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Safeway, INC
An Equity Valuation and Analysis
As of June 1, 2008
Brandon Miller Dallas Branch
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Table of Contents
Executive Summary……………………………………………………………………..…………… 5
Business & Industry Analysis…………………………………………………………….………. 11
Company Overview…………………………………………………………………………. 11
Industry Overview…………………………………………………………………………… 17
Five Forces Model……………………………………………………………………………………… 19
Rivalry Among Existing Firms……………………………………………………………. 20
Threat of New Entrants……………………………………………………………………. 27
Threat of Substitute Products……………………………………………….………….. 32
Bargaining Power of Buyers…………………………………………………….……….. 34
Bargaining Power of Suppliers…………………………………………………….……. 36
Value Chain Analysis…………………………………………………………………………………. 40
Firm Competitive Advantage Analysis…………………………………………………………. 46
Accounting Analysis……………………………………………………………………….…………. 50
Key Accounting Policies…………………………………………………………………… 51
Accounting Flexibility………………………………………………………………………. 60
Actual Accounting Strategy……………………………………………………………… 66
Quality of Disclosure…………………………………………………………..…………… 69
Qualitative Analysis……………………………………………………….………………… 70
Quantitative Analysis of Disclosure…………………………………………….……… 74
Sales Manipulation Diagnostics………………………………………….….... 75
Sales Manipulation Chart………………………………………………………… 79
Expense Manipulation Diagnostics………………………………………..…. 80
Expense Manipulation Chart………………………………………….……….. 88
Potential Red Flags………………………………………………………………..……….. 89
Undo Accounting Distortions………………………………………………………..….. 91
Financial Analysis, Forecast Financials, and Cost of Capital Estimation.... 96
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Financial Ratio Analysis…………………………………………………..…… 97
Liquidity Analysis…………………………………………………………………. 97
Profitability Analysis……………………………………………………………… 110
Capital Structure Analysis……………………………………….……………. 123
IGR/SGR Analysis………………………………………………..………………. 129
Altman Z Scores………………………………………………………………….. 132
Financial Statement Forecasting…………………………………….……… 135
Cost of Capital Estimations………………………………………….……….. 149
Cost of Debt……………………………………………………………..………… 149
Cost of Equity……………………………………………………………..……… 150
Weighted Average Cost of Capital……………………………………..…. 155
Equity Valuations………………………………………………………………………….. 156
Method of Comparables……………………………………………..……….. 156
Intrinsic Valuations…………………………………………………….……….. 166
Discount Dividends Model………………………………………... 165
Free Cash Flows Model…………………………………………..….. 166
Residual Income Model………………………………………….……
Long Run Return on Equity Residual Income Model……….
Abnormal Earnings Growth Model………………………………..
Analyst Recommendation…………………………………………………………..…..
Appendix………………………………………………………………………….……………
Liquidity Ratios…………………………………………………………………....
Profitability Ratios……………………………………………………….……….
Capital Structure Ratios…………………………………………………………
Growth Rate Ratios……………………………………………………………….
Regression Analysis………………………..…………………………………….
Cost of Debt and WACC………………………………………………………..
Method of Comparables…………………………………………………….….
Altman Z-score……………………….……………………………………………
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Long Run Residual Income Perpetuity Model………………………….
Discount Dividends Model……………………………………………………..
Discounted Free Cash Flows Model…………………………….…………..
Residual Income Model……………………………………..………………….
Abnormal Earnings Growth Model………………………………….………
References……………………………………………………………….…………………..
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Executive Summary
Investment Recommendation: Overvalued; Sell 6/1/08
SWY‐NYSE (6/1/2008): $31.87 Altman Z‐Score
52 Week Range:
$25.75‐$37.14
Revenue: $42286M 2003 2004 2005 2006 2007
Market Capitilization: $12.87B 3.38 3.47 3.7 4.1 4.04
Shares Outstanding: 4,237,728 Valuation Estimates
Percent Institutional Actual Price (6/1/2008): $31.87
Ownership: 91.5%
Book Value Per Share: 15.51 Financial Based Valuations
ROE: 15.7% Trailing P/E: $28.63
ROA: 5.5% Forward P/E: $33.96
P.E.G.: $15.53
Cost of Capital Est. R2 Beta Ke P/B: $41.36
Estimated: P/EBITDA: $21.19
3‐Month 0.207 1.055 11.965 P/FCF: $75.34
6‐Month 0.207 1.055 11.965 EV/EBITDA: $11.15
2‐Year 0.207 1.056 11.972 Dividend Yield $24.22
5‐Year 0.207 1.048 11.916
10‐Year 0.208 1.053 11.951 Intrinsic Valuations
Discounted Dividend: $5.34
Free Cash Flows: $31.90
Published Beta: 1.05 Residual Income: $31.87
Kd(BT ) 4.79% LR ROE: $7.80
WACC(BT ) 9.01% WACC (AT) 8.21% AEG: $5.26
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http://moneycentral.msn.com
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Industry Analysis
The retail grocery store industry in the United States is an increasing competitive
market. Safeway, INC (SWY) has many competitors such as Kroger Company, Wal-
Mart (WMT), Supervalu, INC. (SVU), and Whole Foods (WFMI). With Safeway and all
their competitors selling similar products, it is difficult to gain market share and grow as
a company. In the industry competing firms compete on price and try to create cost
leadership through scales economies, low distribution costs, and efficient production.
