Inflation Tempers Safeway's Optimism for 2nd-Half Earnings

JON SPRINGER

PLEASANTON, Calif. — While performance at remodeled lifestyle stores continued to drive sales for Safeway through the first half of the year, the retailer here last week expressed concerns that inflation and shrink in the second half of the year could constrain earnings growth.

Speaking to analysts during a conference call to discuss financial results for the fiscal second quarter ended June 16, Steve Burd, chairman, president and chief executive officer, said that despite strong sales trends, he would not raise his estimates of yearly earnings per share, but instead narrowed the expected range to $1.95-$2 per share from $1.90-$2 per share.

“As good as we feel about the back half of the year, we think there is enough inflation and worry out there that we just want to be a little cautious,” Burd said.

Safeway experienced “lag” in passing along price increases for items like milk, meat and produce during the quarter, Burd said — enough to affect earnings by 2 cents per share. He described price inflation as the most he'd seen in 15 years, making the coming months difficult to predict.

“If inflation moderates, we have an opportunity to do better than we are currently contemplating,” he said. “But I don't know what the second half is going to bring, and we just want to be careful about it.”

Adding to Burd's trepidation was a shrink reduction program that during the first half of the year underperformed against aggressive goals. He noted that the company was cycling big gains in shrink reduction in the year-ago period.

“We have come up short against our shrink targets. We have lost no ground to what we gained last year,” Burd said. “But we just haven't hit those numbers we believe we could.”

Net income of $218.2 million was down by 11.4% compared with the same period a year ago, though Burd noted that last year's second quarter was boosted by an income tax refund. Gross margins fell by 15 basis points during the quarter, although, excluding gasoline, gross profits were flat. Gross margin increased by 20 basis points in the first quarter, however.

Sales increased 4.9% to $9.8 billion, with identical-store sales, excluding fuel, increasing by 3.7%.

Burd said the sales performance reflected continuing positive results of lifestyle store remodels. Nearly half of Safeway's 1,740 stores have received the new format so far, with the company aiming to complete 60% of the chain by the end of the year, Burd said.

Inside the stores, Burd said the recently introduced Eating Right brand of private-label packaged goods is outperforming Safeway's O Organics line at the same period in its growth, despite fewer SKUs in the line.

“O Organics was a huge win last year, with $164 million in sales, and we will threaten $300 million this year on O Organics,” he said. “The Eating Right brand has roughly half the SKUs of O at the same stage and is outpacing O Organics.

“Our feeling is that Eating Right will be equally as good as O Organics,” he added. “I think we just broke Hank Aaron's home run record with O Organics, and maybe we are on the way to doing that again with Eating Right.”

Burd was confident that Safeway can handle new competitors expected to arrive in its operating areas in Southern California (Tesco's Fresh & Easy — see story, this page) and Northern California (Save Mart's rebranding of Albertsons stores there to the Lucky banner — see Page 4) beginning later this year.

“If I had a bunch of money for every time we were going to be killed by Wal-Mart and Costco and Whole Foods, I would have a higher net worth,” Burd said. “My general attitude about Tesco is they are highly respected. I expect them to take somebody's business, we just don't expect it to be ours.”

About Lucky, he remarked: “The brand has been out of this market for six or seven years. We are not at all concerned about somebody bringing that brand back.”