end up seeing market-share declines while we make higher margins on corporate brands.”

Burd said the gap in the growth rate of corporate brands vs. national brands is 1,000 basis points — “the biggest spread in modern times.”

He said Safeway expects to continue to reduce costs.

“We've spent 17 years building a culture of cost reductions, and nobody does it better,” he declared, noting that last year was the company's best in reducing costs.

According to Burd, 65% of the reductions Safeway experiences year-to-year are locked in, “and we're on track to reduce costs by more than 50% over last year.” Those cost reductions should offset some of the sales declines, he noted.

In terms of capital investment, Burd said Safeway plans to spend $1.2 billion this year to open 10 new lifestyle stores and complete approximately 135 remodels, compared with $1.6 billion spent last year for 20 new stores and 232 remodels. By the end of the year, 76% of Safeway's stores will operate with the lifestyle format, he said, with 88% completed by the end of 2010 and the balance in 2011.

With the lifestyle remodeling efforts nearing its end, Safeway expects to generate free-cash flow of $1 billion to $1.2 billion this year, “and I see great advantages to having an overpoweringly strong balance sheet,” Burd said, “because it enables us to borrow money at a much lower rate, to de-leverage a bit more and to seize opportunities we don't even know about yet.”