Safeway ( SWY - Analyst Report ) , a leading food and drug retailer in North America, is scheduled to report its second quarter of fiscal 2012 results on Thursday, July 19 before the opening bell. The current Zacks Consensus Estimate for EPS is pegged at 49 cents (representing a year-over-year growth of 19.5%) on revenues of $10.37 billion (flat year over year) for the quarter of 2012. Full year EPS is expected to be $1.99 (up 13.7%) on revenues of $44.49 billion (up 0.19%), as per the Zacks Consensus Estimate.

First Quarter Highlights

Safeway reported EPS of 30 cents in the first quarter of fiscal 2012, in line with the Zacks Consensus Estimate. Quarterly earnings, however, were well above the year-ago level of 7 cents, which included a tax charge of 22 cents per share related to the repatriation of $1.1 billion from Safeway's Canadian subsidiary.

The company reported a 2.4% year over year increase in total sales of $10.0 billion in the first quarter, marginally missing the Zacks Consensus Estimate. Despite flat year-over-year identical-store sales, the upside in sales was attributable to higher fuel sales coupled with higher revenue from Blackhawk commissions and additional sales from new stores.

Safeway also reiterated its fiscal 2012 EPS guidance of $1.90–$2.10. Moreover, the company expects identical-store (ID) sales, excluding fuel, to rise in the range of 1–2%. Operating profit margin, excluding fuel, is expected to range from positive to negative 5 basis points. The company also expects free cash flow in the range of $850–950 million. In fiscal 2012, Safeway expects to incur approximately $900 million in capital expenditures, open 10 new Lifestyle stores and complete 10 Lifestyle remodels.

Estimate Revision Trends

Agreement

Estimates for the second quarter elicited somewhat mixed trend over the past week and month. For the quarter, out of the 15 analysts covering the stock, one analyst made an upward estimate revision while one moved downward over the past 30 days. Meanwhile, one analyst has lowered his/her estimate over the past 7 days with no upward movement being witnessed.

On the other hand, for the full year, there is a significant negative bias in estimate revisions for Safeway. For fiscal 2012, no movement has been observed in the positive direction over the past week and month but 3 of the 17 analysts following the stock downgraded their estimates over the past 30 days while one downward movement was witnessed during the last 7 days.

The analysts are worried with the retail inflation, hitting the entire industry (largely through food and fuel), and expect this to dampen the sales growth of the overall industry. The sluggish ID sales during the first quarter for Safeway remained a matter of concern for them. They also apprehend that Safeway may find it difficult to pass on increased prices to its customers due to tough competition.

The analysts also remain bearish anticipating volume trends to stay under pressure in the upcoming period based on increasing competition in key markets with new entrants. The recent disappointing first quarter fiscal 2013 performance of major grocery chain Supervalu ( SVU - Analyst Report ) on the back of global economic slowdown also seconded the bearish sentiments of the analysts. Supervalu missed the Zacks Consensus Estimates on all fronts and also suspended its regular quarterly dividend. Amid such economic uncertainty and price competition, the analysts expect further clarity from Safeway on this front.

However, the analysts are encouraged by Safeway’s constant efforts to capture market share with its value-added offerings, which are expected to enhance its brand equity and reduce its dependency on price. Additionally, in order to improve its bottom line in a recessionary environment, Safeway has stepped up efforts to reduce cost, which the analysts believe will improve its margins going forward.

Magnitude

Overall, estimates for the first quarter remained unchanged at 49 cents per share in the last 7 and 30 days. For fiscal 2012, estimates also remained flat at $1.99 per share over the past 7 as well as 30 days.

Barring the first quarter of fiscal 2012, Safeway has exceeded estimates in the past four quarters. For the last one year, the company exhibited a positive surprise of 6.13% compared to the Zacks Consensus Estimate.

Our Recommendation

We believe, Safeway and its peers in the supermarket sector have been witnessing sluggish revenue growth over the past few quarters due to economic uncertainty accompanied by low disposable income of consumers forcing them to spend cautiously. All these are impacting the company’s lifestyle strategy in a significant manner. Increased competition and tough industry conditions are major headwinds for the company. Apart from Supervalu, the company confronts a wide spectrum of competitive threats, especially from The Kroger Co. ( KR - Analyst Report ) and Wal-Mart Stores ( WMT - Analyst Report ) . Safeway currently retains a Zacks #4 Rank (short-term ‘Sell’ rating).

However, Safeway’s constant efforts to capture market share with its value-added offerings is expected to enhance brand equity and reduce the company’s dependency on price. Further, we are optimistic based on the company’s cost savings loyalty program ‘Just for U’ and investment in store remodeling. All these long term initiatives taken by the company can help the company in gaining market share over its competitors, reduce costs and increase value to the shareholders. Over the long term, we are Neutral on the stock.