SWY - Safeway

[Rabbitisrich]

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.

 

Another factor gross margin decline is the change in accounting for Blackhawk revenues. Not sure why management is so confident that margins are approaching a bottom. Why maintain debt at 5X EBIT after 4 years of negative real comps? Operating and administrative costs were 24.7% of sales in 2011 compared to 23% in 2001. Kroger grew comps at 4.9% (and uses a 4.6% pension discount rate FWIW) while Whole Foods grew at 8.5%. Safeway competes for customers who seek an experience a little better than Ralph's and cheaper than Whole Foods, yet closer than Costco or Wal-Mart. Fresh and Easy is throwing money to compete against Pavilions and QFC targets the same customers as the Safeway brand. The future is uncertain enough to justify lower leverage.

 

 

 

[FCharlie]

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%.

 

Hi, Biaggio.

 

It's fair to take enterprise value into consideration. The reason I'm not especially concerned with it is because Ben Bernanke is blatantly saying zero% rates until late 2014, and because Safeway management is blatantly saying they have no intention to repay debt when interest rates are this low. The money they are using to fund share repurchase is coming from free cash flow, commercial paper between 0.65%-1.0%, and long term debt around 3%-4%... Blending the commercial paper and LT debt rates leaves you with an after tax cost of debt around 2.5-3.0% and remember, the entire buyback isn't debt funded. In fact, the four years prior to now, Safeway repurchased 40% of it's shares and simultaneously decreased it's total debt. Even with the added debt today, interest expense has declined year after year. I think many people hear the words Debt Funded Share Repurchase and get very concerned. You have to remember the first $700-$800 million of the annual buyback is funded with FCF.

[dcollon]

From Bloomberg (see attached)

Safeway_Options_Surge_Signals_Deal_as_Shorts_Pounce__Real_MA_-_Bloomberg.pdf

[A_Hamilton]

From Bloomberg (see attached)

 

I don't see what KKR would do with the company anyway. The board and management are already full up with individuals who have very close ties to KKR. I don't see where they are going to find all kinds of cost saves just by bringing this thing private, the recent share repurchase plan is effectively an LBO, just with no premium being paid for the takeout.

 

FCharlie, don't you have any concerns about what happens to your equity position if cash flow declines in a recession? Further, think about what happens if cash flow declines, borrowing costs will go up substantially on any debt that they need to rollover (like their 30-45 CP program). Bernanke and the Fed, broadly, have the ability to control treasury rates (at least for the forseeable future). However, that says nothing about what will happen to credit spreads over those rates.

[Viking]

When I look at the sector SWY, SVU and KR each look interesting. SVU looks to be the cheapest, but also carries the most risk. KR looks to be the most expensive (of the three), but also looks to be the best managed. If I was looking for a buy and hold for 10 years it would be KR. I also loved the disclosure of KR; they lay things out very well and they answer questions directly. Understanding their business is quite easy. As an example, their pension return assumptions are 6.5%; they mentioned one of their large competitors uses 8.5% (I trhink they were referencing SVU or SWY). I have added KR to my watch list.

[FCharlie]

From Bloomberg (see attached)

 

 

FCharlie, don't you have any concerns about what happens to your equity position if cash flow declines in a recession? Further, think about what happens if cash flow declines, borrowing costs will go up substantially on any debt that they need to rollover (like their 30-45 CP program). Bernanke and the Fed, broadly, have the ability to control treasury rates (at least for the forseeable future). However, that says nothing about what will happen to credit spreads over those rates.

 

The confidence I have comes from historical performance. For example,

 

OPERATING CASH FLOW:

2007 $2.19 billion

2008 $2.25 billion

2009 $2.54 billion

2010 $1.84 billion

2011 $2.02 billion

 

Next, Look at LT Debt maturites

 

2012 $806.9 million @ 5.81%

2013  $  1.6 million @6.72%

2014  $1,048.7million @ 5.18%

2015  $  41.3 million @ 2.48%

 

2012's debt has already refinanced.

