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Safeway Flounders When It Should Be Cruising

Posted: Jul 24, 2008 09:20 AM by Glenn Curtis

Tickers in this Article: SWY, KR

We all have to eat, and so the conventional wisdom follows that grocery chains are safe investments during trying times. When other sales drop off, food sales should always be steady, right? Grocery chain Safeway (NYSE:SWY) has offered the market a little more proof that blindly following conventional wisdom can be dangerous.

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Safeway's second-quarter sales were weak, and its estimates for the rest of the year didn't encourage optimism.

Safeway's Sales Slump
On the earnings side, Safeway did pretty well. In the period ended June 14, it earned $234.3 million, or 53 cents a share. That's a decent jump from the $218.2 million, or 49 cents per share, it earned in the same period last year. For the record, it was also a penny north of Street expectations. These earnings were solid, if unspectacular, but it's the sales line that gives me pause.

In the quarter Safeway generated sales of $10.1 billion, which was a roughly 3% increase over the $9.8 billion it generated in the same period last year. In the quarter its same store sales (excluding fuel) dropped 0.3%. I see three things wrong with these sales numbers.

Analysts were expecting the company to generate about $10.25 billion in revenue during the quarter. Now this is hardly a dramatic miss to be sure, but one nonetheless that I think could cause analysts and/or institutional players to shy away from the stock. (For more on analyst expectations, read Analyst Forecasts Spell Disaster For Some Stocks.)
A 3% top line growth isn't overly impressive when you consider that it will likely see margin pressure due to increased cost of goods sold. Note that in Q2 its gross margin came in at 28.31% which was a 20-basis point drop from the 28.51% it posted in the comparable period last year.
Finally, Safeway's same store sales can't compete with those of rival chain Kroger (NYSE:KR). In its first quarter ended May 24t, Kroger saw its same store sales (excluding fuel) jump 5.8%. Enough said.

Where Are We Going?
To its credit management did reiterate 2008 earnings guidance. It's calling for earnings of $2.25-2.35 per share, which is consistent with what it offered up in conjunction with its Q1 results. However, in its press release Safeway revised guidance for same-store-sales growth, excluding fuel, to 1.0-2.0% from a range of 2.0-2.3%. This is a problem.

I'm concerned Safeway may have trouble hitting the upper end of its earnings forecast in particular. Also, if management is ratcheting this number down, how do we know its not a harbinger of more problems down the road? The investment community is left wondering if there is another shoe that will drop. And we all know how investors just love uncertainty.

Bottom Line
I like Safeway, but its second-quarter results and forward looking comments lead me to believe that the stock could flounder in the near-term.

To get started on your own analysis, check out Analyzing Retail Stocks.

By Glenn Curtis

Glenn Curtis started his career in the 1990s as an equity analyst for a regional firm in New Jersey. There, he covered companies in the technology, entertainment, and gaming industries. Curtis has since worked as a financial writer at a series of both web and print publications, including TheStreet.com and Registered Rep Magazine. He has held his series 6,7,24, and 63 securities licenses.

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