SWY - Safeway

[Palantir]

Looks like market still hates SWY.

[FCharlie]

Looks like market still hates SWY.

 

 

I think the market will hate SWY until it drops to zero.  Look at this comment from a few days ago:

 

http://finance.yahoo.com/news/safeway-asset-sale-not-viewed-115255001.html

 

Susquehanna believes Safeway's sale of its high return Canadian asset should not be viewed as a catalyst for value expansion but rather should lead to valuation challenges that are not reflected in the current share price. The firm expects the remaining company to trade at a discount to where it was prior to the transaction. Shares are Negative rated with a $14 price target.

 

If Susquehanna were correct, SWY should fall to $14 and with 241 million shares outstanding  they would have a market cap of $3.3 billion.    Now remember they are planning on repurchasing $2 billion of shares so they could buy 60% of their shares at $14. Then they would have 96 million shares outstanding, a nearly 6% dividend, a 44% free cash flow yield, almost $90 per share of real estate at cost, etc...

 

At some point these calls people make get ridiculous and you just simply laugh at them.

[Palantir]

On the bright side we have management who will continually buy back and pay us a nice 3% DY....might wait for it to go low 20s.

[Guest hellsten]

Interesting to see Eddie Lampert buy SWY in Q4, 2012 and then sell the shares in Q1, 2013:

http://www.dataroma.com/m/hist/hist.php?f=EL&s=SWY

 

SWY's P/S ratio is similar to SHLD's. I haven't been following SWY very closely, so I wonder what other similarities there are. SWY owns a lot of real estate and is still profitable. Maybe Wall Street won't like SHLD even if they become profitable again, but who cares?

[mcliu]

I can see where the analyst's are coming from. The after-tax proceeds doesn't make this transaction very attractive since the remaining company will have much smaller margins than the combined U.S./Canada business. Given the competitive pressures from big boxes, grocery stores will increasingly face shrinking margins. It's quite worrying when you have the Wal-Mart's of the world selling groceries at cost/a loss competing with you. And with the U.S. business running at 1.6% to 1.8% operating margins (pre-tax and pre-interest), there really isn't much left to shrink.

 

That said, if management does the right thing, such as cutting costs, shutting down unprofitable stores, paying off near-term debt, shrinking capex, the transaction and the currently decent cash flows provide a lot of flexibility to increase shareholder value. Nonetheless, this is definitely an uphill battle.

[FCharlie]

http://www.sec.gov/Archives/edgar/data/86144/000008614413000044/form8-kcanada.htm

 

 

Safeway filed an 8K today with a lot of valuable information regarding the Canada transaction.

 

 

 

[sampr01]

hi Charlie

 

Do you see any near term catalyst for $SWY. I am still surprised by markets negative reaction for canada transaction

 

Thanks

 

http://www.sec.gov/Archives/edgar/data/86144/000008614413000044/form8-kcanada.htm

 

 

Safeway filed an 8K today with a lot of valuable information regarding the Canada transaction.

[gokou3]

http://www.sec.gov/Archives/edgar/data/86144/000008614413000044/form8-kcanada.htm

 

 

Safeway filed an 8K today with a lot of valuable information regarding the Canada transaction.

 

I see the following 2012 stats for the continuing operations:

 

EBITDA = $1752.3M

I = $292.6M

T = $158.6M

Q9. CapEx = $837M

 

2012 FCF = EBITDA - I - T - capex = $1752.3-292.6-158.6-837 = $464M.  This is lower than previously estimated.

 

 

 

[Nnejad]

Dinging 'em rough on the interest given the proceeds/cash flows.

[LC]

http://www.sec.gov/Archives/edgar/data/86144/000008614413000044/form8-kcanada.htm

 

 

Safeway filed an 8K today with a lot of valuable information regarding the Canada transaction.

 

I see the following 2012 stats for the continuing operations:

 

EBITDA = $1752.3M

I = $292.6M

T = $158.6M

Q9. CapEx = $837M

 

2012 FCF = EBITDA - I - T - capex = $1752.3-292.6-158.6-837 = $464M.  This is lower than previously estimated.

Much lower than I estimated. I'm surprised at the breakout of capex of US vs. Canada. I'm not sure how management plans on paying off 800m of debt with FCF and proceeds from Blackhack if their 2012 FCF is less than 500m and are using 100m of the Blackhawk IPO proceeds (pg. 5, ** notation). This  suggests they are estimating ~700m of FCF in 2013. Even my previous conservative (at the time) estimate of $600m of FCF was shooting too high. The only way I see them going from 465 to 700m of FCF in 2013 is by drastically cutting capex. Has management disclosed anything to this effect?

