SWY - Safeway

[FCharlie]

Hi all. This is cross posted in the General discussion category.

 

I wanted to run an idea by you guys and see what everyone thinks.

 

About a year ago I began buying Safeway, around $21.50.  At the time they had 368 million shares outstanding, so we're talking a $7.9 billion market cap.

 

Safeway produced $2.6 billion of cumulative free cash flow in 2009/2010, and at the time they projected $800 million of free cash flow for 2011. I averaged the 2009/2010 free cash flow with the projections for 2011 and realized that Safeway was sitting there with a 14+% free cash flow yield. Safeway also was very actively repurchasing their shares, which excited me as well.

 

One year later, here we are. Safeway ended up on target with their free cash flow. They got even more aggressive with the share repurchase at the end of 2011, so for the year, Safeway repurchased 19.5% of their shares during 2011. Subsequent to the end of 2011, Safeway has further repurchased 9.4% of it's shares this year, only a couple of months in. Today, they authorized a new $1 billion buyback.

 

The current Safeway share count is 268 million, the stock price has barely budged. The market cap is now only $5.8 billion, and Safeway has projected $900 million of free cash flow for 2012, and has projected cumulative free cash for the next five years of about $5.7 billion, almost equal to their current market cap.  What does Safeway do with their cash?

 

1)They pay the dividend, which has been increased at 20% annual rates for many years

2) They repurchase stock in large quantities (Safeway has repurchased 40% of it's shares in the past four years)

3) They have been developing entire shopping centers (currently 32 shopping centers under construction as we speak). Safeway has created a subsidiary for the sole purpose of buying land, developing entire shopping centers, anchoring them with new Safeway stores, and renting the entire shopping center with themselves as the landlord.  Safeway by the way currently has $31/share of owned real estate at cost (land + buildings)

 

 

The attraction here is simple. Hard assets and free cash flow. What's not attractive about a company that sells for $21.70/share with $31.00/share of real estate, generating around $1 billion annually ($3.75/share free cash flow)  Around a 17.5% free cash flow yield, repurchasing it's own shares at an astonishing rate, and a share price that is unchanged from 15 years ago??

 

I can happily discuss further, and will respond to questions/comments.. I'm looking for other opinions here. I think Safeway is one of the best deals out there. Cheap & safe.

 

What do you think?

[Viking]

FCharlie, thanks for posting the idea. I looked at Super Valu last year. The sector does look interesting. And I bagged groceries as a kid so I have some sentimental attachements (perhaps a watch out?).

 

What is your take on management? Can they be trusted? Are they owners (i.e. buying stock or already large owners)?

 

I get nervous when I see a company with a high debt level borrow to buy back 'cheap' shares. Cash flows can shrink (pick a reason) and interest rates can increase fast... resulting in a much lower share price.

 

I do like that they have been aggressively paying down debt the past few years (2011 excepted).

[alertmeipp]

Do they pay down debt as well?

[FCharlie]

Do they pay down debt as well?

 

Safeway's historical debt at year end:

 

2002: $8.45 billion

2003: $7.82 billion

2004: $6.76 billion

2005: $6.35 billion

2006: $5.86 billion

2007: $5.65 billion

2008: $5.49 billion

2009: $4.90 billion

2010: $4.83 billion

2011: $ 5.41 billion

 

During the past four years, Safeway has actually decreased their total debt levels while simultaneously repurchasing 40% of their shares outstanding. Prior the the past four years, Safeway spent almost all of their cash flow remodeling stores and repaying debt.

[FCharlie]

FCharlie, thanks for posting the idea. I looked at Super Valu last year. The sector does look interesting. And I bagged groceries as a kid so I have some sentimental attachements (perhaps a watch out?).

 

What is your take on management? Can they be trusted? Are they owners (i.e. buying stock or already large owners)?

 

I get nervous when I see a company with a high debt level borrow to buy back 'cheap' shares. Cash flows can shrink (pick a reason) and interest rates can increase fast... resulting in a much lower share price.

 

I do like that they have been aggressively paying down debt the past few years (2011 excepted).

I like Steve Burd, the C.E.O.  He's been with Safeway for twenty years now. He does own a large amount of shares, about 1.5% of the company.

