Safeway: Deflation Cuts Gains

PLEASANTON, Calif. — Safeway here believes its price-reduction efforts are beginning to pay off in stronger volume numbers, though an unanticipated spike in deflation is offsetting those improvements, Steve Burd, chairman, president and chief executive officer, told investors last week.

Sales gains in the second quarter and first half, which ended June 19, were basically flat, driven primarily by a more favorable Canadian exchange rate and higher fuel prices but offset by a 2.5% decline in identical-store sales and a deflation rate of 2.4%.

“With normal inflation of 3% instead of deflation, our ID number would have started with a 4,” Burd said, “so we feel very good about our volume.

“And based on the first 4½ weeks of the third quarter, it looks like that will be our single best quarter for volume in more than four years, and we believe the fourth quarter will be stronger than the third.”

Net income for the second quarter fell 40.8% to $141.3 million while sales crept up 0.6% to $9.5 billion; for the half, net income dropped 38% to $237.3 million and sales rose 0.8% to $18.9 billion.

The company said results in last year's second quarter included a tax benefit of $57.8 million, or 14 cents per share, from the resolution of a tax matter.

Safeway lowered its guidance for the year, forecasting earnings in the range of $1.50 to $1.70 per share — compared with prior guidance of $1.65 to $1.85 per share — and identical-store sales between minus-1% and minus-1.5%, compared with earlier predictions of 0% to 1% gains.

Andrew Wolf, an analyst with BB&T Capital, Richmond, Va., said the volume trends Safeway is seeing “are consistent with what I've been seeing industrywide — that volume has been improving — though Safeway is performing as well as or better than the industry.

“While many had expected pricing to recover by the middle of this year, it now appears it will take a full year for pricing to recover,” he said. “Volume recovered in the first half of the year, and pricing will recover in the second half.”

Safeway sought to lower its prices to parity with other conventional operators in the U.S. during last year's third and fourth quarter and in Canada during this year's second quarter, “and as a result, our first-quarter volume this year was better than last year's fourth quarter, the second quarter was better than the first and the first 4½ weeks of the third quarter are better than the second by a wide margin,” Burd said.

“Volume improvements are not uniform across all geographies but they are universal, with all divisions showing improvements since the fourth quarter. In fact, six of the 10 divisions have improved more than 200 basis points, with some over 300 basis points.”

According to Burd, it may take awhile for consumers to give Safeway credit for its lower pricing. “It could take four or five years to win any pricing surveys, but getting the volume first is preferable, even if we're not seen as the best price guy,” he pointed out. “Consumers know when you've lowered prices, and they reward you accordingly.”

Burd said 75% of Safeway's volume increases can be attributed to pricing and 25% to merchandising and communications.

He also said transactions are up and items per transaction are up, “which was our one objective all along — to get customers to come in more often and to buy more.”

The level of competition is about the same as it has been, he added. “Some companies didn't respond to our price changes, while some increased prices as their own volume deteriorated. As a result, we find our price position compared with secondary competitors has widened, and while that may make it tempting to raise prices, we can't do that because of other competition.”

Burd said Safeway was expecting a stronger return of inflation. “We had predicted 1% deflation in the first quarter, which is what we had, and 0.5% inflation in the second quarter, but we ended up with 2.4% deflation in terms of price per item at the retail level in the second quarter, and that was a big surprise.”

He predicted a return to more traditional inflation rates by late 2011.

Among other comments during the conference call:

• Burd said Safeway has reduced shrink by $600 million over the last eight years.

• An employee buyout in one of its markets during the first quarter impacted earnings per share by 2 cents.

Q3 RESULTS