Safeway’s High-End Concept Lifts Earnings

Safeway Inc.’s effort to lure shoppers from upscale rivals such as Whole Foods Market appears to be paying dividends at the checkout counter.

The Pleasanton, Calif.-based parent of the Vons and Pavilions grocery chains said Thursday that fiscal third-quarter profit jumped 42% as it continued to roll out stores based on its so-called lifestyle format, which features high-end meat and produce as well as design flourishes such as subdued lighting and earth-tone color schemes.

The new format “is what they’re focused on and it appears to be doing well,� said Craig Hutson, an analyst at fixed-income research firm GimmeCredit.

Safeway reported net income of $173.5 million, or 39 cents a share, for the quarter ended Sept. 9, up from $122.5 million, or 27 cents, in the third quarter of 2005. Sales increased 5.3% to $9.4 billion.

Although the results matched Wall Street’s expectations, Safeway’s stock initially sank more than 7% when the company didn’t raise its full-year profit outlook and investors worried about thinner profit margins. The stock recovered to close down 42 cents, or 1.4%, at $29.11.

The results follow an 84% year-over-year gain in second-quarter profit and come as Safeway and other Southern California grocery operators are gearing up for contract talks with their unionized workers. Failure to agree on a new contract in 2003 led to a 4 1/2 -month strike and lockout that hammered the grocery chains’ profits and disrupted the region’s grocery market.

Analysts said that labor dispute, which resulted in a contract that reduced benefits and pay rates for new hires, was finally paying off for Safeway.

“There’s no question the restructured labor contracts have had a positive impact� on the company’s bottom line, Hutson said.

The labor agreement covering workers at Vons and Southland competitors Ralphs and Albertsons -- owned by Kroger Co. and Supervalu Inc., respectively -- expires March 5. Talks on a new pact haven’t started.

During a conference call with analysts, Safeway Chief Executive Steve Burd noted that his company’s results for the third quarter of 2005 included several one-time charges that depressed profit, including the cost of closing 29 Texas stores and giving buyouts to an undisclosed number of workers in Northern California.

Excluding the year-earlier charges, a more realistic year-over-year profit growth rate would be around 22%, Burd said.

Sales at stores open for at least one year grew 5%; excluding gasoline sales, so-called same-store sales were up 3.7%. The company raised its forecast for full-year same-store sales growth from 3% to a range of 3.1% to 3.3%.

During the third quarter, Safeway built four lifestyle stores and converted 69 stores to the new format. The company expects to eventually convert all of its 1,767 locations.

Offering a more upscale ambience and higher-quality, more expensive perishable goods -- including proprietary brands such as Select Artisan bakery goods -- should help Safeway attract customers from discount grocers such as Wal-Mart Stores Inc., analysts say.

The strategy also is aimed at helping the company compete with the likes of Whole Foods, which is winning over customers with organic foods, high-quality meats and produce, and extensive bakery and deli offerings.

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