Vons owner’s stock slumps on disappointing profit report

Tuesday, July 10, 2001 | 11:05 a.m.

SUN STAFF AND WIRE REPORTS

Shares of Safeway Inc., the third-largest U.S. food retailer, dropped to a 52-week low Monday after the company reported disappointing second-quarter profits and warned that it will earn less than expected in the last half of its fiscal year.

Safeway operates the Vons grocery store chain in Las Vegas.

The company said Monday that profits for the period ended June 16 totaled $325 million, or 63 cents per share, up 16 percent from the $281 million, or 55 cents, that it reported for the same quarter in 2000. Sales grew 8 percent to $8 billion.

The results matched the consensus estimate of analysts surveyed by Thomson Financial/First Call, but investors had hoped Safeway's fiscal second-quarter profit would surpass Wall Street forecasts. Investors have grown accustomed to Safeway's earnings exceeding projections by a penny or two.

But Safeway's sales growth at stores open at least one year declined considerably from past quarters, hurting results. After routinely reporting same-store growth in the 2 percent to 4 percent range during the last few years, the company said comparable-store sales grew just 1.7 percent in the second quarter.

Targeting 3 percent to 4 percent same-store sales gains in an industry whose average player typically achieves sales growth at half that rate is ambitious, said George Thompson, an analyst with Prudential Securities.

"The issue at Safeway is the fact they've set the bar very high for themselves," he said.

The stock fell as low as $44.06, falling below the 52-week low of $44.25, before rebounding slightly. The stock closed down $3.55, or 7.4 percent at $44.46.

Safeway's second-quarter results exclude a $30 million charge related to the company's investment in GroceryWorks.com, its online grocery delivery service. The charge reduced reported net income to $307 million, or 59 cents per share.

GroceryWorks suspended its operations June 26. It will resume operations as part of a partnership with London-based food retailer Tesco and will operate in the United States under local Safeway banners.

Safeway revealed its results on the same day online grocery retailer Webvan announced it would cease operations. Webvan, once a high-flying member of the late 1990s technology stock boom, said its order volume declined considerably in the second quarter, accelerating the need for cash that investors proved unwilling to supply.

Credit Suisse First Boston lowered its recommendation on Safeway to "hold" from "strong buy," and Salomon Smith Barney changed its rating to "neutral" from "buy."

Safeway said its disappointing sales were the result of unexpected competition and "extraordinary square-footage growth" in the supermarket sector.

The Pleasanton, Calif., supermarket chain's shortfall was primarily the result of square-footage growth in the supermarket industry that outpaced the population growth in three of Safeway's 10 major markets, Chairman and Chief Executive Steven A. Burd told analysts in a conference call.

"A good deal of the square footage came on earlier than expected," Burd said. "And then a lot of the time you see someone moving into a vacated space that we thought was going to remain vacated."

But those trends are already showing signs of waning, Burd said. Market populations are catching up with store sizes, and competitors are closing stores, he said.

In addition, while Burd said Memorial Day weekend sales were the worst he's seen in his eight years at the company, performance during the Fourth of July holiday was closer to normal levels.

"If you're asking for sales guidance for this quarter, we're going to give 1 percent," Burd said, referring to third-quarter identical-store sales. "We think we're going to do better than that. But if you want a number to model, model 1 percent. But look for an upward surprise."

Over the next five years, Safeway expects its identical-store sales to average 3 percent to 4 percent growth. On the whole, consumers are showing "a little more caution," Burd said, but haven't reined in spending significantly.

"We're not seeing any major tradedown from beef to chicken," and sales at specialty counters remain solid, Burd said. "People are not making dramatic changes in how they spend their food money. They're just being careful."

The company has been successful in expense control despite increased property rents, technology investments and high energy costs. But those factors have mostly peaked now, he said. Safeway's energy costs are now expected to increase by $50 million, a lower figure than the company had forecasted at the end of the first quarter.

Over the next four or five quarters, Safeway will improve its gross margins by an additional 50 basis points by reducing shrinkage, or lost sales due to lost, damaged or stolen goods. Since last fall, the company has reduced shrinkage expense by 39 basis points.

But over the next three or four years, the most important component of Safeway's margin expansion will be lowering the cost of its goods through better buying practices, Burd said. The company also aims to reduce revenue loss related to markdowns with new technology systems.

The company is also building its private-label business to further expand margins, Burd said.

He added that he doesn't expect Safeway to be significantly impacted by a more promotional strategy by rival supermarket chain Albertson's Inc.

In response to Webvan's Monday announcment that it is shutting operations and filing for bankruptcy, Burd said Safeway's online venture GroceryWorks.com probably stands to gain the most, since it has the strongest presence in Webvan's California-centered markets. Still, Burd doesn't expect GroceryWorks, which cost Safeway a $30.1 million charge in the second quarter, to benefit dramatically from Webvan's demise.

"We would expect to inherit most of Webvan's business, but it's not going to loom large in the whole picture," Burd said.

Thompson, the Prudential analyst, said the second-quarter sales results are not "the end of the world," and that Safeway remains an excellent company. But the 3 percent to 4 percent earnings growth will be a tough promise to live up to, especially considering Safeway will fall short of that this year, Thompson said.

Thompson added that while Safeway has cited the launch of new "breakaway strategies" when it defends its long-term earnings guidance, the details on those initiatives remain unclear, and their launch appears to be delayed

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