A Safe Way to Play Safeway, Inc.
Safeway* operates the nation’s third-largest retail grocery chain with about 1,740 stores in the United States and Canada. Its primary markets include the western United States, western Canada, Texas, and the mid-Atlantic region.
* Company profile from Morningstar
Safeway [NYSE:SWY] July 28, 2009 $18.70
52-week range: $17.19 (Nov. 21, 2008) - $28.95 (Aug. 15, 2008)
Dividend = $0.10 quarterly = 2.14% current yield
Despite uncertain economic times people continue to eat. In fact, with decreased restaurant traffic, groceries for home-based meals seem to getting a boost. On balance full-year 2009 results are likely to drop from 2008’s $2.21 /share to about $1.80 this year.Zacks see’s $2.23 next year while Value Line looks for $2.10 in 2010.
That makes Safeway’s multiples just 10.3x and about 8.9x the 2009 – 2010 estimates. That is well below historical levels. Here are the per share numbers from continuing operations as reported by Value Line:
Year ………Sales ……. C/F ……… EPS …….. Div. ……… B/V ……… Avg. P/E
2004 ……..80.02 …… 3.25 …….. 1.25 ……. Nil ……….. 9.62 …….. 17.0x
2005 ……..85.48 …… 3.48 …….. 1.40 ……. 0.15 …….. 10.95 …… 15.8x
2006 ……..91.31 …… 4.01 …….. 1.73 ……. 0.22 …….. 12.88 …… 15.7x
2007 ……..96.08 …… 4.45 …….. 1.99 ……. 0.27 …….. 15.23 …… 17.2x
2008 …….102.83 ….. 4.91 …….. 2.21 ……. 0.32 …….. 15.82 …… 12.4x
Dividends were initiated in 2005 and have been raised in each year since. The quarterly distribution was increased to $0.10 in the most recent quarter. Today’s 2.14% yield is better than the rates on most bank CDs and short- term treasuries.
Value Line notes Safeway’s financial strength as ‘B++’ and assigns it an ‘above average’ safety rating. They also note that SWY has a 95th percentile ‘stock price stability’ ranking (with 100th being best) and a 0.7 Beta. Morningstar gives Safeway their highest 5-Star rating and sees ‘fair value’ as $30 /share.
This steady, somewhat conservative company appears undervalued based on all historical metrics such as P/BV, P/CF and P/E. The shares trade near multi-year lows going all the way back to 1996. Peak prices from $24.20 - $38.30 were touched in each calendar year from 2003 right through 2009. SWY shares actually hit $61 - $62 highs in 1998-1999-2000 and 2001 when the supermarket group was ‘hot’.
There’s no reason that Safeway can’t rebound to 14x next year’s $2.10 expectation and hit $29 or better by late 2010. That said, here’s a very low-risk buy/write combination that offers excellent total returns even if Safeway shares don’t get much higher than they are today.
…………………………………………………………….Cash Outlay ………. Cash Inflow
Buy 1000 SWY @$18.70 …………………………. $18,700
Sell 10 Jan. 2011 $20 Calls @$2.45 ………………………………………. $2,450
Sell 10 Jan. 2011 $20 Puts @$3.90 ………………………………………. $3,900
Net Cash Out-of-Pocket ………………………….. $12,350
If Safeway shares merely rise to $20 or better by the Jan. 2011 expiration date [up 7% from the current quote]:
• The $20 calls will be exercised.
• You will sell your shares for $20,000.
• The $20 puts will expire worthless.
• You will likely have collected $600 in dividends.
• You will have no further option obligations.
• You will hold no shares and $20,600 in cash.
That would allow for a best-case scenario profit of $8,250 on your
original outlay of $12,350 = 66.8% cash-on-cash.
That would be a pretty good return for about 17.6 months on shares that only needed to rise by 7%.
What’s the risk?
If Safeway shares remain below $20 through January 2011’s expiration date:
The $20 calls will expire worthless.
The $20 puts will be exercised.
You will be forced to buy another 1000 SWY shares.
You will need to lay out an additional $20,000 of cash.
You will likely have collected $600 in dividends.
You will have no further option obligations.
You will end up with 2000 SWY shares and $600 in cash.
What’s the break-even on the whole trade?
On the first 1000 shares it’s their $18.70 purchase price less
the $2.45 /share cal premium = $16.25 /share.
On the ‘put’ shares it’s the $20 strike price less
the $3.90 /share put premium = $16.10 /share.
Your average net cost would be $16.175 /share (excluding dividends)
and $15.875 (including yield).
While the past is not a guarantee of future stock price movements, I can tell you that Safeway shares have not traded as low as $15.88 in more than 13 years.