 

Safeway has been decreasing debt for almost a decade prior to the very end of 2011. I understand some may not like borrowing to repurchase stock, but the grocery business is very stable, in my opinion, Safeway is extremely stable. They've produced an average of $1.1 billion free cash flow the past three years, and are projecting an average of $1.1 billion free cash flow the next five years..  The debt they have is very manageable. Operating cash flow has been very consistent around the $2.1 billion level. Interest expense has declined eight years in a row.

 

Yearly interest expense:

 

2003: $442 million

2004: $411 million

2005: $402 million

2006: $396 million

2007: $389 million

2008: $358 million

2009: $332 million

2010: $298 million

2011: $272 million

[Packer16]

Where did you find that the average projected FCF is $1.1 billion for the next five years.  Over the past 3 years it declined from $1.4 billion to $700 million and is projecting $900 million in FCF next year.  How do you get comfortable the decline will not continue?  Thanks for the idea.

 

 

Packer

 

[FCharlie]

Where did you find that the average projected FCF is $1.1 billion for the next five years.  Over the past 3 years it declined from $1.4 billion to $700 million and is projecting $900 million in FCF next year.  How do you get comfortable the decline will not continue?  Thanks for the idea.

 

 

Packer

 

Hi, Packer.

 

I find projected average free cash flow  on the slides from Investor Day earlier this month. The slides can be found here:

 

http://www.sec.gov/Archives/edgar/data/86144/000008614412000009/ex9928-kinvestorconference.htm

 

The reason I'm comfortable the decline will not continue is because the company has  a subsidiary called PDC which develops shopping centers. PDC is the reason free cash flow was slightly lower this past year. PDC is reaching a point where it will self fund itself and that is where the confidence comes in. The core grocery business consistently produces huge free cash flow. This will improve if gas prices keep rising. Food price inflation in the 3% range is very beneficial to grocery stores. Also, as fuel prices rise, Safeway captures more of that market. They are seeing double digit increases in gallons sold even as the industry sees zero growth. It's quite an incentive to offer discounts on fuel for buying groceries. Some places you can get gas for 20 or 30 cents less per gallon for buying $100 of groceries at Safeway.

 

Besides, the free cash flow per share is what fascinates me. It's approaching $4.00/share right now and the share count keeps declining. They really don't need an improvement in total free cash flow to have the stock do really, really well.

 

 

[rmitz]

So, I do find this interesting.  Reinvesting in their stores was exactly what they needed to do to avoid becoming one of the very large graveyard of grocery stores.  A&P being the granddaddy, of course.  There have been so many chains over the years to go away, or at least dramatically reduce in size (and value) that I think it may keep people away from a decent investment here. 

[Packer16]

Does anyone know why Safeway and Supervalu cannot do sale/leaseback transactions to reduce debt or buyback sotck?  They both own more than 40% of their stoers versus Winn Dixie who almost exclusively leases its buildings.  TIA

 

 

Packer

[FCharlie]

Does anyone know why Safeway and Supervalu cannot do sale/leaseback transactions to reduce debt or buyback sotck?  They both own more than 40% of their stoers versus Winn Dixie who almost exclusively leases its buildings.  TIA

 

 

Packer

 

They both could do this, I think it's probably not a bad idea for SuperValu... Safeway regularly states that they like owning property, They actually just cited a situation earlier this month where they wanted to buy a property where the land alone cost $20+ million... There was no way they could earn a decent return on a store when the land alone was that expensive, but they ended up closing and selling a nearby property, booking a $20+ million gain on the sale.... so they were able to do what they wanted because of the value created in owning property over time.

 

Safeway doesn't really need, In my opinion, to reduce debt further. They already have interest expense at the lowest levels in many years, and they are repurchasing stock at 10+% annually as well... The past four years Safeway has repurchased 40% of their shares. They just authorized another $1 billion to buy more so I'd expect more activity this year. That's the beauty here, The price to free cash flow is around six... Meaning even after paying the dividend the company can repurchase about 12% of it's shares annually and not add debt.

[valueinvesting101]

I am reading through the company's annual report. I am trying to understand why did they incur goodwill impairment charges of 1.8 billion in 2009.

 

As per 2009 annual report:

 

Our goodwill impairment analysis also includes a comparison of the aggregate estimated fair value of all reporting units to our total market capitalization. Therefore, a significant and sustained decline in our stock price could result in goodwill impairment charges.

