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Finally, Safeway Inc. (SWY - Analyst Report) has reached a conclusive decision with respect to its Canadian operations. Share price of this food and drug retailer climbed 29.68% (or $6.86) higher during the after-trading hours following the company’s announcement of an agreement to sell its Canadian operations. The stock was also up 24.45% (or $5.64) before the opening bell on Thursday.

Safeway inked a definitive agreement to divest its business operations in Canada – Canada Safeway Limited to Canadian food retailer Sobeys Inc. for $5.68 billion in cash (roughly $3.91 billion after taxes and expenses), plus the assumption of certain liabilities. Empire Company Limited owns the Sobeys supermarket chain.

Safeway is still liable for roughly $294 million of Canada Safeway’s public debt due Mar 2014. It will also retain cash and other receivables of a similar amount.

Safeway’s net asset sale to Sobeys include its 213 full grocery stores in Western Canada, 199 in-store pharmacies, 62 co-located fuel stations, 10 liquor stores, 4 primary distribution centers and the related wholesale business and 12 manufacturing facilities in Canada.

The transaction is expected to close in the fourth quarter of 2013, subject to standard closing conditions. The company will report Canada Safeway as discontinued operations from the second quarter of 2013.

Safeway plans to use the net proceeds to repay $2 billion of its debt. Until the most recent quarter, the company continued to operate with a high debt level of $5.3 billion. As reported earlier, the first-quarter debt level was higher than the debt of $5.2 billion in the sequentially prior quarter. Safeway’s highly leveraged balance sheet was a cause of concern for investors.

According to the company, the bulk of the remainder will be used for share repurchases. As reported earlier, Safeway did not repurchase any shares in the last three quarters. Presently, the company is left with $0.8 billion of authorization to buy back shares. Shareholders should look forward to attractive returns in the form of share buybacks in the near future.

Going forward, Safeway’s share buyback activity along with lower interest expense, owing to reduced debt level, should further leverage earnings in the upcoming quarters.

Our View

Although the company asserts that the divestment reflects a deft plan to sharpen focus on the U.S. market, we remain apprehensive due to the lack of clarity on management plans to gain momentum in the domestic market.

Notably, Safeway’s Canadian operations have been more profitable than the U.S. operations, as seen in the level of operating profit over the past few years. In 2012, the company recorded operating profit of approximately 2% and 5.4% in the U.S. and Canada, respectively. Further, the situation worsened in the domestic market as reflected by the declining profits in recent times. We wait to see the impact of the sale on its profitability going forward.

In light of these facts, Safeway’s decision to sell its Canadian stores might come under intense scrutiny from investors and analysts alike. We prefer to remain on the sidelines for this retail giant until further visibility is obtained.

Accordingly, the stock carries a Zacks Rank #3 (Hold). While we have a neutral investment disposition on Safeway, other players such as Etablissements Delhaize Fr (DEG - Snapshot Report), The Kroger Co. (KR - Analyst Report) and The Fresh Market Inc. (TFM - Snapshot Report), carrying a Zacks Rank #2 (Buy) warrant a look.
 

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