2013's debt is de minimis

2014's debt is material, but it's the only material maturities for the next four years.

 

I truthfully don't have any concern for future maturities. This isn't a roller coaster business. The core business generates huge cash flow. Even during the worst of times, 2008-2009, operating cash flow was nearly $5 billion. Free cash flow those two years, the worst of all years, was over $2.5 billion.... which is almost half of today's market cap. Tell me something that has changed in the core business that would require me to assume operating cash flow will diminish materially?  Regarding future interest rate increases, remember, the goal of the business is to allocate capital to the highest use. Today, the highest return use is share repurchase. In the future, if there are higher interest rates or a lower FCF yield because of a higher stock price, you could find management aggressively repaying debt, which will be great. Hopefully they will be repaying debt with significantly lower shares outstanding.

[FCharlie]

Safeway has repurchased 29.1% of it's shares in the past SIX MONTHS....

 

And No One cares....

 

If  it weren't for a timing difference between the end of the calendar year and the end of the fiscal year, operating income would have been exactly the same as Q1, 2011, which would have left E.P.S. beating analyst estimates by 15% or more....

 

And No One cares....

 

Safeway's free cash flow yield is 18% and rising....

 

And No One cares...

 

Safeway has increased it's dividend by over 20% annually for six years in a row...

 

And N....

 

 

[gokou3]

FCharlie,

 

I have been following this thread and am intrigued by the wonderful FCF yield.  So, I did a little digging myself and pulled out the financial info for the last 10 years.  I notice something interesting: the cumulative FCF over the past 10 years is about 2.8x of the cumulative net income over the last 10 years!  I am sure there are some non-cash writedown somewhere etc, but still a 2.8x difference seems awkward to me.  Can you shed a light on what might have happened?  Is the company slowly liquidating?

 

I used morningstar data:

http://financials.morningstar.com/ratios/r.html?t=SWY&region=USA&culture=en-us

 

Thanks for the idea and great details.

[FCharlie]

FCharlie,

 

I have been following this thread and am intrigued by the wonderful FCF yield.  So, I did a little digging myself and pulled out the financial info for the last 10 years.  I notice something interesting: the cumulative FCF over the past 10 years is about 2.8x of the cumulative net income over the last 10 years!  I am sure there are some non-cash writedown somewhere etc, but still a 2.8x difference seems awkward to me.  Can you shed a light on what might have happened?  Is the company slowly liquidating?

 

I used morningstar data:

http://financials.morningstar.com/ratios/r.html?t=SWY&region=USA&culture=en-us

 

Thanks for the idea and great details.

 

Hello, Gokou3

 

The largest contributor to the difference between GAAP net income and FCF is a $1.8 billion non-cash goodwill charge in 2009. That alone takes your 2.8 number down to 1.7

 

Other factors that explain the difference would be Morningstar using numbers directly off the cash flow statement which are slightly skewed by the growth of Blackhawk, the Safeway subsidiary. Remember that as Blackhawk grows, they take in ever larger amounts of cash, nearly all of which will at some point be redeemed when people use their gift cards.

 

By the way, when I referenced free cash flow earlier in this thread, I was referring to free cash flow after adjusting for Blackhawk. After this adjustment, you're talking $4.1 billion of cumulative FCF over the past four years, which is 82% of today's market cap.

[Rabbitisrich]

The 10 year scale also includes losses from the sale of Dominick's in 2002.

 

FCharlie, any particular reason that you use Adjusted CFO - CAPEX for your valuation? I just assume that working capital adjustments wash out over time so I start from Adjusted EBITDA and work to CAPEX (although I leave in tax benefits for impairments). Both methods provide attractive trailing FCF yields, but there is about a $384 M difference over the last 4 years cumulative.

[A_Hamilton]

The 10 year scale also includes losses from the sale of Dominick's in 2002.

