1 Grocery Chain Fighting to Stay in the Game


Sometimes you're in a pinch and you think, "Well, I don't need this whole house," and then off you go to sell one room to the nearest pop-up cantina -- an hour later, cash in hand, you walk home happy. You're in good company; Safeway (NYS: SWY) has just joined the bulging-pockets, partial-house brigade. Earnings rose last quarter, pushed up in part by the sale of its Genuardi's brand to Giant earlier this year. But is the earnings bump sustainable, or is Safeway going to have to head back to the auction block?

Earnings up, margins down
Safeway's message was positive, overall. The company increased earnings per share from continuing operations, even though income fell. The increase in EPS came largely from an aggressive stock-repurchasing program, which has seen the number of outstanding shares fall by 31% since this time last year. Including the sale of Genuardi's, earnings per share jumped 74% last quarter.

But the increase wasn't enough to keep the company out of hot water. Same-store sales were up just 1%, which the company blamed on lower inflation and a strong Canadian dollar. In addition to the lackluster sales increase, the company's operating margin fell to 2.2% from 2.5% last year. Most of that fall was pinned on the launch of a new customer loyalty program, and the company said that those costs would not be seen again in the fourth quarter. At the end of things, Safeway confirmed the earnings guidance already in place.

The crush of competition
Investors largely saw the downside of all that news, and shares were down 3% at midday after the earnings release. The problem that everyone is seeing is the weakness that much of the grocery industry has been showing this year. With rising commodity prices, weak job growth, and an influx of high-end grocery chains picking up the best margins and customers, discount chains are having a rough time. Both Roundy's (NYS: RNDY) and SUPERVALU (NYS: SVU) have seen shrinking sales and earnings recently. Both chains reported declines in same-store sales last quarter, while earnings per share have fallen 28% at Roundy's and 46% at SUPERVALU.

The only competition that investors should be looking at is Kroger (NYS: KR) . While substantially larger than Safeway in market cap and footprint, Kroger has managed to avoid the race to the bottom. Last quarter, the company reported an increase in same-store sales and an 11% growth in EPS. While that EPS growth wasn't as impressive as Safeway's, most of it was built on the back of actual earnings growth, as opposed to a decrease in the number of shares.

But in classic grocer style, even Kroger is squeaking by on thin margins. Last quarter, it came in with an operating margin in line with Safeway's, just 2.5%. That's not being helped by the increasingly large footprint of Whole Foods (NAS: WFM) , which posted an operating margin of 6.3% last quarter. It also had great same-store sales growth, up 8% that quarter and starting the new quarter up 10%. Whole Foods reports fourth-quarter results in early November, and I'm looking for very good things.

The bottom line
All that said, Whole Foods is incredibly expensive compared to Kroger and Safeway. Any shortfall in expectations is going to have a huge impact on the stock, and with increasing pressure on it from other companies, I'm not convinced the party can go on forever. Kroger, on the other hand, is only slightly more expensive than Safeway, and a great deal stronger, in my opinion. If I have to pick just one, I'm sticking with Kroger.

But Whole Foods would be my second pick. While the company may not be able to grow like this forever, it still has a good run ahead of it. The Fool has a special report on Whole Foods, just for Fool readers. It has all the details on what's to like, and what challenges lie ahead. We'll be updating the report as new information comes out, so you'll always have the best view of things. Click here to sign up for your copy today.

The article 1 Grocery Chain Fighting to Stay in the Game originally appeared on Fool.com.

Fool contributor Andrew Marder has no positions in the stocks mentioned above. The Motley Fool owns shares of Supervalu and Whole Foods Market. Motley Fool newsletter services recommend 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.

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