Squeezing Safeway Workers Wont Solve the Problem

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Squeezing Safeway Workers Wont Solve the Problem
An Analysis of the Real Issues
Undermining Safeways Competitiveness
Shareholder Value
Presentation to Safeways Institutional Sharehol
ders Investment Analysts By Hope Crifo, CFA f
or the AFL-CIO Office of Investment October 30,
2003
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Safeways Stock Down 58 in 3 Years Substantialy
Underperforms Direct Peers
Three-Year Relative Share Price Performance
Albertsons
Kroger
Safeway
Loss of 19.9 B in shareholder value in just
under three years, adjusted for stock repurchases.
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Safeways Issues(thats Issues with an Attitude)

• Deteriorating fundamentals
• Lost market share/declining same store sales
• Acquisition prices and flawed integration
• Mistimed stock repurchases
• Under investing
• Loss of management credibility
• Credit rating change possibility
• Lack of detailed and timely disclosure

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1 -Falling Profitability Relative to Peers
Year over Year Margin Changes, 2002 vs. 2001

• Operating miscues allowed a poor economy to hurt
  Safeway more than its competition.

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2 Losing Market ShareIts Neither Wal-Mart nor
the Economy
39 weeks ending 6/29/03 (Stater Bros has 9/29
fiscal year end)
Unlike Stater Bros., Safeway and Kroger include
fuel sales in same stores figures, which should
result in even more favorable same store sales
comparisons. Safeway without fuel would be 0.9
in 3Q03. Stater Bros. period adjusted for com
parability (e.g. 3/30 quarter compared with 1Q at
Safeway and Kroger)
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Losing Market Share Its Not the Supercenters,
Its the Other Competitors

• Safeway competes with Wal-Mart at approximately
  18 of its stores.
  
• About 60 of Kroger stores compete with Wal-Mart,
  yet Krogers same store sales are stronger than
  Safeways.
  
• For us, its not the supercenters, its not the
  clubs that are creating the soft sales that we
  had in 2002 and certainly in the first part of
  2003. Its really predominately the business
  slowdown that has affected our top line sales
  growth and not either the supercenters or the
  clubs that we have competed with, really, for
  decades. (Steven A. Burd, Safeway Chairman and
  CEO, at Goldman Sachs Conference, 9/3/03)

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3 - Failed Integration Strategy

• Well-executed acquisitions can be a key component
  of a grocery chains growth strategy.
  
• Safeway has made five acquisitions, plus some
  relatively small store purchases, since 1997,
  paying between 6MM and 16.5MM per acquired
  store. The price paid for each sales dollar
  ranges from 36 cents to over 70 cents.
• Two of the five acquisitions appear to have been
  successes. Three have cost the company mega
  dollars.
  
• Whether one views Safeways acquisition strategy
  as prudent, the 1.5 billion goodwill write-offs
  from the acquisition of Dominicks and Randalls
  indicate Safeway overpaid. With free cash flow
  of 5 at best, the need to achieve quick cost
  savings to earn a return on the investment
  resulted in mistakes and increased, not
  decreased, costs.

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4 - Mistimed Stock Repurchases

• Safeway paid 2.9B to repurchase stock since 4th
  quarter 1999, at between 22 to 44 per share.
  
• These share purchases have an ongoing cost the
  interest expense on money borrowed to fund them.
  Using the companys recent five-year borrowing
  cost, interest expense on the 2.9B in funds
  equates to over 121MM per year.

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5 - Safeways Underinvesting Jeopardizes
Future Competitiveness
according to revised plan 11/02 2003 plan
called for 135-160 store remodels

• Rule of Thumb 80 of supermarket stores should
  have been remodeled within past five years.
  
• At year-end 2001, Safeway believed approximately
  75 of stores had been remodeled within the
  previous five years. Above chart shows the
  percentage has gone down since then.
• Last year, Safeway claimed to be revisiting the
  prudence of what they term defensive remodels,
  resulting in reduced remodeling spending.
  
• Aggregate capital spending also declined, by 18,
  to under 4 of sales.

