Epiphany Investing

Searching Out the Optimal Portfolio of “Revelation” Stocks

A Three-Pronged Thesis for Safeway

Posted on | September 24, 2008 Time: 6:13 pm |

Anyone who listened to Ben Bernanke’s testimony this morning got an extremely frank rundown on the state of the U.S. consumer. Some tidbits from his testimony:

“Real economic activity in the second quarter appears to have been remarkably resilient; however in the third quarter economic activity appears to have decelerated broadly”

“Real PCE fell in June and July, and the Retail Sales Report for August suggests that consumer outlays for goods have fallen noticeably in the past month”

Value Hard to Locate

Investors seeking to maintain some semblance of a sector allocation for consumer stocks had better be picky, now more than ever. Safeway hits all the right value buttons, and may have just enough growth juicers to grow the bottom line in the 10-15% range in ‘09 while generating strong operating cash flows.

Compelling Value - at less than 12x trailing and 10x forward estimates, Safeway sits well below sector and industry and broad market averages. Enterprise Value/EBIDTA is under 6, well below that of Wal-Mart, Target, and Kroger. Debt is heading in the right direction - down nearly a billion in the past two years - and the Debt/Equity ratio below .9 absolutey blows the doors off Kroger and other triumvirate member SUPERVALU (both sit above 1.4). Management has been diligent costs, with SG&A falling this year

Consumer Trends - Safeway is just the kind of stock I want to overweight in this environment, not underweight as this Morgan fellow suggests. Away from restaurants and into grocers, it’s just that simple at the end of the day. Given Safeway’s recent push towards store “facelifts”, the company can position itself as modern upscale (think Whole Foods without the snob) while still attracting the value-conscious crowd.

Growth Engines - With Whole Foods still reeling from operational hazard in 2008, Safeway should be able to gain market share with its in-house organics brands. They offer higher margins than vendor packaged goods, and also enable management to add some desparately needed pricing power in their business. Safeway also has an organics distribution deal with Sysco Corp (SYY) that could help drive unit growth and build the brand.

Safeway has a stellar gift card business (Codename: Blackhawk….no, really, that’s what it’s called) that should shine again this holiday season. They get between 3%  and 5% commissions, and management may be shopping a stake in segment to try and get a value pegged on it for investors. They’ve got over 60,000 store fronts up and running, hundreds of card parnters, even set up shop in their competitor’s stores.

Finally, there is still over $1 billion left in the company’s stock repurchase authorization, enough to retire roughly 10% of the outstanding shares.

To get a more in depth view of my thesis, check out my commentary from January. I also noted the risks in Whole Foods Markets (Nasdaq: WFMI) in my first article on Safeway last summer.

There are certainly risks as the U.S. consumer is being hit from all sides right now. But this stock nearly doubled during the recession of 2001-2002, and looks poised to offer strong returns from here. Other folks may prefer Kroger, but I see Safeway performing the best of the three (KR, SWY, SVU) non-wholesalers (COST) and non Wal-Marters.

Disclosure: Author does not hold shares in the stocks mentioned; SWY shares may be purchased for Secular Trends Model Portfolio

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