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New Paths to Growth Are Proving Hard to Find for This Grocery and Drug Retailer

Based on sales, Safeway Inc. (SWY) is one of the largest North American food and drug retailers. The company operates a network of 1,335 stores in the U.S., two-thirds of which have in-store pharmacies. Moreover, many locations operate adjacent fuel centers and have Starbucks Corp. (SBUX) coffee shops. The firm's new store format, called "The Lifestyle Store" provides customers with a better shopping experience and a vast array of grocery products, which is tailored to meet local needs and preferences. Further, Safeway has 49% ownership interest in Casa Ley, a general merchandise and Mexican food retailer which operates 185 stores in Mexico.

Debt and Divestiture

In 2013, seeking to reduce its high debt level, the company went on an IPO of a minority stake of its subsidiary Blackhawk Network Holdings, which is engaged in the provision of prepaid products and payment services through a network of retail stores located in the U.S. and 18 other countries. As a result of this operation, the company received $243 million in cash, repaid its outstanding debt and reduced outstanding commercial paper.

Later the same year, the firm also divested its business in Canada. Canadian food retailer Sobeys Inc. acquired Safeway net assets in the country for $5.68 billion in cash and the assumption of certain liabilities. Safeway deployed the net proceeds to repay $2 billion of its debt, thus reducing it by almost half.

A Challenging Position

Safeway achieved some respite from debt pressures and has undertaken measures to cut costs through the enhancement of supply chain efficiencies and a greater focus on the cost of goods sold. However, a recessive economic environment and aggressive competition from premium retailers like Whole Foods Markets Inc. (WFM) deep-discounters like Dollar Tree Inc. (DLTR) and sturdy rivals like Wal-Mart Stores Inc. (WMT), depicts a gloomy horizon for the firm.

Lacking a solid pricing strategy, the firm lost traffic in the hands of low-cost operators during the recession, and it has not been able to gain market share among high-end consumers. Along these lines, the Lifestyle remodel investment did not provide the firm with the expected revenue lift. Consequently, returns on capital have been on a steady decline and this trend is not expected to change any time soon.

Bleary Management Strategies

On the other hand, the firm's strategy to divest its Canadian business in favor of a greater focus on the U.S. market is not clear. Over the past years, Canadian operations have been more profitable than those in the U.S. In 2012, for example, operating profit from the U.S. segment was 2%, against 5.4% in Canada. Furthermore, profits have been declining at a domestic level, evidencing a deterioration that will not be easy to reverse.

The Stock

Safeway's stocks trade at 40.3 its trailing earnings compared to the industry median of 17.3 and its return on capital posted a lean 8.43% against its rivals' average of 20.02%. Moreover, revenues have declined by -11.85% over the last year and -4.2% on a three-year basis. Investment gurus Ray Dalio (Trades, Portfolio) and Charles Brandes (Trades, Portfolio) recently sold out their holdings in the company, supporting my feeling that Safeway's challenges will be hard to overcome.

Disclosure: Vanina Egea holds no position in any stocks mentioned.

This article first appeared on GuruFocus.