For a grocery store to have a competitive advantage over another competitor, they
need to incorporate differentiation strategies such as brand image, superior product
quality, and superior customer service. Safeway will be able to grow as a company in
the retail grocery store if they can successfully keep costs down, and successfully
incorporate differentiation strategies. With low switching costs in the industry, Safeway
needs to create an image better than the rest.
The industry is so competitive it is difficult for firms to establish and maintain a
long term competitive advantage. Large companies own a large portion of the industry
because keeping costs low allow the large companies to undercut their smaller
counterparts on the majority of products found in grocery stores. The demand for
groceries is limited to the growth of the population where the stores operate. The
population growth in the United States is one percent per year. The amount of
competition varies by market area for firms.
Retail grocery stores sell a variety of goods, most of which are found at every
competitor’s store for similar prices. The buyers’ power over the retail grocery stores
influences individual company’s strategy. Since Retail Grocery stores target both high
and low income families with limited resources, the Industry does not consider
substitute products a threat. Within the industry every competitor sells relatively the
same product.
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Accounting Analysis
The income statement, balance sheet, and statement of cash flows of a company
are the basic tools needed for an effective accounting analysis. These financial
statements can be found in the company’s 10-K. During the accounting analysis of a
company, an analyst attempts to determine out a firm’s key accounting policies, actual
accounting strategy, and also the level of their disclosure. After that an analyst can
analyze the quality of disclosure and whether or not any manipulations have occurred in
the firm’s accounting figures. It is crucial that a firm’s key success factors line up with
their key accounting policies. It is vital to look deep into a company’s accounting
numbers because they are made by people and managers have incentives to make their
firm appear more profitable to potential investors.
Safeway and the rest of the retail grocery industry include key accounting
policies that revolve around lease options and defined benefit (or pension) plans. A firm
can disguise the liability of their benefit obligations if they use a high discount rate. A
company’s liabilities can be extremely overstated or understated with too high or too
low of a discount rate. This is not an issue with Safeway because they do not
exaggerate the discount rate on their defined benefit plan. They also do a very good
job disclosing this information on their annual report. Safeway and its competition also
have the choice of using capital or operating leases to account for their leased property.
When a company uses capital leases they are booked as liabilities on the balance sheet.
However, operating leases are not which leads to off-balance sheet financing
(aggressive accounting). Safeway uses operating leases in order to keep their liabilities
off of the books. This was a red flag that we had to analyze. This makes Safeway
appear more profitable to potential investors than they really are. We have restated
Safeway’s financials to account for their leases and therefore display the more truthful
value of the firm. Safeway did a very good job of disclosing these leases so that we
were able to do these restatements.
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After looking at Safeway’s sales and expense diagnostic ratios, we found no red
flags with these calculations. Sales are difficult to manipulate in the retail grocery
industry because customers buy groceries on a cash basis (items are also scanned at
purchase). Safeway also maintained consistent expense manipulation ratios (no red
flags). Overall Safeway does a solid job of disclosing their key accounting procedures in
their annual reports.
Financial Analysis, Forecast Financials, and Cost of Capital Estimations
The purpose of the financial analysis of a firm is to evaluate how well a firm is
performing in comparison to its competition in the industry. Important tools used for
this process are computing a firm’s liquidity, profitability, and capital structure ratios.
These ratio calculations are then compared to the rest of the industry’s ratio results to
find industry trends. The industry trends are then used to determine how well the firm
is performing and aide in the financial statement forecasts of the company.
We forecasted Safeway’s income statement, balance sheet, and statement of
cash flows out ten years. We used industry trends as well as Safeway’s five year history
to determine our forecasts. We determined a 4.3 percent sales growth per year and an
asset turnover of around 2.5 times. We also decided future CFFO should be forecasted
using the CFFO/ sales ratio. These educated assumptions allowed us to forecast the
remainder of Safeway’s financial statements. We also forecasted our restated financials
on the same basis using sales, once again, as the cornerstone of our forecasts.