 

I do not understand how can declining stock price reduce book value of company. Are they including value of stock after buyback since it is held in treasury?

 

When are they exactly cancelling shares which are bought back? Are they are issuing dividends on those shares? As per 2011 annual report they hold 307.9 million shares in treasury.

[FCharlie]

I am reading through the company's annual report. I am trying to understand why did they incur goodwill impairment charges of 1.8 billion in 2009.

 

As per 2009 annual report:

 

Our goodwill impairment analysis also includes a comparison of the aggregate estimated fair value of all reporting units to our total market capitalization. Therefore, a significant and sustained decline in our stock price could result in goodwill impairment charges.

 

I do not understand how can declining stock price reduce book value of company. Are they including value of stock after buyback since it is held in treasury?

 

When are they exactly cancelling shares which are bought back? Are they are issuing dividends on those shares? As per 2011 annual report they hold 307.9 million shares in treasury.

 

The 2009 goodwill impairment was primarily related to VONS in California. What the stock price has to do with goodwill impairment I don't know either.  Interestingly, 2009 was Safeway's best year ever for free cash flow, at $1.5 billion, almost 30% of today's market cap.

 

 

 

 

[FCharlie]

Interestingly, SWY filed their proxy yesterday and claim to now have only 257 million shares outstanding on March 16th. This is 10.5 million fewer than they had on Feb 22nd when they filed the 10K. Looks like Safeway has been steadily buying over half a million shares each business day since that time.

 

This puts the total decline in share count over the past four years at 41.4%

 

Anyone care to bet on how long a company can repurchase stock at this rate and how many years a company can raise it's dividend by over 20% without the stock responding in a big way?

[rranjan]

Interestingly, SWY filed their proxy yesterday and claim to now have only 257 million shares outstanding on March 16th. This is 10.5 million fewer than they had on Feb 22nd when they filed the 10K. Looks like Safeway has been steadily buying over half a million shares each business day since that time.

 

This puts the total decline in share count over the past four years at 41.4%

 

Anyone care to bet on how long a company can repurchase stock at this rate and how many years a company can raise it's dividend by over 20% without the stock responding in a big way?

 

 

I did very quick scan and I have not looked at their SEC filings.

 

http://finance.yahoo.com/news/swy-announces-dividend-buyback-plan-200935052.html

 

"In the fourth quarter of fiscal 2011, Safeway repurchased 43.3 million shares for $858.6 million (76.1 million shares for $1.6 billion during the year) and was left with $0.9 billion under its existing stock repurchase program at the fiscal end."

 

"The Board of Directors of the company also approved an additional $1.0 billion for the company's existing stock repurchase program with just $400 million remaining as of February 22, 2012."

 

 

Based on above two statements , it seems that Safeway had 0.9B left at fiscal end and on Feb 22, they had 0.4B left. So they spent 0.5B in buyback. Diluted share count on fiscal end was 344M. So if they bought on average 20 bucks a share then by using half billion they bought 25M shares. So

 

At Feb 22, their share count should be around 344 - 25 = 319M

 

Your numbers on Feb 22 comes at 268M.

 

Big difference in numbers. I need to check the source directly later.

 

I was just scanning quickly and came up with their pension underfunding issue.

 

http://finance.yahoo.com/news/safeway-shares-fall-downgrade-165735156.html

 

" Credit Suisse analyst Edward Kelly said that his firm's analysis of Safeway's multi-employer pension plans found a $7 billion pre-tax underfunded liability."

 

Safeway replied that underfunding is only 1.9 Billion. These are big numbers and difference. I don't trust analyst's number so need to look at long terms return assumptions Safeway is making. I don't have much idea about Safeway but stock buy back looked aggresive.

 

 

[Packer16]

What the stock price has to do with goodwill impariment is every year in the goodwill impairment test, the stock price is used as an indicator (typically weighted the most) to determine if the book value (which includes a goodwill write-up when an acquistion occurs) is impaired.  It is a non-cash charge and does not effect cash flow but typically tests whether the projections in the original acquisition are met or not.

 

Packer

[valueinvesting101]

As per 2011 Annual report Safeway had 296.6 millions common shares outstanding and at February they had 268 millions common shares outstanding.

