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Safeway Inc. (SWY) Wastes a Rare Opportunity

Empire Co, the buyer of Safeway Inc. (NYSE:SWY)‘s Canadian property, saw its stock jump 11% in early trading the day after the sale. Meanwhile, Safeway Inc. (NYSE:SWY)’s stock was up 10%, on the announcement of the $5.7 billion deal. All in all, not a bad setup for investors.

The only downside, from my viewpoint, is that the cash from the sale isn’t going to help Safeway make much of its American operation. The company stated that the proceeds would be used to pay down debt, buy back shares, and — if there was anything left — maybe invest in the business. Who’s to say?

The folly of the buyback

Safeway Inc.Look, we all get it. If a company buys its outstanding shares, then there’s more apportioned to the remaining investors. If I divide income by the number of shares — calculating the company’s most quoted statistic, EPS — I can bump the result up by increasing the income, or by decreasing the number of shares. Companies are quickly discovering that the income bit is hard, but buying shares is easy.

In the last four months of 2012, Safeway Inc. (NYSE:SWY) bought back 13.6 million shares, spending an average of $16.83 per share to do so. That helped the company boost its EPS, but it did nothing for the underlying strength of the business. That’s one of the reasons that share buybacks don’t typically work. Analysts have found that the buybacks typically don’t help a business out and, in close to a third of cases, the purchase won’t stop a fall in the share price.

When buybacks work

Not all repurchase plans are created equal, though. Strong companies often build an ongoing repurchase program alongside their dividend payments. Those companies are usually focused on generating a stronger business first, and buying back shares as a secondary measure.

The Home Depot, Inc. (NYSE:HD) has been a consistent repurchaser of shares, and is an excellent example of striking a good balance. In the fourth quarter, the company authorized a $40-billion buyback program in the middle of last year, and added $17 billion earlier in 2013. Since the announcement, the company’s stock has risen 50%.

The Home Depot, Inc. (NYSE:HD) has certainly spent a lot on the program, but it’s also had a heavy focus on the core business. Comparable store sales were up 4.3% in the first quarter, while Safeway Inc. (NYSE:SWY) only managed a 1.5% rise. That fell well short of The Kroger Co. (NYSE:KR)‘s 3.5% increase in its last reported quarter.

The bottom line

In short, Safeway Inc. (NYSE:SWY) still has a long way to go before being close to “best in class.” The Kroger Co. (NYSE:KR) is still dominating its market, while Safeway falls behind. If the best Safeway can do with a windfall cash injection is buy back shares, I have almost no hope for the longevity of the business. It’s still possible that management will wake up to the reality of the situation, and spend the announced repurchase cash elsewhere — almost a quarter of all announced programs never get completed. If that happens, we can re-address the business; but for now, I’m opting out of Safeway.

The article Safeway Wastes a Rare Opportunity originally appeared on Fool.com and is written by Andrew Marder.

Fool contributor Andrew Marder has no position in any stocks mentioned. The Motley Fool recommends Home Depot.

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