SAFEWAY TARGETS SHRINK REDUCTION

ELLIOT ZWIEBACH

PLEASANTON, Calif. - Safeway here said last week it expects to continue to reduce shrink by applying additional best practices to the center store.

Speaking with analysts last week to discuss the company's strong financial results for the first quarter that ended March 25, Steve Burd, chairman, president and chief executive officer, said one of the chain's divisions, which he did not identify, "outshines the others [in terms of shrink control in the center of the store], and we are trying to transfer those procedures to other divisions, so in the second half we will see the benefits of shrink reduction on a broader base."

During the quarter, he said shrink declined 18 basis points, although that decline was offset by "select investments in pricing and advertising and increases in energy-related costs," he noted.

Asked if there is any limit to how much longer Safeway can continue to achieve shrink reductions, Burd replied, "Our long-term objective is to continue to reduce shrink over the next four to five years, and so far this year we're running ahead of our own goals. As long as we continue to increase sales, we will see flow-through in shrink."

Sales for the 12-week quarter rose 3.2% to $8.9 billion, while comparable-store sales rose 1.7%, excluding fuel, and net income increased 8.8% to $142.9 million, or 32 cents per share - 2 cents better than consensus estimates, Burd pointed out. He said earnings exceeded the chain's internal expectations, despite $6 million in employee buyouts, which translated to 1 cent per share, and rapidly escalating fuel costs, which affected margins by more than $6 million, or just over 1 cent.

"And we were able to produce a double-digit increase in earnings per share [10.3%] despite the shift of Easter from last year's first quarter to the second quarter of this year," he added.

"Clearly, the Safeway turnaround is gaining traction," said John Heinbockel, an analyst with Goldman Sachs, New York.

Among the encouraging factors, he said, was Safeway's ability to exceed consensus earnings expectations - "the first clean 'beat' in a while," he noted, which reflects Wall Street's overestimation of the adverse impact of the late Easter. "EPS quality was quite good," he added, with Safeway able to hit or exceed expectations despite a higher than expected tax rate.

The federal tax refund of approximately $259 million that Safeway previously announced it would be receiving will be recorded in the second quarter as an increase to additional paid-in capital, Burd said.

Burd said he's been discouraged by fuel margins "because the rise in fuel costs has been extraordinary and has squeezed margins for a sustained period of time. Gas is the lowest-margin component of our business, but we are the price leader on gas and we use that to bring people to the stores. We're seeing more people than we used to at stores with fuel stations, so while we lose margin, we gain traffic from those consumers at the stores."

Burd said he does not see consumer demand dampening in the face of higher fuel prices. "We've seen baskets go up as people get more efficient in their shopping trips because our stores are more conveniently located than discounters, but while it hurts margins on the fuel side, it helps on the identical-store-sales side."

He said Safeway began reducing opening expenses for remodeled lifestyle stores in the fourth quarter and is satisfied that approach does not impact performance.

He said he continues to believe the sale of Albertsons will provide opportunities to buy some locations, and he said he has not seen any change in behavior at Albertsons since the deal was announced.

1ST-QUARTER RESULTS

Qtr Ended: 3/25/06; 3/26/05

Sales: $8.9 billion; $8.6 billion

Change: 3.2%

Comp-store: 1.7%*

Net Income: $142.9 million; $131.3 million

Change: 8.8%

Inc/Share: 32 cents; 29 cents

*Excluding fuel