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6 - Management Credibility Concerns

• On an April 2001 analyst call, Safeway management
  said an EBDIT margin of 11 is a very realistic
  target.
  
• Management also forecast that, at most, economic
  softness would cause two negative quarters of
  same store sales growth.
  
• Genuardis transition is right on track, was
  the company line early on.
  
• Management was forecasting 13-15 annual earnings
  growth until 12 months ago.
  

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6 - Management Execution Problems

• Managements strategic plan was to generate
  higher gross higher identical store sales.
  
• In addition to the acquisition-related write
  offs, recent failed investments include 30MM in
  an internet business, and another 30MM charge
  for an investment in a meat venture.
• The 2001 strike at the Tracy, California
  distribution center operated by 3rd party Summit
  Logistics cost Safeway roughly 67MM. Less than
  two years later, Safeway replaced Summit and
  decided to operate the facility directly.
• Operational issues including the shrink program
  which had to be changed, plus integration and
  centralization of dry grocery/non-perishables,
  which approximate 60 of total sales.
  Centralization has proved costly so far, cutting
  an estimated 50bp from quarterly gross margins
  earlier this year.
• Randalls loss of market share and store closures
  shortly after their acquisition resulted in
  related charges.
  
•  

Safeway has repeatedly failed to deliver on its
promises to Wall Street. The chains execution
of a number of initiatives to get the company
back on the right track continues to disappoint.
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7 - Credit Ratings Financial Flexibility

• What the credit rating agencies have said about
  Safeway
  
• Safeways strengths valued by the rating agencies
  are eroding
  
• Dominicks issue introduces uncertainty
• Should investors be concerned that the rating
  companies will revisit their outlooks?
  

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8 Lack of Detailed Timely Disclosure

• Declining same store sales at Dominicks were not
  disclosed on a timely basis.
  
• Yucaipa lawsuit not mentioned in recent 10-Q.
• Safeways conference calls and analysts meetings
  are not available in an archived format after the
  call.
  
• The company consistently provides only anecdotal
  information regarding food inflation, cost
  components, competitive store openings, gasoline
  sales and margins. This contrasts with the detail
  provided by Krogers and Albertsons, as well as
  information provided by privately-held Stater
  Bros.

In comparison to other supermarket firms, Safeway
discloses little in a formal, traceable way.
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The State of the Grocery Industry
Source Food Marketing Institute Annual Financial
Review 1Beginning in 1983, data is based on a fis
cal year instead of a calendar year.
2Prior to 1984-1985, statistics were based on
sales, assets and liabilities of companies
operating only supermarkets. Beginning in
1984/1985, includes diversified companies with
primary supermarket operations.
3Net profit was pulled down by extraordinary
items not related to normal supermarket
operations. Excluding these factors, net profit
is 0.74 . Key Industry Facts - Prepared by FMI I
nformation Service
Record industry net profitability in 2001-2002
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The Wal-Mart Worry

• Safeway has a different customer.
• It is cheaper to retain existing customers than
  attract new ones.
  
• What other chains are doing to improve strategic
  competitiveness
  
• Investing 100 of cash flow in the business
• Improving the value proposition
• Upgrading fresh foods expanding higher margin
  frozen foods, perishables
  
• Increasing customer loyalty by adding services,
  i.e. banks in stores, etc.
  
• Experimenting with other formats
• Reducing procurement and logistics costs
• Extensive remodeling
• Focusing marketing strategies to leverage
  demographic regional strengths
  
• Pursuing growth through greater successful
  industry concentration
  

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The Wal-Mart Worry

• Factors that top the list when customers decide
  where to shop for groceries, according to the
  Food Marketing Institute, are
  
• a clean, neat store
• a convenient location and ease of shopping
• value not necessarily price, but includes
  selection service
  
• According to Safeways own 2002 10-K, the
  principal competitive factors that affect the
  Companys business are location, quality,
  service, price and consumer loyalty to other
  brands and stores.
• Given Safeways shopper demographics, the FMI
  findings may be especially relevant to Safeways
  future prosperity.