To estimate a firm’s cost of equity, regression analysis or the back door method
may be used. By distributing the proper weights and rates to debt line items on the
balance sheet, an analyst can figure out a firm’s cost of debt. Once the cost of equity
and debt have been computed, they can be plugged into the weighted average cost of
capital (WACC) formula to compute the company’s estimated cost of capital.
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The back door method proved better for us when determining Safeway’s cost of
equity. We then calculated Safeway’s cost of debt before and after tax by weighing the
debt line items on the balance sheet, multiplying them by the proper rate, and finally
adding them together. After computing Safeway’s cost of equity and debt, we were
then able to plug them into the WACC formula and calculate Safeway’s weighted
average cost of capital.
Valuations
After we inspected the industry analysis, accounting policies, and financial ratios
in detail, we were able to use equity valuations to value the firms share price. We used
many different models to determine if Safeway was overvalued, undervalued, or fairly
valued.
The first method we used to value Safeway was the method of comparables. The
method of comparables uses seven ratios. We used these seven ratios to calculate
original and restated share prices. According to the method of comparables, Safeway is
a slightly overvalued firm. However, this is not the best method to use because it is
based on industry averages and not intrinsic information. The method of comparables is
just a faster way to estimate share price than intrinsic models (they are generally not as
accurate).
Then we used intrinsic models which are very important when it comes to
estimating a company’s market value of equity. We relied more heavily upon intrinsic
models when valuing Safeway’s share price. There are some intrinsic models that are
better than others. The residual income model, long run residual income model, and the
abnormal earnings growth model are not near as sensitive to the perpetuity as the
discounted dividends and free cash flow models. This makes the first three models
much more accurate. The discounted dividends model showed a share price of $6.00
Compared to our share price of $31.87, this model shows Safeway to be overvalued.
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The free cash flows model gave us a share price of $20.88 which shows Safeway as
being overvalued once again.
The residual income model displayed Safeway’s share price as $10.28, this
explains Safeway’s observed per share price to be overvalued also. The residual income
model is the most accurate of all of the models. Therefore, we relied most heavily on
the residual income model. When we calculated the long run return on equity residual
income model, we once again found Safeway’s share price to be overvalued. Finally we
used the abnormal earnings growth model to value Safeway’s share price. The AEG
model showed a share price of $8.84 which also pointed to the observed share price as
being overvalued. The AEG model also has a reputation of being a very accurate model
and has a direct relationship with the residual income model. Once we had calculated
Safeway’s intrinsic valuation models, we were able to clearly conclude that Safeway’s
has an overvalued share price as of 6/1/08.
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Business & Industry Analysis
Company Overview
Safeway was founded in 1915 in American Falls, Idaho. The Safeway chain was
later created in 1926 through a merger of two companies by the names of Skaggs
Stores and Sam Seelig Company. Safeway was incorporated in the state of Delaware in
July 1986 as SSI Holdings Corporation and, thereafter, its name was changed to
Safeway Stores, Incorporated. In February 1990, the Company changed its name to
Safeway Inc (Safeway 2008 10K).
In the late 1990’s to the 2000’s Safeway began to acquire regional chains around
the nation. These include Carr’s in Alaska, Randall’s & Tom Thumb in Texas, Von’s &
Pavilions in Southern California, Dominick’s in Illinois and Genuardi’s in Pennsylvania,
New Jersey and Delaware. These stores still operate as subsidiaries. Safeway also has a
49% interest in Casa Ley, S.A. de C.V., in Western Mexico which operates 137 stores.
Casa, Ley sells food and general merchandise.
Safeway Inc. is now one of the largest food and drug retailers in North America.
It has a total of 1743 stores at year-end 2007. These stores are in the Western,
Southwestern, Rocky Mountain, and Mid-Western Atlantic regions of the United States
as well as in Western and Mid-Canada. About 79% of Safeway stores are 35,000 square
feet or larger. In addition to that Safeway also has a network of distribution,
manufacturing and food processing facilities to support its stores. The table below
shows the stores location, size, and number of stores in area.
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Table provided by Safeway fact book 2008.
Safeway’s products include Bakery, dairy, deli, dry Cleaning, frozen foods,
general grocery, meat, pharmacy, Photo Dept., produce, seafood, snacks, liquor,
flowers, Western Union and lottery. Safeway also offers a variety of services in their
stores as well. They have Floral Services, Deli, Bakery, Pharmacy, Starbucks and Fuel
stations. The table below shows the percentage of stores that offer the special services
as of December 29, 2007.
