UPDATE 4-Safeway cuts year view, cites falling prices

Thu Jul 22, 2010 2:10pm EDT

* Cuts 2010 EPS view to $1.50-$1.70 from $1.65-$1.85

* Q2 EPS 37 cents, matching Street view

* Shares off 1.5 percent; Kroger, Supervalu also dip (Adds analyst comments; updates shares)

By Lisa Baertlein

LOS ANGELES, July 22 (Reuters) - Supermarket operator Safeway Inc (SWY.N) cut its full-year outlook, saying it underestimated the extent of falling grocery prices in a weak economy, and its shares fell 1.5 percent.

At the height of the recession, grocery stores embarked on a price war to attract and hold onto customers. Now, as the economy improves slightly but unemployment remains high, food manufacturers are backing aggressive price cuts to woo back shoppers they lost to lower-priced store labels.

Safeway executives said the strength of that push on pricing caught the company by surprise.

"Deflation continues in price per item and is not expected to significantly improve until the fourth quarter," said Chief Executive Steve Burd, who oversees supermarkets including Safeway, Vons and Dominick's.

Burd now expects 2010 price deflation of 1.2 percent, compared with his earlier call for inflation of 0.4 percent.

Safeway has been hit harder by deflation than its peers because it made deep cuts in the second half of last year to get its store pricing on par with key rivals. As it laps that period, the impact should ease, Burd said.

Safeway cut its 2010 earnings forecast to a range of $1.50 to $1.70 a share, down from its previous view of $1.65 to $1.85. Analysts were expecting $1.69 a share, according to Thomson Reuters I/B/E/S.

Hapoalim Securities USA analyst Ajay Jain called Safeway's move "appropriate and somewhat anticipated." But he warned in a client note that the revised view may not be conservative enough, and said 2010 earnings of $1.10 to $1.30 are "a plausible downside scenario."

BB&T Capital Markets analyst Andrew Wolf said the industry's price issues had likely hit bottom, but improvement could be slow in coming.

Safeway "expected the recovery to start right around now with a little more momentum and a little more pricing power," Wolf said.

Wal-Mart Stores Inc (WMT.N), which sells more groceries than any other U.S. retailer, has aggressively promoted temporary discounts on food ranging from ketchup to ice cream bars, but has not slashed prices across the board.

Kroger Co <KR.N, the biggest and top-performing U.S. supermarket company, recently reported higher-than-expected quarterly earnings, holding its own amid heated competition from Walmart and other rivals. [ID:nN17152791]

The competitive threat from other stores has not waned, making the industry reluctant to raise store prices and boost margins even though production costs are heading higher.

"There is a pent-up demand" from consumer packaged goods companies and retailers "to stop taking all these body blows and pass some of that along," said Burd.

Safeway shares fell 1.5 percent to $19.91, while the wider market rose more than 2 percent. Kroger stock slipped 1 percent and Supervalu Inc (SVU.N) fell less than 1 percent.

PROFIT DOWN

Safeway's second-quarter net profit fell to $141.3 million, or 37 cents per share, from $238.6 million, or 57 cents a share. The year-earlier quarter included a tax benefit that boosted earnings by 14 cents per share.

Results matched the expectations of analysts polled by Thomson Reuters I/B/E/S.

Sales were $9.52 billion, up slightly from last year, and volume hit the highest level in four years, Burd said.

A higher Canadian exchange rate and higher fuel sales were largely offset by a 2.5 percent decline in identical-store sales excluding fuel. At Safeway, identical-store sales include established supermarkets that have not been significantly renovated or replaced.

Gross profit declined 32 basis points during the latest quarter to 28.6 percent of sales. Safeway attributed the drop to increased advertising and efforts to make its prices more competitive.

Safeway had focused on a more upscale customer than Kroger and Supervalu, and also competes with Whole Foods Market Inc WFMI.O in some markets. It has been trying to jump-start its business after lowering prices to levels that match its rivals.

Walmart recently won approval for a second store in Chicago, a key market for Safeway's Dominick's chain. [ID:nN30203636] (Reporting by Lisa Baertlein and Ben Klayman; editing by Maureen Bavdek, Tim Dobbyn and John Wallace)

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