Thursday, October 15, 2009

Good(ish) quarter at Safeway (SWY). Yes, I still like it.

I say (ish) because things can only be so "good" with earnings down 30% from a year earlier. Shares finished up over 6% today.

AlphaNinja readers who bought Safeway (SWY)shares along with me have enjoyed a 22% gain, double the 10% rise in the S&P500 since I recommended shares August 17th. No victory lap, just sharin'.

From here I'll look at what's changed, and whether to re-evaluate.

The same problems persist, and management isn't shy about discussing them. Currency exchange rates are hindering them. Deflationary pressure - especially in perishables - is also a drag. And customer trade-downs to cheaper alternatives are also hurting. That said, perishable volumes increased for the first time in 11 quarters, and non-perishables for the first time in 5 quarters. Volumes are key, because taking more and more "wallet share" of the customer's total spending creates long term opportunities when prices recover.

In good news, debt reduction continues, and the next debt due is August 2010. The company's overall debt is $5.4billion, and the cost of debt at a little over 6%. They can borrow in the overnight market (also called commercial paper, or what I like to call "fake financing") for 30basis points.

Safeway repurchased about 10million shares this quarter for $18.84 per share. I'd prefer management "dividend" that back to us shareholders, but at least the trade is in the money.

Management left this year's EPS and Free Cash Flow guidance intact - a good call, maybe they won't have to reduce guidance again like they did a few months back. With shares ouststanding down due to the buyback, maybe this guidance is conservative.

With all the headwinds facing them, there is room for things to get a LOT better. Here's a thought - own Safeway as an INFLATION hedge, as their gross profit dollars will SOAR if food inflation becomes and issue.

Guidance is for $1.1-1.3billion in Free Cash Flow this year, but I exclude tax credits and other unsustainable cash flows, so say $1billion. That is a Free Cash Flow Yield (FCFY) of 10.6% -->> way above their 6% borrowing costs, and is why I think shares have further to run.

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