 

FCharlie, any particular reason that you use Adjusted CFO - CAPEX for your valuation? I just assume that working capital adjustments wash out over time so I start from Adjusted EBITDA and work to CAPEX (although I leave in tax benefits for impairments). Both methods provide attractive trailing FCF yields, but there is about a $384 M difference over the last 4 years cumulative.

 

Yes, when looking at SWY it's important to realize that they've taken $5 billion in asset writedowns/goodwill hits with Dominick's sale and Von's writedown. All of these acquisitions were made when operating margins were 4% instead of 2% in the grocery space, so thse assets weren't worth nearly what Steven Burd and Co paid for them.

[FCharlie]

The 10 year scale also includes losses from the sale of Dominick's in 2002.

 

FCharlie, any particular reason that you use Adjusted CFO - CAPEX for your valuation? I just assume that working capital adjustments wash out over time so I start from Adjusted EBITDA and work to CAPEX (although I leave in tax benefits for impairments). Both methods provide attractive trailing FCF yields, but there is about a $384 M difference over the last 4 years cumulative.

 

Mainly I adjust cash from operations because the company does. Look at page 27 of the 2012 Safeway annual report. They back out the impact of Blackhawk so the company doesn't "appear" to be gushing free cash flow in Q4 and "appear" to be burning cash in Q1.

 

In their words "Cash from the sale of third-party gift cards is held for a short period of time and then remitted, less our commission, to card partners. Because this cash flow is temporary, it is not available for other uses, and it is therefore excluded from our calculation of free cash flow."

[FCharlie]

 

 

Yes, when looking at SWY it's important to realize that they've taken $5 billion in asset writedowns/goodwill hits with Dominick's sale and Von's writedown. All of these acquisitions were made when operating margins were 4% instead of 2% in the grocery space, so thse assets weren't worth nearly what Steven Burd and Co paid for them.

 

Yep. Past shareholders have paid the price. It's sort of like Bank of America. You can't criticize the current BofA for the assets of 2006/2007. The pain has been inflicted. The company has absorbed nearly a hundred billion of net charge offs, the past shareholders have suffered extreme dilution, but to a new shareholder, BofA is a dream.  Safeway also. Steve Burd may have overpaid for Vons, Dominicks, and everything else, but what's left today is a cash machine and a hated stock.  Sometimes that creates the best possible situation, especially when the company repurchases (at 5 times FCF) 29% of it's shares in the past SIX Months.

[StubbleJumper]

I scrawled down SWY on my "to do" list a month ago.  Finally browsed the annual today.  Fascinating.  I hate the industry, but the FCF yield has become silly.  Thanks for posting the idea.

 

 

A couple of miscellaneous questions/observations:

 

1) Does anyone else wonder why the top 5 execs earned $25m last year to operate a grocery chain?  Really, it's not like launching the space shuttle...

 

2) I seem to recall reading that the execs have about 33m options outstanding under their option program.  Since there are only 268m shares outstanding, that's one hell of a pile of options.  It's a curious thing that they didn't just crank up the dividend to $1/sh about 4 or 5 years ago since they were swimming in FCF (which would be a juicy yield at today's prices).  Why is my Spider-sense™ tingling about this?  It really feels like management is trying to get those options "into the money"  through the buy-backs and have even taken on a bit of debt to get there.  Am I being paranoid (wouldn't be the first time!)?

 

 

SJ

[twacowfca]

I scrawled down SWY on my "to do" list a month ago.  Finally browsed the annual today.  Fascinating.  I hate the industry, but the FCF yield has become silly.  Thanks for posting the idea.

 

 

A couple of miscellaneous questions/observations:

 

1) Does anyone else wonder why the top 5 execs earned $25m last year to operate a grocery chain?  Really, it's not like launching the space shuttle...

 

2) I seem to recall reading that the execs have about 33m options outstanding under their option program.  Since there are only 268m shares outstanding, that's one hell of a pile of options.  It's a curious thing that they didn't just crank up the dividend to $1/sh about 4 or 5 years ago since they were swimming in FCF (which would be a juicy yield at today's prices).  Why is my Spider-sense™ tingling about this?  It really feels like management is trying to get those options "into the money"  through the buy-backs and have even taken on a bit of debt to get there.  Am I being paranoid (wouldn't be the first time!)?

