Safeway Inc. (SWY) reported net income from continuing operations of $108.0 million in the third quarter of 2012, much lower than $130.3 million in the year-ago quarter. However, the company’s earnings per share (EPS) of 45 cents in the reported quarter were 3 cents ahead of the Zacks Consensus Estimate and 18.4% above the year-ago quarter’s 38 cents. This was possible on the back of an approximately 31% reduction in the outstanding share count.
The company reported a nominal 0.2% year-over-year decline in total sales to $10.04 billion during the reported quarter, marginally missing the Zacks Consensus estimate of $10.22 billion. Disposition of Genuardi’s stores during the quarter combined with a lower Canadian exchange rate, partially offset by higher fuel sales impacted the quarterly sales result.
Although volume improved on the back of encouraging performance from the company’s loyalty card program, this was more than offset by larger-than-expected weakening in price inflation. All these resulted in a mere 0.1% rise in identical-store sales (excluding fuel).
Notably, earlier the company expected identical-store sales, excluding fuel, to rise in the range of 1–2% in the current fiscal. We expect volume trends to improve further with easing of inflation.
Gross margin in the reported quarter contracted 56 basis points (bps) year over year to 26.44%. However, excluding the 11 bps impact from fuel sales, gross margin declined 45 bps. This was on the back of higher expenses associated with the launch of ‘just for U’ loyalty program, cost associated with Genuardi’s stores dispositions, a marginally high shrink expense, higher revenue from the company’s low-margin Blackhawk business and change in sales mix, partially offset by lower LIFO expense.
Operating income during the quarter decreased 12.1% year over year to $218.3 million, resulting in a 30 bps drag in operating margin to 2.17%.
Safeway exited the quarter with $202.8 million in cash and cash equivalents, down from $729.4 million at the end of fiscal 2011. Net cash flow provided by operating activities in the first 36 weeks of 2012 was $358.5 million compared to $710.9 million in the year-ago period due to greater use of cash for working capital in 2012, driven by increased inventory and settlement of Blackhawk payables, partly offset by lower corporate pension contributions.
Safeway made no share repurchase during the third quarter of 2012. Year to date, the company repurchased 57.6 million shares for $1,240.3 million (including commissions) and is now left with $0.8 billion of authorization to buy back shares.
In the third quarter of 2012, Safeway incurred $159.2 million in capital expenditures. The company opened 1 new Lifestyle store, completed 1 Lifestyle remodel and closed 23 (including 17 Genauardi’s) stores during the quarter.
Safeway reiterated its 2012 EPS guidance of $1.90–$2.10. Operating profit margin change, excluding fuel, is expected to range from positive to negative 5 bps. The company also expects free cash flow in the range of $850–950 million (unchanged).
In fiscal 2012, Safeway expects to incur approximately $900 million in capital expenditures to open 10 new Lifestyle stores and complete 5 Lifestyle remodels, refurbish in-store pharmacies and develop properties.
Safeway has been witnessing a sluggish revenue growth over the past few quarters due to economic uncertainty impacting the company’s lifestyle strategy. However, we are impressed by Safeway’s constant efforts to capture market share with its value-added offerings, which are expected to enhance brand equity and reduce the company’s dependency on price.
We are also encouraged with the company’s successful rollout of “Just for U” loyalty program. According to the company, during the reported quarter, the incremental sales through just for U helped offset lower inflation and increase volume.
The company expects in the fourth quarter, identical-store sales will improve with increased just for U engagement, roll out of Safeway’s partner fuel loyalty program and launch of Wellness initiative. We believe, these initiatives will help the company gain market share from competitors like Supervalu Inc. (SVU), The Kroger Co (KR) and Wal-Mart Stores (WMT). Also these are expected to reduce costs and enhance shareholder wealth. We currently have a Neutral recommendation on Safeway, which carries a Zacks #3 Rank (short-term Hold rating).
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