Summary:
Safeway shares seem like conservative, decent yielding shares with reasonable upside and low risk. A share price of $25 - $30 appears a reasonable 12- 18 month target.
The buy/write combination described here offers a best-case total return of about 67% (in under 18 months), as long as Safeway shares rise by at least 7% between now and January of 2011.
Safeway shares could fall by as much as 15% without causing you a loss on this trade providing a decent ‘margin of safety’.
Disclosure: Author is long SWY shares and short SWY options.
You make a compelling case here on SWY and also on GIGM. It looks on the two that there is much more upside than downside - especially as these are both 2011 expirations. If the upside is much greater than the downside why not a Synthetic Long — Sell the Put, but Buy the Call.
Any insight on this?
I would have no problem with your strategy if you are resolutely bullish.
In general I never buy options (except to close them out). For me, I’d rather buy the shares, sell the puts and wait to write calls until after a move up. You could also sell in-the-money puts such as the $7.50 strike instead of the $5.00 to give your self more upside.
Thanks for commenting.
FRIDAY, AUGUST 21, 2009
INVESTORS’ SOAPBOX PM
Bag Shares of These Two Supermarkets
Jefferies & Co. likes Safeway and Kroger as food at home rebounds.
THE JOB SITUATION CONTINUES to improve at the margin, but deflation on food at home has officially arrived with the CPI down 0.9%. Consumption remains tepid; although at-home is outperforming away-from-home nicely in a possible sign of a trend that is more secular in nature than cyclical.
The headline jobs numbers continue to improve a bit. The apparent peak in new claims for unemployment is now 19 weeks in the past and the unemployment rate actually fell slightly to 9.4% in July. We must note that the headline number hides the considerable number of people that have dropped out of the workforce and, debatably, is obfuscated somewhat by the birth/death adjustment. Nevertheless, claims are down and, perhaps more importantly, a sense of the worst being in the past seems to be entering the minds of consumers.
July food-at-home CPI fell to negative-0.9% from positive-0.8% in June. This remains the primary headwind facing the supermarkets, and we see no signs of improvement at this time. Indeed, producer prices legged down incrementally in July after moderating in the previous three months, and some commodities, notably corn, have fallen below their February lows. Still, we are lapping peak inflation rates from a year ago with comparisons getting considerably easier into the first half 2010, and we think bottom of the cycle is closer than currently discounted by the stocks.
Consumption appears to have bottomed. Volume appears to be recovering to a degree considering a negative 0.4% food-at-home result, this is better than the negative-1.6% we saw in May. While this is a “real” number, it is impacted by trade down activity which could reverse in 2010 leading to much higher numbers.
Safeway (ticker: SWY) remains one of our top ideas for 2010. The combination of lower prices and an improved message for consumers should lead to share gains, and the company is best-positioned to benefit from any economic rebound on the West Coast. Safeway should also begin to cycle deflationary pressure, its own sharp price adjustments and significant customer trade down; add in better Blackhawk [prepaid and payments network subsidiary] gift-card performance and Safeway could see a very sharp earnings rebound in 2010.
Kroger (KR) may have slightly less upside but should perform well even if the economy takes a turn for the worse. Kroger’s value image, private-label program and solid merchandising effort make it a best-in-class operator which is leading to market share gains. While we would note that the deflationary climate could put some pressure on earnings in the short-term, recent reports from Wal-Mart Stores (WMT), BJ’s Wholesale Club (BJ) and Ahold [of Amsterdam] give us some comfort that Kroger’s efforts to lower prices throughout this decade will insulate them from worst of the deflationary cycle.
–Scott A. Mushkin
–Bakley Smith
–Mike Otway
Safeway shares have been pretty good with a 14% gain from the July 28, 2009 write-up through Jan. 15, 2010.
My suggested buy/write used the Jan. 2011 $20 calls and puts.
I’d leave the whole trade alone until next year.
If you had wanted to unwind the trade one year early here are the results you could have had as of last week’s closing prices…
Inital cash outlay for 1000 shares …………………… $12,350
Sell 1000 SWY @ $21.32 /sh ………………………….. $21,320
Buy to close 10 Jan. 2011 $20 calls @ $2.90 /sh …………($2,900)
Buy to close 10 Jan. 2011 $20 puts @ $1.85 /sh ………….($1,850)
Dividends collected so far ……………………………. $200
Net cash at liquidation ……………………………… $16,770
Net profit = $16,770 - $12,350 = $4,420
$4,420/$12,350 = + 35.78% cash-on-cash
A 14% move up in SWY shares translated into a 35.78% total return over the same 5.6 month holding period for our buy/write strategy.