 

 

SJ

 

The long term problem is the pension plan run by the union that's extremely underfunded.  Under the agreement with the union, they don't have to set realistic return assumptions or pay what they should have to pay into the plan to fund it's obligations -- yet.  But there will come a time of reckoning.

 

The management is playing games with the technicality that under GAAP they don't have to recognize the huge deficiency because that's the union's responsibility.  Thus all the 'free' cash flow.

 

What's going on is gamesmanship between the shorts who recognize the huge latent pension deficiency and the mediocre business vs management that wants to pump up the stock with free cash flow that shouldn't be there if realistic projections were used for the pension liability.

[Rabbitisrich]

 

What's going on is gamesmanship between the shorts who recognize the huge latent pension deficiency and the mediocre business vs management that wants to pump up the stock with free cash flow that shouldn't be there if realistic projections were used for the pension liability.

 

The discount rate used for the balance sheet PBO deficit is less ridiculous than the rate for pension expense. IF we are approaching a bottom for margins then you can add capitalized operating leases, any additional PBO estimate, and arrive at a decent trailing enterprise yield (ignoring w/c effects for the numerator).

 

I passed on the investment because it puts you in the odd position of having to get interest rate moves right for a grocery store. You also have to know that margins have bottomed. Also, comp store sales ex/fuel surpassed the inflation rate in only 3 of the last 10 years.

 

The pension issues don't seem large enough to warrant a short. Is there an expectation that one the members of the pension trust is insolvent enough to leave a hidden future obligation?

[twacowfca]

 

What's going on is gamesmanship between the shorts who recognize the huge latent pension deficiency and the mediocre business vs management that wants to pump up the stock with free cash flow that shouldn't be there if realistic projections were used for the pension liability.

 

The discount rate used for the balance sheet PBO deficit is less ridiculous than the rate for pension expense. IF we are approaching a bottom for margins then you can add capitalized operating leases, any additional PBO estimate, and arrive at a decent trailing enterprise yield (ignoring w/c effects for the numerator).

 

I passed on the investment because it puts you in the odd position of having to get interest rate moves right for a grocery store. You also have to know that margins have bottomed. Also, comp store sales ex/fuel surpassed the inflation rate in only 3 of the last 10 years.

 

The pension issues don't seem large enough to warrant a short. Is there an expectation that one the members of the pension trust is insolvent enough to leave a hidden future obligation?

 

Don't know.  But if one domino falls, we all know what happens to the rest of the dominos in the chain.

[StubbleJumper]

I scrawled down SWY on my "to do" list a month ago.  Finally browsed the annual today.  Fascinating.  I hate the industry, but the FCF yield has become silly.  Thanks for posting the idea.

 

 

A couple of miscellaneous questions/observations:

 

1) Does anyone else wonder why the top 5 execs earned $25m last year to operate a grocery chain?  Really, it's not like launching the space shuttle...

 

2) I seem to recall reading that the execs have about 33m options outstanding under their option program.  Since there are only 268m shares outstanding, that's one hell of a pile of options.  It's a curious thing that they didn't just crank up the dividend to $1/sh about 4 or 5 years ago since they were swimming in FCF (which would be a juicy yield at today's prices).  Why is my Spider-sense™ tingling about this?  It really feels like management is trying to get those options "into the money"  through the buy-backs and have even taken on a bit of debt to get there.  Am I being paranoid (wouldn't be the first time!)?

 

 

SJ

 

The long term problem is the pension plan run by the union that's extremely underfunded.  Under the agreement with the union, they don't have to set realistic return assumptions or pay what they should have to pay into the plan to fund it's obligations -- yet.  But there will come a time of reckoning.

 

The management is playing games with the technicality that under GAAP they don't have to recognize the huge deficiency because that's the union's responsibility.  Thus all the 'free' cash flow.