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Table provided by Safeway fact book 2008.
Market Capitalization & Sales Volume and Growth
Safeway market capitalization has been increasing. It gained approximately $5.3 billion
since 2003. In an article written by Naureen Malik in Barron’s Online Services Mark
LoPresti, vice president of Thomson Financial's proprietary research group states that
“From March 2005 through April 2007, this defensive stock has acted more like a
growth stock to outperform the Standard & Poor's 500 stock index by 83%”. This
indicates that Safeway is performing really well. He also adds that” Safeway, "should be
a target for fund flows going forward," says LoPresti.
2003 2004 2005 2006 2007 Sales and
other revenue
$35,727.2 $35,822.9 $38,416.0 $40,185.0 $42,286.0
The sales volume for Safeway, INC. over the past five years is expressed in the table
above (10K). The sales volume has increased consistently every year from 2003
through 2007, an average sales and other revenue growth rate of 4.325%. This data
shows that Safeway, INC. has been expanding every year for the past five years.
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The “Total Assets Chart” below is reviewing and comparing financial years 2003
through 2007 of not only Safeway, INC. but also three major competitors, which are
Kroger’s, Wal-Mart, and Supervalu. The retail grocery industry is an extremely
competitive business for all these companies. In order to succeed in this type of
business the company needs to be able to focus on economies of scale. Economies of
scale is one of the most vital parts of the retail grocery industry that will make a
company successful or make a company go out of business. After looking at the chart,
if you are only analyzing the success of a company through the total assets, you would
come to a conclusion that Safeway, INC. is a successful company and has good
economies of scale. The reason being, there total assets have increased over these five
years of values. Due to economies of scale, larger companies have greater access to
markets in terms of selecting media to access those markets, and can operate with
larger geographic reach (www.learnthat.com). Efficiency and production is the key to
making a company drive profits higher year by year and ultimately making the company
successful. As the company grows and become more efficient, then the company will
be able to have more control over prices charged and how much they will eventually
grow over time.
Total Assets 2003 2004 2005 2006 2007
Safeway 15,096 15,377 15,756 16,273 17,651
Wal‐Mart 92,900 105,407 117,139 136,230 151,587
Kroger 20,349 20,767 20,491 20,482 21,215
SuperValu 5,896 6,162 6,274 6,151 21,702
Whole Foods
1,213 1,521 1,889 2,043 3,213
Numbers are in Millions Statistics provided by 10-k if each firm.
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Safeway, INC. is located in not only the United States, but in Canada as well.
This table differentiates the total assets on how much Safeway earned for the fiscal
years 2003 through 2007 in each of the reportable countries they are incorporated.
Safeway’s retail business, which represents more than 98% of consolidated sales and
other revenue and operates in the United States and Canada, is its only reportable
segment (Form 10-K Safeway, INC. – SWY).
As the chart shows, Safeway has many more total assets in the United States
than in Canada. There are many more locations in the U.S. compared to Canada which
is the factor that drives the amount of total assets are in each country. Besides the
years of 2004 to 2005 where the total assets decreased in Canada, Safeway has a trend
of acquiring more total assets each year since 2003 which adds to the growth of the
overall company.
Total Assets-Safeway, INC. (numbers in millions)
2003 2004 2005 2006 2007
United States 13679 13753 14141 14456 15453
Canada 1416 1623 1615 1816 2197
Total Assets 15096 15377 15756 16273 17651
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Stock Price Performance
https://trading.scottrade.com
Safeway is listed as SWY on the NYSE. The industry as a whole has experienced
growth, with only one competitor loosing stock value. If you held stock from 2003 to
2008 your capital gains outpaced the three major competitors. Safeway’s stock
performance the last five years has beaten is competitors. The stock price in 2008 is on
the rise after dividends and a stock repurchase programs have been being implemented
by management. Over the past 5 years Safeway’s stock has risen $4.97 and since
June, 2005 has paid dividends. Since June, 2005 dividend payments have risen steadily
from $0.05 to $0.069 a total of 38%. As of May 14, 2008 Safeway has approved a
20% increase from $0.08 per share on a quarterly basis. The board of directors also
approved an increase in authorized level of stock repurchases by seaway from $1 billion
to $5 billion (WSJ #3). The stock price took its largest jump in 2007. The chart below
shows stock prices of Safeway and competitors at the end of each year.