[mcliu]

On the filing, they're projecting $0.9B in FCFE and $0.9B of capex.

 

This all seems reasonable and pretty close to the $510M in FCFE that I was estimating earlier.

If you look at trailing twelve months, FCFE is slightly higher, as tax and interest expense are slightly lower. I think U.S. standalone should generate somewhere between $470M to $500M in FCFE.

$700M in FCFE for 2013 seems reasonable since you'll have both divisions for most of the year. Your Canadian division cash flows only go away once the deal closes sometime in late Q3 or early Q4.

 

If they're planning to do as they say and buy back around $2.7B in bonds, you'll have savings of around $90M for next year, so you're looking at a proforma FCFE of $560M to $590M, which is quite reasonable on a market cap of $3.8 billion.

 

I've yet to make those adjustments that Rabbitisrich (thanks!) mentioned regarding asset dispositions and pension expenses. If management does a good job realizing value on its real estate and operating divisions, it'll provide an additional boost to FCFE to over $600M. Overall, it's around 6.5x FCFE, which I feel is quite reasonable for this company.

 

 

[fareastwarriors]

UBS's take on swy

UBSInvestmentBank_Safeway_ImplicationsofitsCanadadisposal_SellDeRise_Jun_13_2013.pdf

[mcliu]

Thanks fareastwarrior.

 

Do you guys have a sense of how they come up with the estimates of pension obligations? UBS is suggest own pensions of $531 million and share of multi-employer pension of $1.3 billion..

[fareastwarriors]

Kroger Agrees to Buy Grocer Harris Teeter for $2.5 Billion

 

 

http://www.bloomberg.com/news/2013-07-09/kroger-agrees-to-buy-harris-teeter-supermarkets-for-2-5-billion.html

 

 

Kroger Co. (KR), the largest U.S. grocery-store chain, agreed to buy Harris Teeter Supermarkets Inc. (HTSI) for $2.5 billion in cash to bolster its presence in the southeastern part of the country.

 

...

 

 

Kroger is paying 7.9 times earnings before interest, taxes, depreciation and amortization for Harris Teeter, the data show. That would be the highest multiple for a U.S. food retailer deal larger than $100 million since December 2007, when Pathmark Stores Inc. was acquired by Great Atlantic & Pacific Tea Co. for 9.9 times Ebitda, the data show.

 

 

[fenris]

Short thesis on SWY with very negative take on the deal:

http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/101012

[tripleoptician]

@ fenris

 

I don't have a VIC membership, what is the jist of the short thesis?

 

Cheers

 

 

[LC]

@ fenris

 

I don't have a VIC membership, what is the jist of the short thesis?

 

Cheers

Essentially they are on the lower rung of us operators, and the Canadian ops were the only thing worthwhile. They're the next Supervalu.

[tripleoptician]

Thanks LC.

So based on this short thesis, they were better off with the Canadian division despite getting a premium to going market rate on the sale?

I haven't studied this company closely, but I thought the long thesis was excellent capital allocation from solid stable cash flows being used for stock repurchases. This was increasing per share owner earnings to a degree that even despite a challenged business model in the long run ( greater than 5 years?) the company was providing cheap per share earnings for the foreseeable future.

 

I thought that pay down of debt/ share repurchases from the Canadian sale haven't changed this overall superior owner earnings in the next few years, despite losing the superior cash flow of the Canadian ops. My feeling was the potential decline secondary to low cost operators would take longer to play out than most think. Is the American division really that bad? I thought it is still producing meaningful FCF/yr to continue being allocated to share repurchases. This is assuming management continue to buy undervalued stock.

 

Fcharlie seems to know this company well...does this short thesis hav substantial ground?

[FCharlie]

I am not a VIC member so I can't read the article either.

 

All I have to go on is "Essentially they are on the lower rung of us operators, and the Canadian ops were the only thing worthwhile. They're the next Supervalu.

 

So, my response to that would be:

 

They may be below Kroger and Publix on the rung of US operators but I see them above Food Lion, Lowes, Hannaford, Albertson's, etc.