 

Weighted average shares outstanding for year 2011 were 343.4 millions. Since they did big chunk of buyback in the last quarter weighted number seems higher compared to year end number.

 

 

I find this note on page 74 of 2011 Annual report:

 

Anti-dilutive shares totaling 25.1 million in 2011, 26.4 million in 2010 and 42.5 million in 2009 have been excluded from diluted

weighted-average shares outstanding.

 

Not sure what these shares are.

 

 

Interestingly, SWY filed their proxy yesterday and claim to now have only 257 million shares outstanding on March 16th. This is 10.5 million fewer than they had on Feb 22nd when they filed the 10K. Looks like Safeway has been steadily buying over half a million shares each business day since that time.

 

This puts the total decline in share count over the past four years at 41.4%

 

Anyone care to bet on how long a company can repurchase stock at this rate and how many years a company can raise it's dividend by over 20% without the stock responding in a big way?

 

 

I did very quick scan and I have not looked at their SEC filings.

 

http://finance.yahoo.com/news/swy-announces-dividend-buyback-plan-200935052.html

 

"In the fourth quarter of fiscal 2011, Safeway repurchased 43.3 million shares for $858.6 million (76.1 million shares for $1.6 billion during the year) and was left with $0.9 billion under its existing stock repurchase program at the fiscal end."

 

"The Board of Directors of the company also approved an additional $1.0 billion for the company's existing stock repurchase program with just $400 million remaining as of February 22, 2012."

 

 

Based on above two statements , it seems that Safeway had 0.9B left at fiscal end and on Feb 22, they had 0.4B left. So they spent 0.5B in buyback. Diluted share count on fiscal end was 344M. So if they bought on average 20 bucks a share then by using half billion they bought 25M shares. So

 

At Feb 22, their share count should be around 344 - 25 = 319M

 

Your numbers on Feb 22 comes at 268M.

 

Big difference in numbers. I need to check the source directly later.

 

I was just scanning quickly and came up with their pension underfunding issue.

 

http://finance.yahoo.com/news/safeway-shares-fall-downgrade-165735156.html

 

" Credit Suisse analyst Edward Kelly said that his firm's analysis of Safeway's multi-employer pension plans found a $7 billion pre-tax underfunded liability."

 

Safeway replied that underfunding is only 1.9 Billion. These are big numbers and difference. I don't trust analyst's number so need to look at long terms return assumptions Safeway is making. I don't have much idea about Safeway but stock buy back looked aggresive.

[Viking]

FCharlie, thanks for posting the idea and answering questions (in the process providing much of the rationale).

 

After reading a fair bit, I am amazed at the speed with which they are repurchasing shares. This is not a small company and to take out over 40% of the stock in such a short amount of time is unusual. During the Q4 conference call one analyst stated the perception is SWY is repurchasing shares to enable it to hit guidance - telling me the analysts are not understanding or believing management - which also likely explains why the share price is not moving.

 

SWY 2012 plan is back end loaded; mgmt stated they expect Q1 to be tough with things getting better as the year progresses. This type of guidance will likely not help the share price in the short term. I wonder how low the share price will go in the next few months once SWY stops buying (perhaps thay have stopped and this explains the stocks fall into the $20 range.

 

The recent investor day session was quite informative. Mgmt expects the underlying food business to be flat as it is a mature business. They touted 'just for U' marketing program as a key driver to reverse the decline in same store sales (after inflation). I am not a big believer in these sorts of programs (having worked for Kraft for years and hearing story after story...). SWY almost sounds like they are placing their food business in runoff and milking it for the cash flow (to buy back stock).

 

They expect the move the needle growth over the next few years to to come from non-food businesses they are growing within SWY leveraging the companies core competencies:

1.) Blackhawk - gift card company - profitable now

2.) Property Management Company - will help drive profits in 2013-14 and forward

3.) Health and Wellness (specifics not yet provided as it is just getting fleshed out)

What I like with this stuff is the entrepreneurial drive and the long term focus (these businesses take 4 years or more to really impact profitability and this is OK with SWY).

 

I still have trouble with the debt they are taking on to fund the stock repurchase. The rationale SWY provided is the after tax interest rate is lower than the dividend they pay on the shares they are repurchasing (it is accretive to earnings immediately). Fortunately, SWY still has much less debt than more levered competitors like SVU. SWY also recently invested heavily in their stores so near term capital costs are manageable.

