TURNAROUND AT SAFEWAY

ELLIOT ZWIEBACH

OAKLAND, Calif. -- The Steven A. Burd era at Safeway is off to a fast start.

Since Burd, president and chief executive officer, assumed major decision-making control of the 1,089-unit company here a year and a half ago, Safeway has achieved high levels of success by reducing operating costs and reinvesting some of the money saved to drive sales.

But there's a lot more to be done.

"At Safeway we think we're writing a five-year story," Burd said recently at the Lehman Bros. food retailing conference in New York.

The one-year story is already a very positive one, with earnings

up 183% in 1993, compared with a drop of 21% in 1992. Sales increased 0.4% to $15.2 billion, compared with a gain of 0.2% in 1992, when there was an extra week in the fiscal year.

The first-quarter results -- reported last week -- have gotten the second-year story off to a positive start. During the first quarter ended March 26, earnings were $41.9 million compared with a loss in the prior year, and sales increased 2.6% to $3.5 billion.

More significantly, Safeway reversed a yearlong same-store-sales decline in 1993, and has since achieved improved same-store sales results for five consecutive quarters. During 1993 same-store sales jumped 2.1%, and the upswing continued in the first quarter this year with a 4.2% same-store increase.

In addition, eight of Safeway's nine divisions showed positive comparisons during last year's third quarter, and all nine showed increased comparable-store sales during the fourth quarter, company officials told SN.

"It's the most dramatically successful turnaround I've ever seen," said Gary Giblen, a securities analyst with PaineWebber, New York.

While acknowledging Safeway's success under Burd, Jonathan Ziegler, an analyst with Salomon Bros., New York, said, "The results are great, given where Safeway has been, but they've basically put the company back to where it should have been a couple of years ago.

"Now, with a $15 billion sales base, it may take only slight margin improvements to generate impressive earnings growth."

Despite the overall financial turnaround, observers told SN Safeway faces some tough decisions in the months and years ahead, particularly in the areas of new-store growth and the future of certain divisions.

Burd declined to be interviewed for this story. However, he outlined Safeway's progress and discussed areas that will require future attention during his New York presentation.

The chain's three top priorities last year, Burd told the Lehman Bros. conference, were to reduce expenses, build sales and refocus its capital spending programs.

Safeway has made progress on all three, he said. "Our priorities for 1994, not surprisingly, are similar to our 1993 priorities," he said. They are:

· Continuing to reduce operating costs. "We still have a high operating structure, and we are continuing to make cost reductions a priority until we get costs down to a level with which we're comfortable."

Among the areas Safeway will pursue to achieve additional reductions, Burd said, are facility consolidations and better labor contracts.

· Continuing to build sales. "We plan to build on the sales momentum we established in 1993. That momentum began with our low-price program in Alberta, and wherever we've needed to tweak prices to drive sales, we've done so.

"And we know we can't rely on food inflation to help us. We anticipate a flat economy, and we must build sales in that environment."

· Keeping a close eye on capital expenditures, which will increase this year. "We will increase capital spending because as we lower expenses, we will have more money available," Burd explained.

Safeway reduced capital spending last year by about $100 million -- to a total expenditure of $290.2 million -- as it sought to enhance the quality of projects and to focus on near-term operating challenges. In the process the chain opened 14 new stores and completed 45 remodels.

This year it plans to invest about $400 million to open 15 to 20 new stores and complete 50 to 60 remodels, and it expects to increase its level of capital spending gradually over time, company officials said.

Analysts contacted by SN said capital spending will be critical to Safeway's long-term financial health.

Debra Levin, a securities analyst with Morgan Stanley, New York, sees increased spending on new stores as a necessity. "Inflation won't bail out any operator any longer, and to grow sales without inflation requires continued increases in square footage."

However, some analysts maintain that Safeway must spend more money more quickly than it intends to in order to maintain its competitive edge.

"Safeway needs to start ramping up its replacement store program more aggressively because it still has a lot of mediocre stores, especially in the Pacific Northwest and the Baltimore-Washington, D.C., area," said Ed Comeau, an analyst with Lehman Bros., New York.

"With nearly 1,100 stores, the handful of new and remodeled stores it contemplates this year is not much. And even if it opens the floodgates on remodeling now, it won't see the fruits of those labors till 1995 or 1996, and competition may pass Safeway by by then."

Ziegler expressed similar sentiments. "Safeway needs to open more stores faster because it's a moving target out there. We're no longer in a stagnant economy, and all companies, including Safeway, are being constantly challenged by competition."

Observers also said Safeway may have to take some decisive action in its Arizona division in the next couple of years.

"The warehouse there is operating below capacity," Levin pointed out, "and Safeway will have to decide whether to build more stores there or sell off that division."

