Earnings Scorecard: Safeway (SWY)

The announcement of Safeway Inc.’s (SWY) second quarter results on July 22, 2010, has triggered a downward revision of estimates among analysts.

Second Quarter Highlights

Safeway reported an EPS of 37 cents, missing the Zacks Consensus Estimate by a penny. The company had reported an adjusted EPS of 43 cents in the year-ago quarter, excluding a tax resolution benefit of 14 cents.

The company reported sales of $9.5 billion, marginally exceeding the Zacks Consensus Estimate of $9.48 billion and $9.46 billion in the year-ago quarter. The effect of a higher Canadian exchange rate and higher fuel sales were partially offset by a 2.5% decline in identical-store (ID) sales (excluding fuel).

Based on weak outlook, Safeway has lowered its guidance for 2010. The company now expects EPS in the range of $1.50−$1.70, down from the earlier guidance of $1.65−$1.85. It expects same store sales (excluding fuel) to decline 1%−1.5%. Free cash flow guidance, however, remained unchanged at $0.9−$1.1 billion.

For a full coverage on the earnings, read: Safeway Misses, Cuts Guidance

Agreement of Analysts

Following the release of second quarter results, estimate revision trends among the analysts depict a clear negative bias for the company’s earnings in the forthcoming period. Over the last 30 days, 13 of the 17 analysts covering the stock have made downward revisions for the next quarter, with estimates for fiscal 2010 and fiscal 2011 being lowered by 15 and 14 analysts, respectively. The same trend has persisted for the last 7 days with 1 analyst lowering estimates for the next two quarters.

Only one analyst has raised the estimate for fiscal 2011 in the last 30 days.

We believe persistent retail deflation was the primary reason that led the analysts to lower their estimates.

The magnitude of deflation, much greater than anticipated during the latest quarter, continues to be the deciding factor for Safeway. Although the company predicted 0.5% inflation during the quarter, in reality, it experienced a 2.4% deflation, higher than 1% witnessed in the first quarter of 2010. For 2010, the company expects deflation to be at 1.2% compared with the earlier expectation of an inflation of 0.4%.

Moreover, we are concerned about the weak macro environment, which is taking a toll on consumers. Economic uncertainty and high unemployment rates are forcing many consumers to settle for cheaper substitutes or cut back on spending altogether.

Magnitude of Estimate Revisions

The magnitude of revisions is quite significant following the second quarter results. Over the past 30 days, estimates for the next two quarters have gone down by 8 cents and 7 cents to 31 cents and 62 cents, respectively. A similar trend can be seen for 2010 and 2011, with estimates going down by 16 cents to $1.56 and 14 cents to $1.82, respectively, over the last 30 days.

Our Recommendation

Safeway recorded a marginal growth in sales although its EPS dropped 14%. Many factors were responsible for the sluggish revenue growth of the company – unemployment, deflation and the price competition to lure budget-conscious shoppers. Although the company has been able to pass on higher prices of milk to customers, significant identical store sales growth is not feasible without inflation or a decline in unemployment. Based on the headwinds witnessed by Safeway, we have a Zacks #4 Rank for the company (in the short term), which corresponds to a “Sell”.

However, we believe a recovery in the US economy will bring shoppers back to Safeway, boosting the company’s financials in the long term. We are also happy to note that Safeway’s cost reduction initiatives are on track and with a gradual improvement in volume, the company should benefit going forward. Given the long term potential of the company, we are Neutral on the stock.

About Earnings Estimate Scorecard: Len Zacks, PhD in mathematics from MIT, proved over 30 years ago that earnings estimate revisions are the most powerful force impacting stock prices. He turned this ground breaking discovery into two of the most celebrating stock rating systems in use today. The Zacks Rank for stock trading in a 1 to 3 month time horizon and the Zacks Recommendation for long-term investing (6+ months). These “Earnings Estimate Scorecard” articles help analyze the important aspects of estimate revisions for each stock after their quarterly earnings announcements. Learn more about earnings estimates and our proven stock ratings at http://www.zacks.com/education.

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