Safeway Sees Cost Pressures

PLEASANTON, Calif. — Safeway here expects deflation to decline and inflation to increase through the first half of the year but does not anticipate reflecting rising costs in its pricing immediately, Steve Burd, chairman, president and chief executive officer, told analysts last week.

“We're still in a relatively slow economy, and we can't pass all cost increases on in the form of higher retails right now, but that's just a temporary phenomenon.

“It's not because the competitive environment is getting worse, which it isn't, but because we are in an economy where operators are slow to make price movements that may disturb volume, so they make their price movements with much greater care, and they probably adjust everyday retails more quickly than they adjust promotional numbers,” Burd explained.

“But from a competitive standpoint, it won't be long before retailers reflect cost-of-goods increases, and I think the second half will clearly have inflation in it.

“We're seeing a bit of a recovery in the U.S. economy, but it's slow, and we don't think things will return to normal until 2011.”

Burd made his remarks during a conference call to discuss financial results for the first quarter, which ended March 27. The company reported net income fell 33.4% to $96 million, sales rose 1% to $9.3 billion and identical-store sales fell 3.1%.

During the quarter Safeway saw increased transactions per household and increased items per basket.

With the Canadian division converting to everyday low pricing during the quarter and with volume trends up in the first four weeks of the second quarter, “all 10 of our operating areas are showing improvements, which is something we haven't seen in a long time,” Burd said.

First-quarter sales were driven by a higher Canadian exchange rate and higher fuel sales, which were offset in part by volume declines and deflation, he noted. The drop in ID sales reflected Safeway's excessive promotions tied to the Super Bowl a year ago, the company said.

Burd said he expects earnings to strengthen as gross margins are able to rise as the year progresses. “Commodity prices in meat, milk and eggs are showing enormous volatility, and coupled with a little sensitivity on the part of retailers to not scare away volume, you end up being just a little bit ginger about making cost increases on the retail side.

“But at the end of the day, you've got to recoup it because retailers won't eat that inflation for a full year.”

He said he doesn't anticipate margin pressures in other categories. “We didn't work so hard in the last couple of years to suddenly give up our competitive price position. We did that to be at parity with our primary conventional competition, and we widened the gap with secondary competitors, so they're certainly not going to be encouraged not to recover their cost increases, nor will anybody else.”

Deflation was running at a rate of 1% during the first quarter, softening a bit to “an estimated zero to marginally negative” during the early weeks of the second quarter, Burd said. “We should end the second quarter with less deflation than we experienced in the first quarter, and with volume improving, that should yield better ID sales numbers.”

Burd also said private-label sales, “though not as strong as a year ago, are continuing to outpace sales of branded goods, and given our strategy, we expect to see private-label sales outpacing the growth of national brands past the economic recovery.”

Q1 RESULTS