Recently, Safeway (SWY) entered into an agreement to sell three of its Genuardi’s stores in Pennsylvania to Weis Markets, Inc. (WMK). However, the financial terms of the deal have not been disclosed.
The company’s decision was based on the prevailing economic scenario, which has led to food cost inflation during the first three quarters of 2011 and made consumers more price-sensitive. Retail inflation remains a constant overhang and companies like Safeway may find it difficult to pass on the increased prices to its customers owing to the tough competition.
This tough scenario has also induced certain consumers to opt for a less expensive mix of products or search for discounts on grocery items, all of which have impacted Safeway’s sales.
The company expects that these difficult economic conditions to persist for the time being. In the last reported quarter, gross margin of the company contracted 114 basis points (bps) year over year to 27.0%. Operating margin also decreased 11 bps year over year to 2.46%.
In an attempt to control operating expenses and to increase focus on areas with strong presence, the company entered into another agreement with Giant Food Stores (a division of Ahold, US) in early January to sell 16 of its Genuardi’s stores in the greater Philadelphia area. Moreover, the company has closed its distribution centers in British Columbia and Vancouver to lower its operating expenses further.
Additionally, in order to improve its bottom line amid a sluggish economic environment, Safeway has undertaken cost reduction initiatives focused on cost of goods sold and supply chain efficiencies. The company is building a distribution network in the US where some of its existing card content providers are becoming distributors, thereby reducing the number of retailers in the market.
Moreover, the company is focusing on shrink reduction, which will in turn increase its inventory level. Safeway expects pricing as well as volume to improve as the year progresses and to further benefit from the shrink reduction in upcoming quarters.
However, the company confronts a wide spectrum of competitive threats, especially from players like SUPERVALU Inc. (SVU), The Kroger Co (KR) and Wal-Mart Stores (WMT). Currently, we are Neutral on Safeway, which corresponds to the Zacks #3 Rank (Short-term Hold rating).
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