 

What's going on is gamesmanship between the shorts who recognize the huge latent pension deficiency and the mediocre business vs management that wants to pump up the stock with free cash flow that shouldn't be there if realistic projections were used for the pension liability.

 

 

Good observation.  Yeah, just eye-balling it, they're probably short ~$100m per year on their pension expense. 

 

Why do I feel like I want to take a shower after reading the annual?

 

SJ

[Tim Eriksen]

 

Good observation.  Yeah, just eye-balling it, they're probably short ~$100m per year on their pension expense. 

 

Why do I feel like I want to take a shower after reading the annual?

 

SJ

 

If SWY has $1 billion in FCF per year and 250 million shares outstanding, is the $100 million shortfall material?  $4 per share in FCF versus $3.60 per share. 

[StubbleJumper]

 

Good observation.  Yeah, just eye-balling it, they're probably short ~$100m per year on their pension expense. 

 

Why do I feel like I want to take a shower after reading the annual?

 

SJ

 

If SWY has $1 billion in FCF per year and 250 million shares outstanding, is the $100 million shortfall material?  $4 per share in FCF versus $3.60 per share.

 

 

Material?  Perhaps not.  Unless their "$1b in FCF guidance" is more like $700m in reality, and then knock off the ~$100m for the pensions benefits, and then figure out how much management is skimming off through the options grants, and then.... 

 

When I read the OP about the share re-purchases, I was quite surprised to see such thoughtful capital management.  It's great that management is not wasting money on organic growth in a difficult competitive environment, and it's great that they're not making value-destroying acquisitions like so many other arrogant management teams.  The choice of a repurchase instead of a higher dividend for a company that has had reasonably stable reported FCF was another curiosity, as most slow growth companies focus on the dividend route.  In principle, it's a great thing for shareholders because the benefit of the repurchase is realizable only when you sell, which is fabulous for income tax purposes.  So, really, on paper, capital management looks great in broad strokes.

 

But being a little paranoid, I looked at the options section.  Management has granted themselves options for more than 10% of the outstanding share float.  Really?  This is friggin Safeway, not Microsoft!  Why are there nearly 30 million options outstanding?  And what kind of behaviour might this encourage for a bunch of executives that are nearing retirement (take a quick read of their bio, they're mostly lifers at SWY)?  It strikes me as completely rational for them to use all the FCF to buy back shares, borrow money to buy back shares, and exaggerate FCF by understating the pension liability.  If they do enough of this, eventually the share price will rise, and their options will finish in the money.  So, if these guys have 30 million options that each finish $3 or $4 in the money, that strikes me as a pretty nice little payday.

 

Ok, so maybe management's interest is simply well-aligned with the shareholder?  Perhaps.  But, IMO a slow growth company that's been selling food for like 100 years should not be dishing out the options like that.  As I said up-thread, my Spider-sense is tingling about this management team after only a quick perusal of their financials.  When I read them, I feel like I need to take a shower.  And, I wonder what other little tricks might be going on behind the scenes that would help support FCF in the short-term, but might not be shareholder friendly in the long-term?

 

I fully admit that I have a tendency to be paranoid and delusional, but those are my impressions after spending 20 minutes SWY.

 

 

SJ

 

 

[twacowfca]

 

Good observation.  Yeah, just eye-balling it, they're probably short ~$100m per year on their pension expense. 

 

Why do I feel like I want to take a shower after reading the annual?

 

SJ

 

If SWY has $1 billion in FCF per year and 250 million shares outstanding, is the $100 million shortfall material?  $4 per share in FCF versus $3.60 per share.

 

 

Material?  Perhaps not.  Unless their "$1b in FCF guidance" is more like $700m in reality, and then knock off the ~$100m for the pensions benefits, and then figure out how much management is skimming off through the options grants, and then.... 