 

Bottom line, SWY's management team are either smart like a fox or delusional. Unfortunately, my read is the analyst community is not drinking the Kool-Aid so Safeway will need to deliver before people buy in. Given they are forecasting a weak Q1 I am not sure what the catalyst will be for the stock over the next 6 months or so. I will likely buy an initial position should the stock drop closer to $19; should it fall back to its 52 week low of $16 I would be very interested.

[FCharlie]

FCharlie, thanks for posting the idea and answering questions (in the process providing much of the rationale).

 

After reading a fair bit, I am amazed at the speed with which they are repurchasing shares. This is not a small company and to take out over 40% of the stock in such a short amount of time is unusual. During the Q4 conference call one analyst stated the perception is SWY is repurchasing shares to enable it to hit guidance - telling me the analysts are not understanding or believing management - which also likely explains why the share price is not moving.

 

SWY 2012 plan is back end loaded; mgmt stated they expect Q1 to be tough with things getting better as the year progresses. This type of guidance will likely not help the share price in the short term. I wonder how low the share price will go in the next few months once SWY stops buying (perhaps thay have stopped and this explains the stocks fall into the $20 range.

 

The recent investor day session was quite informative. Mgmt expects the underlying food business to be flat as it is a mature business. They touted 'just for U' marketing program as a key driver to reverse the decline in same store sales (after inflation). I am not a big believer in these sorts of programs (having worked for Kraft for years and hearing story after story...). SWY almost sounds like they are placing their food business in runoff and milking it for the cash flow (to buy back stock).

 

They expect the move the needle growth over the next few years to to come from non-food businesses they are growing within SWY leveraging the companies core competencies:

1.) Blackhawk - gift card company - profitable now

2.) Property Management Company - will help drive profits in 2013-14 and forward

3.) Health and Wellness (specifics not yet provided as it is just getting fleshed out)

What I like with this stuff is the entrepreneurial drive and the long term focus (these businesses take 4 years or more to really impact profitability and this is OK with SWY).

 

I still have trouble with the debt they are taking on to fund the stock repurchase. The rationale SWY provided is the after tax interest rate is lower than the dividend they pay on the shares they are repurchasing (it is accretive to earnings immediately). Fortunately, SWY still has much less debt than more levered competitors like SVU. SWY also recently invested heavily in their stores so near term capital costs are manageable.

 

Bottom line, SWY's management team are either smart like a fox or delusional. Unfortunately, my read is the analyst community is not drinking the Kool-Aid so Safeway will need to deliver before people buy in. Given they are forecasting a weak Q1 I am not sure what the catalyst will be for the stock over the next 6 months or so. I will likely buy an initial position should the stock drop closer to $19; should it fall back to its 52 week low of $16 I would be very interested.

 

Viking,

 

I too am amazed at the speed that Safeway is repurchasing stock. I would say that is probably the most interesting part of this story. In my opinion, when you have a business that is selling this cheap that is repurchasing shares at this rate, you almost can't lose provided the core business remains on track. It sounds too simple and too good to be true, but if you look at this situation for what it is, a company with a $5 billion market cap repurchasing close to $1 billion of shares annually, in five years there won't be any shares left in existence. Any time I've ever come across situations like this in the past, the stock has taken off at some point. Think Philip Morris, AutoZone, DirecTV... Huge buyers of their own stock, core business remains constant, stock eventually explodes higher.

 

Analysts certainly don't believe management. One analyst even asked why guidance isn't higher and Steve Burd responded by saying that if guidance were higher, no one would believe it anyway.... Seems like management understands Wall Street doesn't care.

 

I personally don't see how the guidance isn't higher. If you simply take the historical earnings from Q2 2011 ($145.8 million) and divide by today's share count (257 million) you get almost 57 cents. Current estimates are for 47 cents.  If you take earnings from Q3 2011 ($130.2 million) and divide by today's share count you get 50 cents. Do the same for Q4 2012 and you get 84 cents. Put it all together and you're talking about current estimates being way, way off....  Safeway should be running E.P.S. growth at 25%+ by the end of this year. For some reason, Wall Street isn't impressed with that because it's not from ID Sales growth.

