SAFEWAY FORGES FIXES FOR SALES, EARNINGS SHORTFALL

ELLIOT ZWIEBACH

PLEASANTON, Calif. -- Safeway here said last week it will focus on "basic blocking and tackling" in the wake of negative same-store sales and an earnings shortfall for the second quarter ended June 15.

Same-store sales for the quarter will decline 1.1% -- the company's first comp-store decline in 38 quarters -- and earnings per share before one-time charges will be 71 to 73 cents, 5% to 8% below consensus estimates of 77 cents, the company said.

"But you can be sure we will try to make this a one-quarter event," Steve Burd, chairman, president and chief executive officer, declared during a 90-minute conference call with securities analysts to discuss the shortfalls.

Safeway said it will release second-quarter results July 8.

According to Burd, the shortfalls are the result of a combination of a weak economy, aggressive competition, Safeway shrink-reduction initiatives and its transition to centralized procurement.

He said Safeway hopes to reverse the declines through a series of changes, including the following:

Investing 75% to 100% of gross margin improvements to drive sales, rather than 25%. Slowing down the company's shrink reduction efforts to allow for more employee training. Overcoming disruptions as it moves to centralized buying.

Reducing capital spending for 2002 to $1.9 billion, down 10% from the $2.1 billion originally projected.

"This is not a gut-wrenching change to everything the company does," Burd said. "It's more of a mid-course correction. We're experiencing some growing pains, but we will make the changes and get the savings."

Analysts contacted by SN after the conference call said they expect Safeway's actions to provide short-term solutions to a long-term problem.

Chuck Cerankosky, an analyst with McDonald Investments, Cleveland, said he's optimistic that Safeway is pursuing the right strategy for the long term. Although others may match or beat Safeway's pricing, "the process squeezes out operators who can't compete at that level and delays expansions by some operators into more competitive markets," he said.

Others were less optimistic, including Gary Giblen, senior vice president and director of research for C L King Associates, New York, who said, "It's a new paradigm for the industry when Safeway and Kroger, the two best companies in the industry, are both struggling, and it raises questions about how well the companies trying to catch them will do, because if the leaders are struggling, then the others will certainly be under pressure."

Neil Currie, an analyst with UBS Warburg, New York, said Safeway needs to be even more price-aggressive than it plans to become. "Safeway is not being aggressive enough," he said. "It should be taking down earnings to a greater degree and reinvesting the proceeds in even more price and promotional activities than it's planning."

Jonathan Ziegler, Santa Barbara-based managing director for Deutsche Banc Alex. Brown, New York, said he was surprised at the degree of the sales shortfall, but bringing shelf prices down will not be enough. "Kroger grabbed the initiative when it dropped prices in December, and competitors like Costco and Wal-Mart will always find ways to go lower, so I think Safeway should let others have price and find something else to differentiate itself, such as making better use of private brands."

Lisa Cartwright, an analyst with Salamon Smith Barney, New York, also said any downward adjustments in price are likely to be met by Kroger and Albertson's, "and in a sluggish economy, Safeway won't get any substantial sales increase if everyone is doing the same thing. Besides, consumers are convinced that other formats, like clubs and supercenters, have lower prices."

During the conference call Burd talked in depth about each of the changes Safeway contemplates:

GROSS MARGIN INVESTMENTS. As Safeway invests 75% to 100% of gross margin improvements to drive price, "We contemplate some competitive reaction," Burd said. "But not everything we do will involve in-your-face promotions.

"Going forward, we think It makes sense to invest more heavily in regular and promotional prices so customers who choose to shop at different stores will find better everyday values at Safeway."

Burd said he expects to see some sales improvements from simple merchandising shifts, citing initiatives at a handful of high-volume stores in the last few weeks where a few merchandising changes in the stores' produce sections resulted in sales increases per store of 3%.

Safeway faces particular challenges at its Randall's stores in Texas and Dominick's in Chicago, Burd said.

"Randall's is viewed as a high-end operator, but the problem there is related more to price perception than to price. Part of our marketing plan going forward will deal with those perceptions."

Dominick's has a good price position in the Chicago market, Burd noted, "but that market tends to be quite promotional, and we know we need to be more promotional there. So you'll be seeing more flair in merchandising, particularly in perishables. The changes will be subtle, but the customer will spend more money without knowing why."

SHRINK REDUCTION. Safeway expects to reduce shrink by $160 million this year -- down from its original target of $188 million, Burd noted, which he acknowledged may have been too aggressive for the short term, prompting some stores to attempt to meet the targets at the expense of sales.

Some stores took the wrong approach to meeting the chain's goals, Burd said. "For example, if a store had six varieties of tomatoes and one variety was accounting for 60% of shrink, the easy solution would be to eliminate that item. But the smarter approach would be to simply order less and merchandise it less while maintaining overall variety." CENTRALIZED BUYING. According to Burd, "There's a real challenge transferring local knowledge to a centralized buying organization, and we've identified glitches that we will now be able to avoid as we go forward with centralization," including making adjustments for new buying systems and overcoming delivery delays.

Burd said 36% of the centralization process will be completed by the end of this month, 76% by the end of the year and 100% by next January. Safeway expects to save $1 billion through centralizing procurement, he added.

REDUCED CAPITAL SPENDING. The 10% cutback in capital spending will primarily involve scaling back new store openings, Burd said. "We'll still spend 5% of sales on capital projects, but we'll postpone some projects."

According to Burd, Safeway will take a one-time charge of $60 million to $70 million for the second quarter, including $37 million to $43 million for costs related to the closure of 11-14 stores; $17 million for severance and transition costs associated with the company's move to centralized procurement, and $7 million for severance costs related to a labor contract covering 29 stores in Canada.