Safeway cuts year view, cites price deflation

LOS ANGELES Thu Jul 22, 2010 12:38pm EDT

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LOS ANGELES (Reuters) - Supermarket operator Safeway Inc (SWY.N) cut its full-year outlook, citing falling prices for its merchandise as it tries to hold on to shoppers in a weak economy, and its shares fell 4 percent.

During the height of the U.S. recession, grocery stores embarked on a price war to keep consumers. 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 them 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 acknowledged that retail deflation was much greater than expected in the second quarter and drove a decline in identical-store sales.

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 a share. 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" in a client note. But he warned 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 that 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.

The competitive threat from other stores has also not entirely waned, making the industry reluctant to raise store prices and boost margins.

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, suggesting it was holding its own amid heated competition from Walmart and other rivals.

Shares in Safeway fell 4 percent to $19.39 while the wider marker rose more than 2 percent. Kroger stock slipped 1.7 percent and Supervalu (SVU.N) fell 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 from the latest quarter matched the expectations of analysts polled by Thomson Reuters I/B/E/S.

Total sales were $9.52 billion, slightly up from last year and above analyst expectations for $9.47 billion.

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 decline 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.

(Reporting by Lisa Baertlein and Ben Klayman, editing by Gerald E. McCormick, Maureen Bavdek and Tim Dobbyn)

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