According to Comeau, "Safeway has gone through a painstaking process of examining what to do in Arizona -- whether to sell all or part of the division or make an acquisition or find additional customers, as it attempted to do with Megafoods."

Safeway was on the verge of becoming the supplier for some of Megafoods Stores' needs in Phoenix, but lost out to Fleming Cos., the existing supplier, when Fleming met the Safeway offer.

"The [Safeway Phoenix] division is doing OK, but long-term, it's not in the kind of competitive situation that can sustain its position without adding more stores or paring back," Comeau added.

Chain officials declined to discuss the specifics of Arizona or any other division.

Despite the sale of 15 stores in the Richmond, Va., area last year, Safeway does not contemplate any more store sales, Burd said in his New York speech.

"The sale of the Richmond stores was really a strategic necessity to get us out of a market we didn't feel we could compete in because we were the only nonunion operator there," he explained. "But in general, we feel good about being able to operate stores more effectively than we have in recent times, so we don't expect to sell more stores."

Burd said he expects future cost-cutting to result from consolidations of some of Safeway's facilities, as well as through more stringent labor negotiations.

The chain has begun a 12-month program to reduce its administrative staff in Canada by about 300 people by consolidating division operations in Winnipeg, Edmonton and Vancouver into its Canadian head office in Calgary, Alberta, which Burd said will result in a $10 million savings.

In addition, Safeway has shut down a cheese processing facility in Hanford, Calif., and moved that volume to a plant in Bellevue, Wash.; closed and sold a Sacramento milk plant and moved that production to San Leandro, Calif., and shut down a Sacramento distribution center and moved its volume to a new facility in Tracy, Calif., Burd noted.

During 1994 it plans to shut down an ice cream plant in Oakland and move that volume to the Bellevue, Wash., facility; close a cheese plant in Carthage, Mo., and incorporate that volume into a facility in La Crosse, Wis., and move bread plant production from a Phoenix bakery to a facility in Denver.

On the labor front, Safeway has already cut a swath across the Canadian landscape, seeking buyout provisions similar to what it achieved in Alberta.

Faced with severe competition from nonunion operators, Safeway threatened to close the Alberta division completely if the union refused to grant concessions. The union subsequently agreed to a buyout of 4,000 employees -- a move that saved Safeway $40 million. "We replaced each full-time person with part-time workers to emulate the costs of our major competitors, and we achieved a significant cost reduction," Burd said.

A new labor agreement in Vancouver allows for "a modest wage increase," Burd said, in return for a provision allowing Safeway to offer employees a buyout at individual stores.

In Winnipeg, Safeway negotiated a new two-year contract that enabled it to achieve a wage freeze and allows for a moderate voluntary buyout that will make it possible for the chain to reduce overall labor costs, he added.

Safeway's tough stance in negotiating labor concessions last year is likely to have repercussions in this year's negotiations in Regina, Saskatchewan, in June; Portland, Ore., in July, and Arizona in September, Comeau said.

"Following Alberta, the United Food and Commercial Workers Union recognizes that Safeway's new management has a mandate for change that may enable the chain to bargain a little more forcefully. That could help Safeway in Arizona, where it will have a little more flexibility to achieve a level playing field as it competes with nonunion chains. But I don't have a sense that the existing Arizona contracts are significantly out of whack the way they were in Alberta."

Paying down Safeway's debt has been and remains a low priority, Burd said in New York. "We reduced debt by $360 million in 1993, but I can't give a projection on 1994 because I'm not sure how much our expense reduction programs will affect our ability to cut the debt," he explained.

Melissa C. Plaisance, Safeway's vice president of investor relations and public affairs, told SN, "Debt hasn't been a priority, but as a result of increasing cash flow, reducing capital spending and making better use of working capital through lower inventories, we were able to pay down $360 million of debt in 1993."

The debt stands at about $2.7 billion, "and we are comfortable with that level," she noted. "Our interest coverage has continued to improve due to refinancing high-interest debt. "But the debt isn't holding us back in terms of what we feel we need to do."

Three-Year Financial Performance by Quarter

% Change in % Change % Operating

Comparable Store Sales in Sales Profit Margin

1991

1st 0-1 1-2 3-4

2nd 0-1 2-3 4

3rd 0-1 2 3-4

4th -1-(-2) 0-1 0-1

1992

1st 0-(-1) 0-(-1) 3

2nd (-3)-(-2) (-2) 3-4

3rd (-3)-(-2) (-3)-(-2) 3-4

4th (-1)-(-2) 4 2-3

1993

1st 0-1 0-1 1-2

2nd 1-2 2-3 3-4

3rd 3-4 3 3-4

4th 3-4 (-3)-(-4) 3-4

1994

1st 4 2-3 3-4