Promotions Hurt Safeway's Q1

PLEASANTON, Calif. — Safeway's stock took a hit last week as the company guided sales and earnings downward for the balance of the year and acknowledged a miscalculation on the impact of a heavy margin investment.

“We consciously made some aggressive promotional investments in the middle of the period — during the four weeks after the Super Bowl — that we thought was worth a risk,” said Steve Burd, chairman, president and chief executive officer, in a conference call discussing first-quarter results. “We thought it would flesh out the earnings side, so we spent the money and didn't get the kind of return we expected to get.”

Burd said the investment cost Safeway 38 basis points in gross margin — a price investment of approximately $35 million, according to one retail analyst.

Asked why the investment didn't work, Burd said, “These are really unprecedented times, and old models may not apply, so [the program] didn't get the result we expected. We thought it was worth the shot, and we took more risk than would be normal, but it didn't work.”

He said it was not any competitive response that hurt the effort. “The bottom line is, consumers were not inventorying product. We were trying to put more items in the basket and it just didn't happen.”

John Heinbockel, an analyst with Goldman Sachs, New York, said he was surprised by Wall Street's negative reaction to Safeway's first-quarter results, “[since] the company is taking tangible steps to improve its competitive position; it has brought its earnings per share guidance down to more appropriate levels; and its cash flows remain strong.”

Neil Currie, an analyst with UBS Warburg, New York, said he is pleased to see Safeway addressing its high-price image, “but as we have noted in the past, we felt that balancing the investment with cost savings and sales increases would be a challenge initially.”

He said price re-positioning is the right thing to do, “and it's easier to do when product costs are declining.”

Another analyst told SN she believes the large margin investment “indicates Safeway has been too high-priced for too long.” She also said the miscalculation in margin investment may indicate that Safeway isn't using its loyalty card data as well as its competitors.

Net income for the quarter, which ended March 28, fell 25.4% to $144.2 million, while sales declined 7.6% to $9.2 billion. Comparable-store sales, excluding fuel, dropped 0.7%. Excluding the impact of the shift of Easter to the second quarter, the company said comps would have been up 0.2%.

Burd said the drop in earnings was the result of several factors, including the investment in gross margin, which accounted for declines of 8 cents per share; the shift of Easter (4 cents per share); the drop in fuel margins (2 cents per share); and the currency exchange rate with the Canadian dollar (2 cents per share).

During the call Burd revised Safeway's earlier earnings guidance, saying the company expects earnings per share for the year to fall in the range of $2.10 to $2.30 — compared with the previous range of $2.34 to $2.44 — and sales increases of 0.5% to 1.5%, down from earlier guidance of 2% to 3%.

At the time it issued the guidance last December, Burd said, “We didn't expect the economy to necessarily get better, but we didn't expect it to necessarily get worse. But what we're seeing is an economic decline that has really been elongated.”

Burd said gross margin excluding fuel declined 86 basis points during the first quarter, of which 38 basis points came from the promotional spend during the four weeks that began with the Super Bowl.

Burd said Safeway expects to use an incoming tax refund to invest in price moving forward. “We've already invested in items that are really sensitive to consumers, where we can get an immediate demand response, and now we will get into those categories that are not purchased as frequently and for which it's not as easy to convey to consumers that we've made the investment and therefore you don't get the demand response [as quickly].”

In other comments during the call:

• Burd said Safeway plans to cut capital spending more than originally forecast — moving from its original estimate of $1.7 billion for the year to $1.2 billion and now down to $1 billion as the company completes its lifestyle makeover.

• Burd also said he expects free cash flow to fall in the range of $1 billion to $1.3 billion, compared with earlier guidance of $1 billion to $1.2 billion. Safeway expects to use free cash flow to reduce debt, increase dividends and buy back stock, he noted.

Q1 RESULTS