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On Aug 16, we reaffirmed our long-term Neutral recommendation on Safeway Inc. (SWY - Analyst Report) following an eventful second-quarter. The food and drug retailer carries a Zacks Rank #3 (Hold).

Why Neutral?

On Jul 18, Safeway announced tepid second-quarter results. Adjusted EPS from continuing operations was 28 cents, up 40% year over year. However, after including the impact of discontinued operations (primarily the Canadian operations), Safeway posted adjusted EPS of 51 cents. The Zacks Consensus Estimate was pegged at 50 cents.

Total sales declined 1.6% year over year to $8.7 billion, well below the Zacks Consensus Estimate of $10.5 billion. Despite a 1.2% rise in identical-store sales (excluding fuel), top line decreased due to soft fuel sales and disposition of Genuardi stores in 2012.

Additionally, Safeway decided to divest its Canadian operations in June and settled the Blackhawk initial public offering (IPO) earlier in April. We believe that margin pressure is an area of concern as Safeway’s Canadian operations have been more profitable than the U.S. operations. Furthermore, lower income on account of the Blackhawk IPO is another cause of concern.

As a result, Safeway envisages EPS to hover around the lower end of the previous guided range of $2.25-$2.45. On the other hand, based on the assumptions of no gains from the sale of Safeway Canada, the company expects adjusted EPS in the range of $1.02-$1.12.

On the positive side, the Just for U program continues to be seen as a major catalyst driving profitability and market share gains. Moreover, Safeway’s several strategic initiatives should improve its growth profile. We are optimistic that cost-control measures should yield positive results moving forward.

Stocks to Consider

While we remain on the sidelines for Safeway, other stocks such as Koninklijke Ahold N.V. (AHONY), Etablissements Delhaize Fr (DEG - Snapshot Report) and The Kroger Co. (KR - Analyst Report) warrant a look. While AHONY carries a Zacks Rank #1 (Strong Buy), the other two are Zacks Rank #2 (Buy) stocks.

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