Safeway's Profit Growth Fueled by New Vehicles

ELLIOT ZWIEBACH

SAN FRANCISCO — Safeway believes it can sustain earnings per share growth of 12% to 15% over the next few years — and re-emerge as the growth company it was in the 1990s — through a combination of ongoing lifestyle store conversions, making acquisitions in new markets, developing new store formats, growing its third-party marketing business and using club card data to develop more effective programs.

Steve Burd, chairman, president and chief executive officer of the Pleasanton, Calif.-based chain, made those predictions here last week at the company's annual investors conference.

With analysts' expectations of Safeway's annual earnings growth rate at a consensus level of 10.8%, Burd noted, “you might ask how one of our competitors” — presumably Kroger Co., though Burd did not identify the competitor by name — “can say it expects to grow earnings at 8% and we say we're going to grow at 12% to 15%. Part of the difference is Blackhawk Network.”

Blackhawk is a division Safeway developed in 2001 to create marketing initiatives outside the supermarket norm, Burd said. Its chief initiative currently involves marketing third-party gift cards at Safeway and through other outlets around the country — a business that has grown at a rate of 100% in each of the last few years and that is expected to grow at a rate of 80% going forward, he indicated.

“If Blackhawk's business grows at the 80% level we expect, then supermarket growth could be anemic — around 5%, though we don't expect that — and we'd still hit a 12% growth rate,” Burd said. “With the national distribution channel we have established [through Blackhawk], we have the opportunity to add new products and services to the offering, which could be an explosive growth engine.”

Don Kingsborough, CEO of Blackhawk, said Blackhawk has expanded distribution to chains that include Publix, Ahold, Roundy's, Giant Eagle, A&P and Sobeys, with growth in Europe, Asia and South America scheduled over the next couple of years. Blackhawk has already expanded its business to encompass cards for sports and entertainment venues as well as open-loop cards, Kingsborough said, and the company expects to unveil seven new initiatives over the next few years “with growth possibilities that may exceed [growth in] the gift-card business,” he added.

He said Safeway expects Blackhawk to contribute $100 million to pretax income in 2007.

Citing another growth possibility, Burd said Safeway would consider moving into new markets through acquisitions “over the next five to 10 years.”

“We believe acquisitions will be more of a growth vehicle for us in the next few years than it looked to be two or three years ago because we see what the lifestyle stores have done within our own retail operations, and we're looking for opportunities to overlay that into another market environment.”

Robert Edwards, executive vice president and chief financial officer, said the lifestyle stores Safeway has been opening since 2003 continue to show strong results in their third year. “Sales in the first year are very robust, sales in the second year are still very strong — just under half of first-year sales — and sales in the third year are slightly down from year 2 but are at levels any supermarket company would be proud to have as identical store sales,” he explained, without being more specific.

He said lifestyle stores perform well against conventional, price and niche competitors, “though our strategy is to take market share from conventional competitors,” Edwards explained. He also said the lifestyle stores deliver attractive sales increases and rates of return regardless of their size or the demographic makeup of a given area, “and we're optimistic we'll be able to deliver similar results going forward.”

Edwards said 760 Safeway stores, or 43% of the store base, will have been converted to the lifestyle format by the end of 2006, with expectations of achieving 60% penetration by the end of 2007 and 94% penetration by the end of 2009.

Safeway will earmark $1.7 billion for capital spending next year to open 25 new stores and remodel 275, and it expects to complete 300 new stores and remodels a year in 2008 and 2009 at a similar rate of investment — approximately 3.4% of sales — Edwards said. Beginning in 2010 Safeway expects to reduce capital spending to a level of about 2.9% of sales, he added.

Burd said Safeway has been opening 80 new stores a year, “and a company of our size can probably spend 3% of sales and do 40 or 50 new stores a year, plus remodels. When we're spending at that level, we could increase the number of remodels, but it would also allow room for initiatives to invest in our infrastructure or to move to new markets with lifestyle stores that would require more capital.”

Edwards said lifestyle stores operate under six different formats: a standard model, three gradations known internally as “lifestyle plus” and two gradations that incorporate fewer elements than the standard model, called “lifestyle light.”

According to Burd, “These are not six new formats. They are conventional supermarkets that are assorted differently to meet the particular needs of customers with all the right bells and whistles.”

However, he said Safeway would consider new formats as a growth engine.

In another presentation, Brian Cornell, executive vice president and chief marketing officer, said Safeway is about to introduce a new brand — Eating Right, geared to customers concerned with health and wellness. He also said Safeway is using consumer-driven insights to improve pricing, selection and promotions.