(By Kevin Donovan) A weak economy and high unemployment call for comfort food; you can't fight ‘em, but you still gotta eat. And the big grocery store chains may be the best place to find security if you have to be in equities.
We looked at The Kroger Co., Safeway Inc., and Wal-Mart Stores Inc. All three are attractive, but we like Safeway (SWY) best, based on valuation, dividend yield and potential for multiple expansion.
Safeway pays a dividend yielding 4.02%, compared with 2.02% for Kroger and 2.23% for Wal-Mart. It is also the cheapest of the three, trading at a forward PE of 8.31 vs. 9.05 and 13.36 for Kroger and Wal-Mart, respectively. On a price to sales basis, Safeway is at 0.10 compared with 0.14 for Kroger and 0.53 for Wal-Mart.
One need only look at reported margins to explain the valuation haircut. Safeway's first quarter operating margin was 1.39% versus 2.52% for Kroger and 5.93% for Wal-Mart. Gross profit declined 70 basis points to 26.84% of sales in the first quarter of 2012 compared with 27.54% in the first quarter of 2011.
With what we consider a safe dividend and the potential for improved margins from ongoing productivity initiatives that were still being implemented as the first quarter ended, we think Safeway is a good play in a dicey economy.
Safeway reported income from continuing operations of $0.30 per for the first quarter of 2012 compared with $0.07 in the first quarter of 2011. The first quarter of last year included an $80.2 million tax charge ($0.22 per diluted share) resulting from the decision to repatriate $1.1 billion from Safeway's wholly-owned Canadian subsidiary. Were it not for the tax charge, net income would have been $0.29 per diluted share for the first quarter of 2011.
On the revenue front, sales increased 2.4% to $10.0 billion in the first quarter of 2012 from $9.8 billion in the first quarter of 2011, primarily due to higher fuel sales, higher revenue from Blackhawk and additional sales from new stores. Identical-store sales were flat.
For the second quarter, to be reported July 19, analysts expect EPS of $0.49 on revenue of $10.36 billion. Close attention will be paid to margin performance.
Shares of Safeway fell 1.75% Monday to $17.40. There was no apparent catalyst for the slump, which pushed the dividend yield above 4%. The company's payout ratio is 31%, so the dividend appears safe.
Year-to-date, Safeway shares have underperformed competitors, declining 15.86% versus a 6.38% decline for Kroger and a 21.71% gain for Wal-Mart.
As of March 24, 2012, Safeway operated 1,675 stores in the western, southwestern, Rocky Mountain, Midwestern and Mid-Atlantic regions of the United States and in western Canada. In support of its stores, Safeway has an extensive network of distribution, manufacturing and food processing facilities. Safeway also holds a 49% interest in Casa Ley, S.A. de C.V., which operates 185 food and general merchandise stores in western Mexico.