 

When I read the OP about the share re-purchases, I was quite surprised to see such thoughtful capital management.  It's great that management is not wasting money on organic growth in a difficult competitive environment, and it's great that they're not making value-destroying acquisitions like so many other arrogant management teams.  The choice of a repurchase instead of a higher dividend for a company that has had reasonably stable reported FCF was another curiosity, as most slow growth companies focus on the dividend route.  In principle, it's a great thing for shareholders because the benefit of the repurchase is realizable only when you sell, which is fabulous for income tax purposes.  So, really, on paper, capital management looks great in broad strokes.

 

But being a little paranoid, I looked at the options section.  Management has granted themselves options for more than 10% of the outstanding share float.  Really?  This is friggin Safeway, not Microsoft!  Why are there nearly 30 million options outstanding?  And what kind of behaviour might this encourage for a bunch of executives that are nearing retirement (take a quick read of their bio, they're mostly lifers at SWY)?  It strikes me as completely rational for them to use all the FCF to buy back shares, borrow money to buy back shares, and exaggerate FCF by understating the pension liability.  If they do enough of this, eventually the share price will rise, and their options will finish in the money.  So, if these guys have 30 million options that each finish $3 or $4 in the money, that strikes me as a pretty nice little payday.

 

Ok, so maybe management's interest is simply well-aligned with the shareholder?  Perhaps.  But, IMO a slow growth company that's been selling food for like 100 years should not be dishing out the options like that.  As I said up-thread, my Spider-sense is tingling about this management team after only a quick perusal of their financials.  When I read them, I feel like I need to take a shower.  And, I wonder what other little tricks might be going on behind the scenes that would help support FCF in the short-term, but might not be shareholder friendly in the long-term?

 

I fully admit that I have a tendency to be paranoid and delusional, but those are my impressions after spending 20 minutes SWY.

 

 

SJ

 

$100M per year is peanuts.  A realistic recognition of their pension liability would take a bite out of most of their equity.

[gokou3]

Safeway: CEO Steve Burd only made $4 million, not $11 million

http://www.bizjournals.com/sanfrancisco/blog/2012/05/safeway-ceo-burd-only-made-4-million.html?ana=yfcpc&page=all

 

Regarding performance share payout:

 

Safeway wants to base it on how well earnings per share grow over three years relative to the S&P 500.

 

Now, that seems reasonable, although anyone who’s read a few company balance sheets knows that there are plenty of ways, like buying back shares, for a company to boost its per-share payments.

 

    If EPS CAGR is less than the median of the S&P 500, none of the “performance shares” will vest, and the executives get nothing from that half of their LTIP.

    If EPS CAGR hits 80 percent of the median for the S&P 500, half the performance shares vest.

    If EPS CAGR hits the median, the middle of the range, of the S&P 500, then 100 percent of the shares vest.

    And if EPS CAGR soars into the top quartile of the S&P 500, then the shares double in value, vesting at 200 percent.

 

No wonder why Safeway leverages up to buy back shares.  It isn't too hard to be in the top quartile of EPS growth when you are buying back 20%+ of the O/S in one year.  Incentive explains action again.

 

 

[FCharlie]

 

Good observation.  Yeah, just eye-balling it, they're probably short ~$100m per year on their pension expense. 

 

Why do I feel like I want to take a shower after reading the annual?

 

SJ

 

If SWY has $1 billion in FCF per year and 250 million shares outstanding, is the $100 million shortfall material?  $4 per share in FCF versus $3.60 per share.

 

 

Material?  Perhaps not.  Unless their "$1b in FCF guidance" is more like $700m in reality, and then knock off the ~$100m for the pensions benefits, and then figure out how much management is skimming off through the options grants, and then.... 

 

When I read the OP about the share re-purchases, I was quite surprised to see such thoughtful capital management.  It's great that management is not wasting money on organic growth in a difficult competitive environment, and it's great that they're not making value-destroying acquisitions like so many other arrogant management teams.  The choice of a repurchase instead of a higher dividend for a company that has had reasonably stable reported FCF was another curiosity, as most slow growth companies focus on the dividend route.  In principle, it's a great thing for shareholders because the benefit of the repurchase is realizable only when you sell, which is fabulous for income tax purposes.  So, really, on paper, capital management looks great in broad strokes.

