This Grocer Still Isn't Safe

Marshall is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Safeway (NYSE: SWY) got a big boost last week, in both its stock price and its coffers, but does that make the stock any safer for investors? The grocer's stock was up as much as 12.5% on news that it was will pocket some C$4 billion thanks to the sale of its Canadian operations. However, the stock might not be so safe. 

The uptick in the stock comes as the cash injection could alleviate some liquidity concerns. Safeway appears to struggling on the liquidity front; its cash on hand is below $300 million and its current ratio is less than 1.0. 
 
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The sale of Safeway Canada will help with this liquidity problem, but even with the upcoming cash injection, there is still another fundamental issue; this includes the grocer's cash flow generating capabilities. Over the past couple of years, Safeway has seen growth in free cash flow turn negative, while other major industry players, including Whole Foods Market (NASDAQ: WFM), have been on a tear when it comes to churning out cash. 

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Part of this free cash flow contraction is a result of margin pressure, related to the entry of new nontraditional competitors, such as Whole Foods, as well as pressure from other major grocers Kroger (NYSE: KR) and SuperValu.

Going a step further, Safeway has also seen its leverage position deteriorate over the past five years, with its leverage ratio and debt-to-equity ratio having risen drastically over that period.
 
<table> <tbody> <tr> <td> </td> <td><strong>2008</strong></td> <td><strong>2009</strong></td> <td><strong>2010</strong></td> <td><strong>2011</strong></td> <td><strong>2012</strong></td> </tr> <tr> <td><strong>Leverage ratio</strong></td> <td>2.6</td> <td>3.0</td> <td>3.0</td> <td>4.1</td> <td>5.0</td> </tr> <tr> <td><strong>Debt-to-equity</strong></td> <td>0.69</td> <td>0.88</td> <td>0.86</td> <td>1.26</td> <td>1.79</td> </tr> </tbody> </table>
 
The latest
 
Safeway is still paying investors a 3.2% dividend yield, but sales are expected to be up only 1.5% in 2013. But the grocer is looking to continue its cost-saving campaign. Safeway has already closed its distribution centers in British Columbia and Vancouver due to continued operating losses. The grocer is also exiting the Philadelphia market, having closed 25 Genuardi stores in 2012.
 
A better way?

One of the best ways to play the industry is Whole Foods. This organic grocer has been one of the great growth stories of the industry, namely due to its organic and fresh-food concepts. The company posted 2Q EPS of $0.76, compared to $0.64 for the same period last year, on the back of 6.9% higher comparable-store sales. 
 
Whole Foods has also seen improvement in its inventory turnover, meaning it's selling inventory faster, leading to less waste and markdowns. Days in inventory went from a high of 22 days in 2009 to roughly 16 days over the past 12 months. Sales are expected to be up an impressive 11% in fiscal 2013, thanks to 8% growth in square footage. 
 
The square footage growth should be a key growth driver going forward. Whole Foods opened 16 stores in fiscal 2010, 18 in 2011 and 25 in 2012. The company hopes to open some 32 in 2013 and then 33 to 38 for 2014. The long-run goal is for upwards of 1,000 stores, with expansion opportunities in Canada and the U.K.
 
Being the U.S.' largest grocer, Kroger is one of the best at returning cash to shareholders via dividends and share buybacks. Kroger recently upped its dividend payment by 30% and has plans to enhance shareholder return by 10% to 13.5% over the long run, with 2% to 2.5% of that coming via dividends.
 
Kroger is also looking to grow its bottom line. The grocer plans to either build or expand 50 supermarkets in 2013. One nice thing about Kroger is its pharmacies, which help improve its sales profile. This, in part, is expected to help its EBITDA margin remains above 4% for fiscal 2014.
 
However, one of the big issues that Kroger will face is pricing pressure from the like of Wal-Mart and Target. Wal-Mart already offers groceries via its super-center locations and Target is implementing its P-fresh model, which includes consumables, and both of the retail giants also have in-store pharmacies.  
 
The other struggling grocer, SuperValue, also sold off some of its key assets. Back in March, the grocer sold off some 877 supermarkets to Cerberus Capital. The sale includes stores from the Albertsons, Acme, Jewel-Osco, Shaw's and Star Market chains. The move will allow SuperValu to focus on its Save-A-Lot discount chain. But even with the cash injection from the sale of Cerberus, SuperValu, like Safeway, still has a highly levered balance sheet. 
 
Hedge fund trade

Safeway has some 28 hedge funds long the stock, which was a 27% increase from the previous quarter. This includes billionaire Ken Griffin of Citadel Investment Group with the largest position, owning some $75 million in stock (check out Citadel's cheap stocks).

Meanwhile, Kroger had only 23 hedge funds long the stock. Steve Richman's East Side Capital had the largest position in the stock, worth some $188 million and accounting for 9.4% of its total 13F portfolio (see East Side's top stocks).
 
Holding some of the highest hedge fund interest among grocers was Whole Foods, with 32 hedgies long the stock. Having the largest position was billionaire Jim Simons of Renaissance Technologies, worth some $191 million (check out Simons' cheap stock picks).
 
Bottom line
 
I still like Whole Foods as the best grocer given the company's robust growth prospects and strong balance sheet. Kroger has a debt-to-equity ratio of 1.4, with Safeway at 1.9, while Whole Foods has no debt. Notice I didn't mention the troubled SuperValu, which has a negative equity due to a $3.3 billion accumulated deficit in retained earnings. Whole Foods is at the forefront of the changing consumer preferences and has an awareness of health consciousness shoppers; thus, it's the top investment in the grocery space. 
 

It's hard to believe that a grocery store could book investors more than 30 times their initial investment, but that's just what Whole Foods has done for those who saw the organic trend coming some 20 years ago. However, it may not be too late to participate in the long-term growth of this organic foods powerhouse. In this premium report on the company, The Fool walks through the key must-know items for every Whole Foods investor, including the main opportunities and threats facing the company. So make sure to claim your copy today by clicking here.


Marshall Hargrave has no position in any stocks mentioned. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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