 

The Canadian ops produce better net income but the US operations produce more free cash flow and also own PDC and Blackhawk. US ops own $8 billion of real estate which amounts to nearly $50 per share after the share repurchase from selling Canadian ops. Going forward, management thinks they will distribute 75% of cash to shareholders as dividends and share repurchase and 25% of cash to further debt repayment.  The investment theme of buying hard assets and double digit growing free cash flow per share at a discount is still intact.

 

As far as the next SuperValu,  remember, SuperValu has had negative comps and ID sales for years. Safeway ID sales are positive. Safeway had record sales last year and this is despite closing stores in the New Jersey area.  SuperValu had maximum leverage and Safeway is not even close to being over leveraged. Safeway's net debt/EBITDA will be well below Kroger for comparison and net debt/EBITDA is now and still will be well below their debt covenants after this transaction.

[mcliu]

You can sign up for guess access to read the thesis. Here's an excerpt:

 

SWY just sold its best asset, its Canadian grocery operation (60% of net income), in a highly dilutive deal.  Investors are distracted by the deceivingly high headline sales price, but they have not crunched the numbers to determine how dilutive it is.  Pro forma for the transaction, SWY is significantly overvalued.  EPS estimates should reset materially lower, and the P/E should compress, as investors realize that they are likely holding the next bankrupt US grocery chain.

 

Pro forma for the transaction, SWY is trading at 14x P/E vs pre-deal it was trading at 10x.  But, the remaining business is much worse and deserves a lower valuation.  The remaining business is primarily a US grocer in a sharp secular decline with ZERO “core” FCF.  My EPS is ~$1.70 pro forma for the capital structure changes described below (buyback + debt reduction).  Using a 10x P/E, in-line with SWY’s valuation pre-deal, leads to a target price of $17 or -30% downside to the stock.  Ultimately the US grocery business could be a zero.

 

To get into the weeds for a moment, the crux of the opportunity is that EBIT margins in Canada are four times higher than the US, while EBITDA margins are only two times higher.  So, selling Canada has created a disconnect between valuation based on EV/EBITDA and valuation based on EBIT, P/E and FCF.  SWY looks somewhat cheap on EV/EBITDA (4.8x vs 5.4x pre-deal), which is what people are focusing on right now, but it is very expensive on P/E (14x vs 10x pre-deal).  Similarly, SWY has gotten more expensive on other metrics:  EV/EBIT has gone from 11x to 13x.  The levered non-core FCF yield is the same at 14%, but only because I generously assume that virtually all of the stock comp and the property gains belong to the US operations.  If you exclude the non core property gains, the FCF yield is 8% vs 10% pre-deal.

 

I’ll make the hopefully obvious point that earnings and cash flow matter more than EBITDA.  SWY deserves to trade at a superficially low 4x EBITDA because very little of the EBITDA converts into earnings and FCF.  Few on the sell side have started to do the math of what pro forma earnings and cash flow will look like.  When they do, they’ll realize that SWY is significantly overvalued.

 

The author believes the company is not putting in enough capex. His valuation normalizes capex and removes cash from property gains to reach a U.S. FCFE of ~$300M.

 

I would disagree as I think the right U.S. strategy is to keep reducing store count and extract cash from the property portfolio.

 

I would be wary of the $8 billion of U.S. real estate value given how over-retailed that market is. Commercial property prices may not be worth nearly as much as it currently seems.

[fenris]

Sorry, should've added that you can sign up for the guest pass at VIC with no strings attached (which I highly recommend, you can access all of the old write-ups and there are some great reads).

[FCharlie]

You can sign up for guess access to read the thesis. Here's an excerpt:

 

SWY just sold its best asset, its Canadian grocery operation (60% of net income), in a highly dilutive deal.  Investors are distracted by the deceivingly high headline sales price, but they have not crunched the numbers to determine how dilutive it is.  Pro forma for the transaction, SWY is significantly overvalued.  EPS estimates should reset materially lower, and the P/E should compress, as investors realize that they are likely holding the next bankrupt US grocery chain.

 

Pro forma for the transaction, SWY is trading at 14x P/E vs pre-deal it was trading at 10x.  But, the remaining business is much worse and deserves a lower valuation.  The remaining business is primarily a US grocer in a sharp secular decline with ZERO “core” FCF.  My EPS is ~$1.70 pro forma for the capital structure changes described below (buyback + debt reduction).  Using a 10x P/E, in-line with SWY’s valuation pre-deal, leads to a target price of $17 or -30% downside to the stock.  Ultimately the US grocery business could be a zero.

