Safeway Seen Poised For Ongoing Growth

ELLIOT ZWIEBACH

PLEASANTON, Calif. — Safeway's newly outlined growth vehicles should help it sustain sales and earnings growth for the next several years — as long as consumer spending doesn't slip — according to industry analysts.

Safeway here earlier this month said it plans to introduce three growth vehicles in 2008: a new store format; an effort to sell its O Organics and Eating Right brands to other companies; and a health care-related business that leverages the chain's knowledge and experience in reducing costs.

While Safeway officials were not specific about what the new format will be, some analysts said they expect it to be a smaller store — possibly 5,000 to 10,000 square feet — that will focus on perishables and the chain's new Signature Café line of home meal replacement items that were developed at Citrine Bistro, its restaurant.

“Although management was ambiguous about the identity of the format, it did say it would leverage the company's core competencies, [which] we deem to be perishables merchandising, customer service, consumer data and perhaps fuel,” said John Heinbockel, an analyst with Goldman Sachs, New York. “Hence, our best guess is this could be a fresh-food convenience store [that] would enable the company to gain share in the food-away-from-home space.”

Deborah Weinswig, an analyst with Citigroup Global Markets, New York, suggested Safeway may be considering “a format focused on home meal replacements.”

Another analyst, who declined to be named, said testing a smaller-format store is the right business approach, despite comments by Safeway management that the company is not being adversely impacted by the small-format Fresh & Easy stores Tesco has been opening. “Experimenting with a look-alike concept is a positive move, because it will allow Safeway to understand what a competitor is doing,” he told SN.

In regard to offering its proprietary brands to other retailers, the analyst said, “Safeway is not a national chain, and there are huge regions in the Northeast, the Southeast and most of the Midwest where it does not compete, so there could be a customer base for those items.

“On the other hand, what makes O Organics and Eating Right successful at Safeway is that the price gap with other natural food items is accentuated, which is an approach to category management not all operators might wish to adopt.”

As for spreading the knowledge it's gained in the area of health care cost savings, the analyst said, “I give Safeway a lot of credit for what it's been doing in terms of reducing the cost structure in health care, and it's a good thing for the industry. While I'm not sure if that can be marketed to other companies, I think it's a shrewd move on Safeway's part.”

According to Heinbockel, “[While] management believes it can help virtually any company to noticeably reduce its health care expenditures, it remains to be seen if others would agree with this assessment and be willing to pay Safeway for the service.”

However, according to Weinswig, “Many CEOs of Fortune 500 companies have contacted Safeway to learn how to implement health care programs to reduce overall expenditures, and Safeway is likely to be generating some consulting fees in sharing its knowledge and experience in lowering costs.”

Assessing Safeway's financial prospects, Heinbockel said, “There is much to be encouraged about [at Safeway]. The core supermarket business is showing no signs of the consumer spending slowdown, and with the lifestyle remodel program only two years from completion, earnings visibility is terrific through 2010.

“Blackhawk [the chain's third-party gift card business] is poised to grow well above 50% for the foreseeable future. [Combined with] new growth ventures [that] will debut in 2008, these developments should drive meaningful upside.”

The only possible risk to that upside, Heinbockel noted, would be what he termed “a deeper-than-expected slowdown” in consumer spending.

Weinswig was also bullish on Safeway's prospects, indicating she is “encouraged by the continued strong performance of lifestyle stores, the growth trajectory of Blackhawk and the potential of three newly announced growth vehicles. But we are keeping an eye on whether or not Safeway's premium positioning has been negatively impacted by the weakening consumer environment,” which it has not been to date, she added.

With the completion of Safeway's conversion to a lifestyle format by 2009, the company said capital spending will return to more normalized levels.

Karen Short, an analyst with Friedman Billings Ramsey, New York, also raised the possibility that Safeway might consider selling its Canadian operations. “No mention of the sale of Canada was made [at the conference],” she noted, “but we continue to believe Canada should be monetized. We think a sale could generate in excess of $3.4 billion, or $8 per share.”