Is Safeway Inc. (SWY) a Value Trap?

Safeway Inc. (NYSE:SWY) is a relatively smal company with a market cap sitting at a hair under $6 billion. The company is also discounted to the overall market, trading at just about 9 times earnings. Speaking of earnings, the company has seen its ups and downs over the years:

Improving earnings can be chalked up as a current strength, however. Safeway, in fact, has posted profit gains in four out of its last five quarters.

Safeway Inc. (NYSE:SWY)’s dividend also seems to be strengthening, as the company has continued to raise it even amongst declining profits; Safeway recently boosted its dividend by 14%, and it currently offers a dividend yield of a little more than 3%, supported by a low payout ratio of only around 26%.

What about the balance sheet?

Safeway Inc. (NYSE:SWY)’s balance sheet could definitely use some improvement:

Safeway’s balance sheet carries a lot of debt, and is low on cash. This is a weakness that the company should look to clean up, and it appears it might be doing just that.

So where is Safeway heading?

Newly appointed Safeway Inc. (NYSE:SWY) CEO Robert Edwards is looking to address the company’s debt problems– and this should be encouraging for shareholders. Edwards will be looking to use the company’s free cash flow to not only pay out dividends, but also to accelerate the retirement of debt. The company expects its debt to be reduced by as much as $900 million this year. So where will this free cash flow come from?

Edwards commented that:

“One of the hallmarks of Safeway is a focus on cost reduction and profit improvement… We systematically add projects throughout the year.”

One such program, Fast Forward, which is currently being implemented, uses a loyalty card that shoppers can link to their checking accounts. This allows merchants and consumers to avoid the fees charged by banks when traditional debit cards are used.

Fast Forward essentially allows Safeway Inc. (NYSE:SWY) customers to receive “club” savings and pay for their groceries directly from their checking accounts all at the same time. The company seems to be “skipping over” the traditional fees as a result of this direct-pay feature. The program should also help Safeway boost efficiency and increase its free cash flow.

Wal-Mart Stores, Inc. (NYSE:WMT) is also looking to oust out the bankers

In an alliance with American Express Company (NYSE:AXP), Wal-Mart Stores, Inc. (NYSE:WMT) is taking it a step further and seems to be moving into full-fledged financial services.

With the Bluebird program, prepaid cards can be usable at every one of the millions of locations where American Express is accepted. Users also have access to features many prepaid cards don’t offer, such as getting set up to accept recurring payroll deposits, pay bills, and even retrieve cash at ATMs and reload the cards with more cash for free at most Wal-Mart Stores, Inc. (NYSE:WMT). The cards even offer technology to direct deposit your paycheck by taking a picture of it with your smartphone. Not to mention the cards now offer FDIC insurance coverage and the ability to order and write checks.

Wal-Mart and American Express Company (NYSE:AXP) have created an alternative to traditional banking, and are doing it cheaper. They are also recruiting and capturing many customers who were previously “un-banked.”

As of January, Bluebird boasted 575,000 account holders and $275 million in funds loaded onto the cards. The company also confirmed that 85% of these customers were new to American Express, with about 45% of them being under the age of 35.

American Express will likely gain some nice revenue from interchange fees– which are assessed on a merchant (in this case Wal-Mart) every time a Bluebird card is swiped. American Express Company (NYSE:AXP) also gains access to a huge new customer base, while Wal-Mart gains from the increase in foot traffic and shoppers.

Wal-Mart expanding in groceries

Wal-Mart launched its first Neighborhood Market stores back in 1998, and has since continued to aggressively expand these locations. These stores are designed to be smaller than the company’s gigantic Supercenters, and offer a full line of groceries. These smaller Wal-Mart Neighborhood Markets are like grocery stores– a direct threat to the likes of Safeway.

Safeway Inc. (NYSE:SWY) faces many threats in a crowded industry that is also being expanded by the dominant Wal-Mart, so the company will need to remain as competitive as ever. Programs such as Fast Forward should help, but the threat of Wal-Mart will continue to linger.

While groceries were only about 10% of Wal-Mart’s net sales a decade ago, as of last year, groceries accounted for about 55%, which is around $244 billion in net sales. The company is pushing groceries in a big way.

The bottom line

Safeway, even amongst increased competition, offers a lot of value at its current levels. The company offers a great income-generating dividend that yields over 3% from a very low payout ratio. While the company carries more debt than it probably should, the company’s new CEO knows it and has opted to do something about it.

The company has also managed to increase its earnings, and this is a very encouraging sign for Safeway– especially if the company stays focused on cleaning up its balance sheet. Safeway Inc. (NYSE:SWY) looks like a good domestic play at only around 9 times earnings, but should also be monitored to make sure that its earnings quality remains intact and its debt levels remain in check.

If earnings sink and remain stagnant, Safeway could easily fall into “value trap” territory. As of now, however, the company looks like a good buy at current levels and has positive fundamentals going forward.

The article Is Safeway a Value Trap? originally appeared on and is written by Joseph Harry.

Joseph Harry owns shares of Wal-Mart Stores. The Motley Fool recommends American Express. Joseph is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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