Safeway Inc. (SWY) reported EPS of 30 cents in the first quarter of fiscal 2012, in line with the Zacks Consensus Estimate. Quarterly earnings, however, were well above the year-ago level of 7 cents, which included a tax charge of 22 cents per share related to the repatriation of $1.1 billion from Safeway’s Canadian subsidiary.
Despite the New Year’s holiday shift, weather patterns and high gasoline prices leading to sluggish sales, several cost reduction initiatives during the quarter helped the company improve its bottom line.
The company reported total sales of $10.0 billion during the reported quarter, marginally missing the Zacks Consensus Estimate of $10.08 billion but increasing 2.4% year over year. Despite flat year-over-year identical-store sales, the upside in sales was attributable to higher fuel sales coupled with higher revenue from Blackhawk commissions and additional sales from new stores.
Gross margin in the reported quarter contracted 70 basis points (bps) year over year to 26.8%. However, excluding the 62 bps impact from fuel sales, gross margin declined 8 bps. Operating profit during the quarter decreased 13.4% to $189.8 million, resulting in a 35 bps drag in operating margin to 1.89%.
Safeway exited the quarter with $134.5 million in cash and cash equivalents, down from $729.4 million at the end of December 2011. Net cash flow used by operating activities in the quarter was $541.8 million compared with $60 million in the year-ago quarter due to greater use of cash for working capital in 2012, driven by inventory renewal and the settlement of Blackhawk holiday payables.
The company repurchased 46 million shares during the quarter for $1 billion. The company also increased the authorization for stock repurchases by $1.0 billion. It is now left with $1.1 billion of authorization to buy back shares. From the end of the reported quarter till April 25, 2012, Safeway repurchased 10.6 million shares for $219.5 million (including commissions).
In the first quarter of 2012, Safeway incurred $308.4 million in capital expenditures. The company opened 4 new Lifestyle stores and closed 7 stores during the quarter.
Outlook
Safeway reiterated its fiscal 2012 EPS guidance of $1.90-$2.10. Also, the company expects identical-store sales, excluding fuel, to rise in the range of 1-2%. 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.
In fiscal 2012, Safeway expects to incur approximately $900 million in capital expenditures, open 10 new Lifestyle stores and complete 10 Lifestyle remodels.
Recommendation
In order to improve its bottom line in a recessionary environment, Safeway has stepped up its efforts to reduce cost, which we believe will improve its margins in the upcoming quarters. However, we are concerned regarding flat identical store (excluding fuel) sales of the company during the quarter that was affected by prevailing weak macroeconomic conditions.
The macro environment in the U.S. and Canada is taking a toll on consumers. Falling consumer confidence is forcing people to opt for cheaper substitutes or cut back on overall spending.
Safeway confronts a wide spectrum of competitive threats, especially from SUPERVALU Inc. (SVU), The Kroger Co. (KR) and Wal-Mart Stores (WMT).
Safeway currently retains a Zacks #2 Rank (short-term Buy rating). Over the long term, we are Neutral on the stock.
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