 

Regarding the debt they are taking on to repurchase stock, it's not as if they are funding the entire buyback with debt. This company could repurchase about 15% of it's shares even after paying the dividend simply funded with free cash flow. Management has made clear they will repurchase shares with all of their free cash flow plus however much debt they can take on without lowering their credit rating. They claim to know exactly how much debt they can take on and they don't seem to be slowing the rate of repurchase. I support the buyback funded with debt. I'd even get more aggressive if I were them. Geez. This is a company with an almost 20% free cash flow yield. If I could borrow from the bank at 3% and use the interest as a tax write off, then use the cash to buy an asset yielding 20%, I'd borrow as much as I could. During the three years 2009,2010,2011, what most would consider the financial crisis, Safeway produced $3.4 billion free cash flow, or 68% of their current market cap. Hard to imagine a financial crisis taking Safeway out of business.

 

There are very few times in life opportunities like this present themselves. An almost 20% free cash flow yield, dividend growth of 20%+ for six, seven years in a row, a stock price at the same price it was fifteen years ago, and no one cares. Wall Street doesn't care, even on this board, most don't care. People here can't get enough Bank of America (which I own lots of too) because it's selling for five times normalized earnings. Safeway is at five times free cash flow TODAY. I think you're the only one here who actually may be interested in what I have to say about Safeway.  Sometimes having not a soul on earth care about a company presents better opportunities for investors than being the most hated company on earth.

 

 

[Viking]

The good news for SWY is that as mgmt continues to deliver the stock will pop at some point. My guess is the dividend will get increased another 15 or 20% in May and this will likely get peoples attention.

 

Perhaps the issue is everyone thinks that Walmart/Target will rule the retail food world and SWY and SVU are zeros.

 

Perhaps the issue is the amount debt they are taking on (not to beat a dead horse); the risk for SWY in taking on more debt is if rates rise (a bunch) at the same time EBITDA falls (a bunch). Yes, today that outcome looks remote. However, lots of other well managed businesses were destroyed by leverage working on them in the wrong direction. The debt they have today does look manageable and management is experienced and looks like they have their act together. And, to your point, part of the buyback has been paid via their free cash flow.

 

The picture that is forming for me is SWY views their core business like an annuity (they are not looking to grow their food business) that will deliver $750 million or more in free cash flow per year = $2.92/share = 14% yield. And yes the $750 is a conservative estimate.

[Rabbitisrich]

 

 

 

I was just scanning quickly and came up with their pension underfunding issue.

 

http://finance.yahoo.com/news/safeway-shares-fall-downgrade-165735156.html

 

" Credit Suisse analyst Edward Kelly said that his firm's analysis of Safeway's multi-employer pension plans found a $7 billion pre-tax underfunded liability."

 

Safeway replied that underfunding is only 1.9 Billion. These are big numbers and difference. I don't trust analyst's number so need to look at long terms return assumptions Safeway is making. I don't have much idea about Safeway but stock buy back looked aggresive.

 

Other reports indicated that the Credit Suisse number referred to the total MEP trust shortfall. Safeway does use a fairly high discount rate of 4.9% to determine pension obligations. That is hardly down from 2006. Look at the sensitivity analysis on page 26 of the 2011 10-k. The discount rate seems to be based upon their non-pension cost of debt, but their pension returns have substantially underperformed that benchmark over the last 10 years.

 

Does anyone worry that management changed accounting for Blackhawk simply to bulk up sales and diminish the operating expense ratio? They don't record a valuation allowance or accept recourse risk, so accounting for receipts on a gross basis only adds noise to the gross margin %.

 

Thanks for bringing up this idea. It's worth looking into.

 

 

[FCharlie]

The good news for SWY is that as mgmt continues to deliver the stock will pop at some point. My guess is the dividend will get increased another 15 or 20% in May and this will likely get peoples attention.

 

Perhaps the issue is everyone thinks that Walmart/Target will rule the retail food world and SWY and SVU are zeros.

 

Perhaps the issue is the amount debt they are taking on (not to beat a dead horse); the risk for SWY in taking on more debt is if rates rise (a bunch) at the same time EBITDA falls (a bunch). Yes, today that outcome looks remote. However, lots of other well managed businesses were destroyed by leverage working on them in the wrong direction. The debt they have today does look manageable and management is experienced and looks like they have their act together. And, to your point, part of the buyback has been paid via their free cash flow.

