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Price Cuts Drive Gains at Safeway

Safeway here last week it believes that investing savings from its ongoing cost reductions in lower prices is driving sales gains and will also enable the company to grow earnings. Wall Street analysts said they are encouraged at the prospects, but are taking a wait-and-see attitude. Speaking with analysts during a conference call last week, Steve Burd, Safeway's chairman,

PLEASANTON, Calif. — Safeway here said last week it believes that investing savings from its ongoing cost reductions in lower prices is driving sales gains and will also enable the company to grow earnings.

Wall Street analysts said they are encouraged at the prospects, but are taking a wait-and-see attitude.

Speaking with analysts during a conference call last week, Steve Burd, Safeway's chairman, president and chief executive officer, said there is a perception that if the company invests more in lowering its prices, its profits will suffer.

“That is not the case,” he asserted. “We see a lot of opportunities to lower costs, and then use what we save to finance price investments. And if we get good sales results, as we anticipate, we can grow earnings in 2009 and beyond.”

Burd made his remarks while discussing financial results for the third quarter and the 36-week year-to-date period, which ended Sept. 6.

For the 12-week quarter, net income rose 2.6% to $199.7 million and sales and other revenues increased 3.9% to $10.2 billion. Identical-store sales, excluding fuel, were up 0.5%. For the 36-week period, net income grew 6.9% to $627.4 million, while revenues climbed 4.7% to $30.3 billion.

The company said sales increases were driven by higher fuel sales and by contributions from its lifestyle store remodels, which now represent about 66% of the chain's store base.

Burd said Safeway had same-store sales gains exceeding 1.5% during the first five weeks of the fourth quarter — a result he attributed to the company's ongoing price investments, and “not a blip on the screen.”

Analysts saw some good trends among the company's quarterly data.

John Heinbockel, an analyst with Goldman Sachs, New York, said that although the results were “not exactly robust,” they “provided evidence the company is effectively managing through a difficult environment, and just may have seen the trough in [identical-store sales] momentum.

“On the positive side, sales momentum is encouraging,” he said, pointing to the increased same-store sales during the first weeks of the fourth quarter. “Although a portion of this improvement clearly stems from an uptick in pricing investments, it is encouraging that the consumer is responding, especially in light of the downturn in economic activity post-Labor Day.

“On the negative side, earnings quality wasn't great, but this performance is actually decent given the soft consumer, especially in California,” where Safeway operates a large portion of its stores.

According to Meredith Adler, an analyst with the New York office of London-based Barclays Capital, any changes in consumer perceptions of Safeway's pricing are likely to develop slowly, “so we think Safeway will have to work very hard to lower its cost structure if it is to offset the price investments sustainably.

“Management firmly believes cost savings coming from its initiatives will provide adequate funding for its price investments, [and] this will be, in our view, the most important driver of earnings performance in the next year or so.”

Deborah Weinswig, an analyst with Citigroup, New York, expressed some skepticism. “We were impressed by the company's ability to lower expenses to offset the weak sales environment and pressure on gross margin from inflation and price investments. While sales appear to be improving sequentially, we would remain on the sidelines due to potential pressure on sales from the weak macro environment and gross margin pressure from price investments and inflation.”

According to Burd, cost reductions are coming in part from taking work out of the stores “and making operations more efficient, which allows us to reduce labor. Removing even one second at the check-stand can save millions of dollars, and we believe there's a lot more we can do, and that's what we plan to address in 2009 and beyond,” he said.

Asked about Safeway's small-format store, The Market — a 15,000-square-foot remodeled Vons location in Long Beach, Calif., that it reopened under the new banner earlier in the year — Burd said the company has been surprised by some of what it's learned from that store.

“It's proven we can make money off a small store, and we've learned a lot that we might be able to use in our conventional stores, particularly about a smaller SKU count.

“We reduced the Center Store variety for the smaller store by more than 50%, which required radical thinking, yet we've still increased sales over the store that had previously operated there.

“So now we know we can take an undersized store of 40,000 square feet and create the perishables experience of a 55,000-square-foot store without sacrificing much in the Center Store area, because we can reduce the SKU counts in ways we hadn't realized before.”

Q3 RESULTS

Qtr Ended 9/6/08 9/8/07
Sales $10.2B $9.8B
Change +3.9%
Comp-store +0.5%*
Net Income $199.7M $194.6M
Change +2.6%
Inc/Share 46 cents 44 cents
36 Weeks 2008 2007
Sales $30.3B $28.9B
Change +4.7%
Comp-store N/A
Net Income $627.4M $587.2M
Change +6.9%
Inc/Share $1.43 $1.32
*EXCLUDING FUEL