 

But being a little paranoid, I looked at the options section.  Management has granted themselves options for more than 10% of the outstanding share float.  Really?  This is friggin Safeway, not Microsoft!  Why are there nearly 30 million options outstanding?  And what kind of behaviour might this encourage for a bunch of executives that are nearing retirement (take a quick read of their bio, they're mostly lifers at SWY)?  It strikes me as completely rational for them to use all the FCF to buy back shares, borrow money to buy back shares, and exaggerate FCF by understating the pension liability.  If they do enough of this, eventually the share price will rise, and their options will finish in the money.  So, if these guys have 30 million options that each finish $3 or $4 in the money, that strikes me as a pretty nice little payday.

 

Ok, so maybe management's interest is simply well-aligned with the shareholder?  Perhaps.  But, IMO a slow growth company that's been selling food for like 100 years should not be dishing out the options like that.  As I said up-thread, my Spider-sense is tingling about this management team after only a quick perusal of their financials.  When I read them, I feel like I need to take a shower.  And, I wonder what other little tricks might be going on behind the scenes that would help support FCF in the short-term, but might not be shareholder friendly in the long-term?

 

I fully admit that I have a tendency to be paranoid and delusional, but those are my impressions after spending 20 minutes SWY.

 

 

SJ

 

I think you guys have brought up some very good points. I ask this though. Since you can't predict the future with regards to pension and free cash flow, isn't that where you have to ask yourself if the problems of the future are priced in today??

 

Will the pension expense go up? Perhaps. Will free cash flow be less than $1 billion? Perhaps. If Safeway had no problems, wouldn't a 10% free cash flow yield be sufficient? Today's free cash flow yield is 20%. Free cash could decline by half and Safeway could still pay a 3.5% dividend and repurchase 6.5% of it's shares annually. At some point, the problems of tomorrow are priced in today.

 

With regards to the options outstanding, they are indeed a large % of the total share count. The majority of these are underwater. The stock is at the same price it was about fourteen years ago. Should we worry about these options? You can criticize the company for borrowing to buy back 20-30% of their shares but at the end of the day, the company will either end up buying low and selling HIGHER when the options go "in the money", or the stock will stay low and the options will expire worthless. I personally don't have any issue with the company borrowing at 2-3% to buy a 20% FCF yield. I wouldn't care if it were a 15% FCF yield. And if that pushes the price to a point where Steve Burd & Co can exercise millions of options at  $25, 28, whatever... GREAT! Repurchase low, reissue higher.  I'm a buyer today, there's nothing stopping me from being a partial seller at $25 or $28, right alongside Mr. Burd & Co.

 

[Sportgamma]

 

As I understand, the debt mostly consists of a floating rate 1,5% libor notes and I imagine that the pension funds are discounted with a treasury rate.

 

Wouldn't it then be safe to assume that if rates go up, interest costs will get higher, but at the same time the pension funding percentage will improve?

 

[Tim Eriksen]

 

As I understand, the debt mostly consists of a floating rate 1,5% libor notes and I imagine that the pension funds are discounted with a treasury rate.

 

Wouldn't it then be safe to assume that if rates go up, interest costs will get higher, but at the same time the pension funding percentage will improve?

 

As of March SWY had $6.2 billion of debt.  Of that $1 billion was commercial paper (and is expected to decline to near zero at the end of the year).  They decided to issue $250 million of 18 month floating rate debt to reduce commercial paper and diversify funding sources.  The balance of their debt is fixed rate with $800 million coming due this year, the floating rates due at the end of next year, $1 billion due in 2014, and nothing in 2015.  Their average interest cost is about 4.5%.  Thus higher rates will not materially increase interest costs.  Their pension funding will actually do best if equities rise since the plan is 65% in equities.