Over the past few weeks I have been watching the developments of the food retail industry, providing an excellent opportunity to search for stocks in this sector for investment purposes. One company I think is very interesting to analyze is Safeway Inc. (SWY). Although Safeway is one of the largest food and drug retailers in North America, with 1,335 operating store in the domestic market, 2014’s talk of a leveraged buyout was rather loud. With no specific buyer in sight for now, the company’s focus will be on maintaining its competitive advantages via the Lifestyle branded stores, while reducing capital spending post the remodel program.
After five years on the market, this stores portfolio has reached peak EBITDA margins of 90.80%, resulting in higher cash flow. However, this metric may not be sustainable in the long run, as supercenters and wholesale clubs continue to take over some of the company’s market share, via its competitive advantage of low labor and distribution costs.
While there are many different factors to look at and consider when investing, I will analyze Safeway's total debt, total liabilities, debt ratios and what analysts believe about this company. By studying the debt part of the company, the investor will understand if it’s able to keep its capital and use it for growth in the future.
Total Debt to Total Assets Ratio
This metric, used to measure a company's financial risk by determining how many assets have been financed by debt, results from adding short-term and long-term debt and then dividing this figure by the company's total assets. If the outcome is higher than 1, it means that a company´s total debt surpasses the value of its total assets. Au contraire, a debt ratio smaller than 1 indicates that a company’s assets are worth more than its total debt.
Safeway's ratio has increased over the past three years from 0.32 to 0.37, which indicates that since 2010, the food retailer has added more total debt value than total assets, which is a bad sign for bond investors. However, given that the company’s ratio of 0.37x is smaller than 1x, the financial risk faced by the company is relatively low: Its assets’ value comfortably surpasses its total debt levels.
Debt ratio = Total Liabilities / Total Assets
The debt ratio shows the proportion of a company's assets that is financed through debt. It’s key to look for firms with a ratio lower than 0.5, because otherwise it means most of the company's assets are financed through debt. Companies with high debt/asset ratios are said to be "highly leveraged" and could be in danger if creditors start to demand repayment of debt.
When looking at Safeway's debt ratio over the past three years, we can see that it has, in fact, increased from 0.66 to 0.79. I usually do not like to see the debt side of a company’s balance sheet grow. In addition to this, the 2013 TTM numbers are above the 0.50 mark, which indicates that the company is financing most of its assets through debt. While this number increases, so does the risk of investing in the company.
Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity
This metric is another leverage ratio that compares a company's total liabilities with its total shareholders' equity. It’s also a measurement of how much suppliers, lenders, creditors and obligators have committed to the company versus what the shareholders have committed.
A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt, resulting in volatile earning reports. It also indicates that a company may not be able to generate enough cash to satisfy its debt obligations, and therefore is considered a riskier investment.
I usually like companies with very low debt-to-equity ratios and conservative balance sheets, in general terms. On the contrary, Safeway's debt-to-equity ratio has escalated from 2.02 in 2011 to 4.00 in 2013, surpassing the 1x mark. Therefore, I assume that shareholders have invested more than suppliers, lenders, creditors and obligators, implying a high risk for the company and its stockholders.
Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity
(LT Debt = Long-Term Debt)
This ratio tells investors the extent to which the company is using its equity to support operations and growth, as well as helps in the assessment of risk. Companies with a high capitalization ratio are considered to be risky: If they fail to repay their debt on time, jeopardy of insolvency gets high. Furthermore, companies with an elevated capitalization ratio may find it difficult to get additional loans in the future.
Over the past three years, Safeway's capitalization ratio has increased, from 0.45 in 2011 to 0.63 in 2013. This implies that the company has less equity compared with its long-term debt. As this is the case, the company has had less equity to support its operations and as the ratio increases, so does the risk for the company. Standing at 0.63, financial risk is moderate.
Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt
This coverage ratio compares a company's operating cash flow with its total debt. It provides an indication of a firm's ability to cover total debt with its yearly cash flow from operations. The larger the ratio, the better a company can weather rough economic conditions. As the ratio stands below 1x, the company does not have the ability to cover its total debt with its yearly cash flow from operations, making this stock option somewhat unfavorable.
It is important to check which hedge funds bought the stock in the last quarter and at what price they did so. I assume that if a prominent institutional investor put money into Safeway Inc., the stock will pass strict fundamental standards.
However, in this case, investment gurus John Hussman (Trades, Portfolio) and Ray Dalio (Trades, Portfolio) reduced or sold out their stocks this past quarter at an average price of $30.66, making me feel bearish about this company’s future.
Moreover, many analysts currently have a moderate outlook for Safeway. While analysts at Yahoo Finance expect the firm to retrieve EPS of $1.45 for the current fiscal year and an EPS of $1.51 for the next one, Bloomberg is estimating revenue to decrease slightly from 2013’s $37.68B to $37.60B in the upcoming year.
I believe it’s pretty clear that investors keep their hands away from this company for the time being, or at least until a buyer is announced to take over the firm. Considering Safeway’s debt levels and instability of its balance sheet, it’s difficult to predict further profitability for the moment, especially if the leverage buyout signifies changes in management. Although the company still pays a solid dividend yield of 2.10%, despite low cash flow levels, I think investors looking for long-term profits should turn to other industry players, like The Kroger Co. (NYSE:KR) or Whole Foods Market Inc. (NASDAQ:WFM).
Disclosure: Damian Illia holds no position in any stocks mentioned.