Safeway: No More Upside Related to Impending Merger - Analyst Blog

On Jun 24, 2014, we issued an updated research report on Safeway Inc. SWY following the company's unimpressive results for first-quarter fiscal 2014. As the company is awaiting successful completion of its merger with Cerberus Capital Management LP's Albertsons, upside potential of the stock is limited.

Amid a challenging macroeconomic environment and dwindling customer confidence, Safeway is progressing toward a successful merger with Albertsons for a deal value of $9.0 billion. On the other hand, the company has completed the earlier announced distribution of 37.8 million shares of Class B common stock of Blackhawk Networks Holdings, Inc. owned by Safeway. The company also plans the monetization of its 49% stake in Casa Ley and is currently exploring suitable alternatives to sell its interest in the latter.

Although we believe the combined company will pose major challenges to its rivals, uncertainty related to potential antitrust challenges from the Federal Trade Commission FTC persists. Moreover, following the merger announcement, discontent among the investors was observed regarding the deal price. Perhaps, the expectation of the deal price was much higher than what the company finally arrived at.

Furthermore, we remain disappointed with the company's financial results for the first quarter of 2014. Adjusted EPS from continuing operations of 6 cents in the first quarter of 2014 was down a huge 62.5% from the year-ago quarter. The EPS number also missed the Zacks Consensus Estimate of 19 cents by a wide range. Sales and other revenues inched up 1.0% year over year to $8.3 billion in the quarter, and were marginally in line with the Zacks Consensus Estimate.

We are also concerned about the company's deteriorating gross margin performance which declined two times on a year-over-year basis. Increasing competitive pricing pressure from large peers are other major downsides.

Safeway currently carries a Zacks Rank #5 (Strong Sell). While the upside potential of the stock is limited, stocks worth considering in the broader medical sector are Masimo Corporation MASI, ICU Medical, Inc. ICUI and Globus Medical, Inc. GMED. All the three stocks hold a Zacks Rank #2 (Buy).