Safeway Pinned to Neutral

We are reiterating our long-term ‘Neutral’ recommendation on Safeway Inc. (SWY - Analyst Report), one of the largest food and drug retailers in North America.

Why the Reiteration?

Safeway missed the Zacks Consensus Estimate for revenues as it declined 0.2% year over year to $10.04 billion in the third quarter. However, the company surpassed the Zacks Consensus Estimate for earnings primarily due to a 31% reduction in the outstanding share count.

Estimate revision for Safeway exhibited a mixed trend for 2012 and 2013 over the last 60 days, as most earnings estimates were revised up for the former and down for the latter. With no definitive directional guidance, the company carries a Zacks Rank #3 which translates into a short-term Hold rating.

Although a slowdown in the identical-store (ID) sales (excluding fuel) in the quarter was a cause of concern, the company expects to turn the tables on the back of successful rollout of “Just for U” loyalty program. As the program gains traction, we expect volume growth to improve in the future.

We are also encouraged by Safeway’s efforts to reward its stockholder via dividends and share repurchases. The company has undertaken cost saving initiatives to improve it’s bottom-line amid the continued macroeconomic challenges. However, gross margin contracted in the most recent quarter as the cost saving measures failed to yield positive results.

Safeway has also been taking a number of strategic steps to expand its global foothold, especially in Canada. However, the efforts might weigh on the highly leveraged balance sheet of the company.

Despite various efforts to revive its top-line, sluggish sales growth continues to remain Safeway’s prime concern. The imminent top management change also draws our attention. While the stock consistently outperformed the S&P 500 index under the leadership of Steve Burd, the current top-line challenges imply that the incumbent might have a daunting task ahead.

Despite positive driving events, near-term headwinds prevail. While we remain on the sidelines for Safeway, its peer Kroger (KR - Analyst Report) carries a Zacks Rank #2 (Buy).