 

To get into the weeds for a moment, the crux of the opportunity is that EBIT margins in Canada are four times higher than the US, while EBITDA margins are only two times higher.  So, selling Canada has created a disconnect between valuation based on EV/EBITDA and valuation based on EBIT, P/E and FCF.  SWY looks somewhat cheap on EV/EBITDA (4.8x vs 5.4x pre-deal), which is what people are focusing on right now, but it is very expensive on P/E (14x vs 10x pre-deal).  Similarly, SWY has gotten more expensive on other metrics:  EV/EBIT has gone from 11x to 13x.  The levered non-core FCF yield is the same at 14%, but only because I generously assume that virtually all of the stock comp and the property gains belong to the US operations.  If you exclude the non core property gains, the FCF yield is 8% vs 10% pre-deal.

 

I’ll make the hopefully obvious point that earnings and cash flow matter more than EBITDA.  SWY deserves to trade at a superficially low 4x EBITDA because very little of the EBITDA converts into earnings and FCF.  Few on the sell side have started to do the math of what pro forma earnings and cash flow will look like.  When they do, they’ll realize that SWY is significantly overvalued.

 

The author believes the company is not putting in enough capex. His valuation normalizes capex and removes cash from property gains to reach a U.S. FCFE of ~$300M.

 

I would disagree as I think the right U.S. strategy is to keep reducing store count and extract cash from the property portfolio.

 

I would be wary of the $8 billion of U.S. real estate value given how over-retailed that market is. Commercial property prices may not be worth nearly as much as it currently seems.

 

The author says that Ultimately the US grocery business could be a zero.

 

I suppose ultimately any business could be a zero. For now we have a business that is growing sales, not shrinking. We also have a business that owns an enormous real estate portfolio relative to it's market cap.

 

If you remove property gains then you should remove property impairments. The author is not doing that.

 

 

I think that people have made the same arguments against Safeway for a long time. They may continue. All I focus on is free cash flow, hard assets, and share repurchase. I love BlackHawk. I love PDC. I love the stability of the industry.

 

Here is a quote from Steve Burd at 2013 Safeway Investor Day on real estate and property gains:

 

Now a lot of people like to focus in on the property gains. And some people like to sort of exclude them and say, "Well, if it weren't for the property gains, their numbers would have been x." I've said this for years, I will continue to say this, that if you're in the retail business, you, by definition, are in the real estate business. That is particularly true in food. And if you think about the supermarket business, a lot of family businesses, that's how they all started, they tended to own their real estate, they tended to own their shopping centers. And I've seen family businesses that have finally been absorbed or gone out of business, and the family is still flying around in a G4 because they kept their real estate, okay?

 

 

 

 

 

 

[Rabbitisrich]

It depends on how you incorporate property sales. It shouldn't be confused with recurring operating earnings, which Burd may have been implying (I haven't seen the context). When you sell the property as a real estate business, you are adding an expense to your operations, or reducing revenues and expenses. Burd's statement is frankly confusing as it seems to begin as a defense of incorporating cash from dispositions as a contra to capital expenditures, but then it ends as a defense of the strategic value of holding real estate. These are related, but different topics.

 

 

[FCharlie]

One reason I selected that quote is because it was the first thing that came to mind when the author of the previous article said that Safeway was likely going to be the next bankrupt grocery chain. I really like how Burd made the point that stores will come and go but real estate is always there and the owner of real estate usually ends up just fine.

 

Consistently, Burd has stated that property gains are something that shareholders should get used to because they are going to become larger and larger as time goes on. He says that analysts always want to exclude property gains but they simultaneously will include property impairments which makes no sense.

 

 

[fareastwarriors]

upgraded at CS.

 

 

Shares of Safeway Inc. rallied on Friday after the grocer's stock was hiked to outperform from underperform at Credit Suisse. "The combination of a low U.S. supermarket valuation, growing potential to unlock value through strategic divestitures, and the opportunity to cut the share count by over 40% in coming months provides a path to strong upside with limited risk," Edward Kelly, an analyst at Credit Suisse, said in a report. He also raised the stock's target price to $34 from $26. Safeway shares gained 6% to $28.16 in recent trade.