PRICE STRATEGY BLAMED FOR SAFEWAY PROFIT WARNING

Mark Hamstra

PLEASANTON, Calif. -- Safeway's first-quarter profit warning last week illustrated how painful it can be for traditional supermarket companies to adjust their pricing to meet the demands of today's competitive marketplace, according to analysts.

The company said its results for the first quarter ended March 22 would be about 43 to 45 cents per share, which is a 30% drop from year-ago levels and 20% below what analysts had predicted. It attributed the shortfall largely to a decline in gross margins, which it said were lower than expected because of "transitional issues related to centralizing the company's marketing efforts."

Analysts said the company was simply too aggressive in its pricing and promotion -- a mistake Kroger also said it made last year -- while its efforts to centralize marketing and procurement led to some breakdowns in communication among buyers.

"It seems that now that they've moved to central buying, they've got buyers very focused on one or two categories, and they're not communicating to each other what they're doing and therefore not able to balance the books," said Neil Currie, analyst, UBS Warburg, New York.

He said when buying and marketing were handled locally, the company was readily able to see the effects of lowering certain prices and balance that against higher prices on other items. With centralization, that fine-tuning mechanism may not have functioned as it was supposed to.

"Whatever the reason, it still means that they spent a lot of money, and that didn't have the desired effect," he said.

Analysts said the profit shortfall indicates how difficult it will be for traditional supermarket chains to reverse the trend in declining same-store sales through promotion and competitive pricing.

"I think it just bodes ill for the likes of Albertsons that are trying to turn around their very negative grocery performance right now," Currie said. "I think it shows how expensive it's going to be."

According to a report on first-quarter pricing trends issued last week by Banc of America Securities, New York, Safeway's pricing on a sample basket of goods fell 0.8% in the period, vs. the fourth quarter of last year. That compares with a 5.5% drop at Kroger and a 0.3% increase at Albertsons. The report concluded that the pricing environment for traditional retailers might be improving, however.

Mark Wiltemouth, analyst, Morgan Stanley, New York, said that although Safeway's problems appeared to be "self-inflicted," he expects profits at the other major chains to continue to be squeezed as well this year.

"Kroger, Safeway and Albertsons are all investing in pricing and promotion to drive sales, and we are going to see pressures on margins from this throughout 2003," he said.

Kroger, Cincinnati; Albertsons; Boise, Idaho; and Safeway all have been seeking to improve their sales performance by reducing the price differences between themselves and the lowest-price players in the market.

Safeway's efforts to lower prices appeared to help reverse a trend of declining same-store sales, as the company reported flat comparable-store sales for continuing operations, while identical-store sales were down 0.5%. In the preceding quarter, which ended Dec. 28, Safeway posted a 1.9% decline in identical-store sales.

"It's no surprise that there was an improvement in sales," Currie said. "It shows how much it takes to drive sales from negative two to flattish."

Wiltemouth said the slight dip in identical-store sales was "a little disappointing," given the overly aggressive pricing that Safeway appeared to have undertaken.

Steve Burd, chairman, president and chief executive officer, in a prepared statement attributed the gross-margin shortfall to "learning-curve issues" and said the company expected "to continue to work through these issues throughout the second quarter."

Safeway could not be reached for further comment.

The company also said its expenses in the first quarter were affected by increased costs for health and pension benefits, as well as changes in accounting related to the new Securities and Exchange Commission rules concerning reporting vendor allowances.

In last year's first quarter, Safeway posted a net income of $332.1 million before accounting charges, or 68 cents per share, on sales of $7.93 billion. Analysts had expected earnings per share of about 54 cents in this year's first quarter.

Safeway is expected to report its full results on May 1.