 

The picture that is forming for me is SWY views their core business like an annuity (they are not looking to grow their food business) that will deliver $750 million or more in free cash flow per year = $2.92/share = 14% yield. And yes the $750 is a conservative estimate.

 

 

A handful of quarters back, Safeway said on a conference call that they budget for about $200 million towards the dividend. Based on the level of share repurchase, the dividend would need to go up 33% this year to hit that target.. I don't expect 33%, but I think 20% for the next two years is likely.

 

Regarding Wal-Mart and Target.... It seems like Wal-Mart made their moves into grocery this past decade and they are pretty well established. I also have heard Steve Burd comment on Target where he specifically mentioned that stores like Target end up competing for the shoppers that would already be shopping at Wal-Mart, and that it's a different customer that shops at Safeway. I think this makes sense. I think about produce at a store like Safeway vs. produce at a store like Wal-Mart and I can see a big difference in appeal.

 

Also, last I checked Wal-Mart offers 3 cents off gas per gallon at their fuel stores, Safeway you can get up to $1.00 off per gallon with $1,000 in grocery purchases. $500 in purchases gets 50 cents off per gallon, $100 in purchases gets 10 cents off etc... The beauty here is that there is a limit of 30 gallons, so when someone spends $1,000 on food, the gross profit for Safeway is $275, then the hit at the gas station is about $27(factoring in the fuel margin plus the $1.00 off per gallon).... That also assumes they have a 30 gallon tank and fill up all the way, so likely the hit is much smaller... It's a huge draw and I can see people who "hate" big oil and hate the price of gas happily shopping at Safeway just to feel better about gas prices.  This is why Safeway's fuel sold when measured in gallons tends to be up 10-15% year over year during times like these.

 

And finally, yes, the debt thing I understand people's concern. We just witnessed businesses fail one after another over lack of financing. That was why I brought up the point earlier about how much cash Safeway generated during that same time period. You could also logically assume that once rates rise, Safeway will redirect buyback cash into debt repayment. I don't think anyone would have issue with rolling over Safeway commercial paper or Safeway bonds if Safeway were directing $300-$400 million annually to debt repayment. Just look at SuperValu, their bonds are not distressed at all.

[biaggio]

FCharlie, thanks for posting your idea.

 

Have been following thread.

 

What do you think at looking at FCF/EV as a valuation metric in this case? I am asking that in light of the issue of the debt being issued to buy back stock. Especially with record low interest rates i.e mortgage rates, interest on debt will be higher in the future.

 

$1.1b vs ~ $10b EV still looks good still- a 11% yield vs 20%.

[finetrader]

What about gross margin? I've noticed that their profits or FCF are about the same than 10 years ago while their sales have doubled.

[Tim Eriksen]

What about gross margin? I've noticed that their profits or FCF are about the same than 10 years ago while their sales have doubled.

 

Not exactly.  In 2001 sales were $34.3 billion and gross profit was $10.6 billion.  In 2011 sales were $43.6 billion and gross profit was $11.8 billion.  Sales have not doubled, they have increased only 27%.  Store count is down 6%.  You are correct that gross margin has fallen.  It has declined from 30.9% in '01 to 27% in '11.  The decline in gross margin may be due in part to increased fuel sales.  The stock price is 50% lower.  EV/EBITDA has declined from 8.0 at the end of 2001 to 4.8 at the end of 2011.

 

 

[finetrader]

What about gross margin? I've noticed that their profits or FCF are about the same than 10 years ago while their sales have doubled.

 

Not exactly.  In 2001 sales were $34.3 billion and gross profit was $10.6 billion.  In 2011 sales were $43.6 billion and gross profit was $11.8 billion.  Sales have not doubled, they have increased only 27%.  Store count is down 6%.  You are correct that gross margin has fallen.  It has declined from 30.9% in '01 to 27% in '11.  The decline in gross margin may be due in part to increased fuel sales.  The stock price is 50% lower.  EV/EBITDA has declined from 8.0 at the end of 2001 to 4.8 at the end of 2011.

 

You're right,

my point is that cash flow from operating activities have stayed constant in 10 years while sales have increased.

In those circonstances (no earnings growth, and higher leverage) I think it is justified that evaluation ratios have decreased.

 

Something to consider.