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2003 2004 2005 2006 2007 Whole
Foods Inc. 33.56 47.68 77.39 46.93 37.92
Safeway Inc. 23.36 21.91 19.74 23.66 33.34
Wal-Mart Inc. 53.05 52.82 46.80 47.55 46.90
Supervalu Inc 28.59 34.52 32.48 35.99 37.52
Kroger Inc. 18.51 17.54 18.88 23.17 26.71
Industry Overview
The retail grocery industry is extremely competitive. Safeway, INC.’s top
competitors are Kroger (KR), Supervalu (SVU), and Wal-Mart (WMT). There are 40,000
companies operating in the 70,000 grocery stores in the $400 billion U.S. retail grocery
industry. The average supermarket is 45,000 square feet and carries 40,000 different
items. Seventy percent of the market is held by the 50 largest companies in the
industry (Hoovers.com). Therefore, the industry is highly concentrated. Mass merchants
like Wal-Mart have swiftly expanded their grocery sales. The largest seller of groceries
in the U.S. is now Wal-Mart with annual grocery sales of about $60 billion
(Hoovers.com).
The three main types of products grocers sell are perishable goods (50 percent
of revenue, non-perishable goods (30 percent), and non-food items (20 percent)
(Hoovers.com). Inventory of these goods are kept track of by stock keeping units
(SKUs). Local grocery stores are also beginning to incorporate and compete on the
selling of gas. There is definitely convenience in filling up at the local grocery store.
Most chains and independent stores (Safeway, Supervalu, and Kroger) will usually buy
most of their products from wholesale distributors or buy straight from manufactures.
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Large companies with many stores (like Wal-Mart) may own one or more distribution
centers that receive and redistribute merchandise for their stores.
Individual company’s profitability is based on the company’s product mix and if
they have efficient operations. The Demand for grocery products is restricted by the
U.S. annual population growth of one percent according to Hoovers.com. But we
believe that the market is more global in this day and age. People in China aren’t just
eating rice today. They are consuming groceries just like we are. The demand for
groceries is worldwide today because of modern technology and the ease of
outsourcing groceries overseas.
It is very difficult for modern grocers to compete since most of the market share
is already taken. In order to compete, small grocers must offer better service, produce,
or specialty products because it is unrealistic to compare on price with major market
holders like Wal-Mart.
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Five Forces Model
Michael Porter’s five forces model is a commonly used tool for industry analysis
and company strategy. Porter identifies five competitive forces that distinguish all
industries and markets. These forces are the drivers to industry profitability. The
model itself is structured into two sections.
The first section is the degree of actual and potential competition. The key
factor to this section is price. Price is the most basic factor used by firms to determine
the extent of rivalry within the industry. The degree of rivalry is measured from
monopolistic to perfect competition. Monopolistic competition is one firm that
dominates its industry. Perfect competition is when multiple firms strive for the largest
share of industry profits. There are three elements of competition within an industry.
First is rivalry between existing firms. This is the actual measure of competition
between existing firms. The second element is the threat of new entrants. This
focuses on the barriers within the industry that prevent entry in that industry. The third
element is the threat of substitute products. These are typically costs and ease of
switching among products.
The second section of the model is the bargaining power in input and output
markets. This focuses on the actual profits which are influenced by the industry’s
bargaining power of buyers and bargaining power of suppliers. The bargaining power of
buyers is their relation to price sensitivity. Ultimately the power is choice. The power
of the buyer to choose which firm they will use within the industry on the basis of price
competition. The bargaining power of suppliers is the power over the firm suppliers can
wield with the basis of supplier concentration. As the number of suppliers increases,
firms will tend to choose based on lower prices, which in turn leads to lower costs.
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Retail Grocery Industry
Rivalry Among Existing Firms HIGH
Threat of New Entrants LOW
Threat of Substitute Products LOW
Bargaining Power of Buyers HIGH
Bargaining Power of Suppliers MODERATE
Rivalry Among Existing Firms
In the retail grocery industry there is a very competitive industry. Firms in the
grocery industry face many difficulties related to differentiating their product and
services, low concentration, low growth rate, high fixed prices, high economies of scale
where growth is also stagnant and decreases in demand. All of these factors will be
discussed in further detail.
Industry Growth
In the US retail grocery is a $400 billion industry. There are about 40,000
companies which operate approximately 70,000 stores nationwide
(www.firstreseach.com). The largest of these companies are Kroger (KR), Supervalu
(SVU), Safeway (SWY), and Whole Foods (WFMI). The demand for growth is limited to
1% annual growth rate of the US population. Wal-Mart and Costco aren’t the
“traditional” grocers but, currently Wal-Mart is the largest grocery seller in the country
with sales of approximately $60 million (www.firstresearch.com).
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* Information provided by firstresearch.com
The chart above displays the grocery retail industry’s growth over the past five
years. Industry growth is a very important factor in determining the level of competition
among existing firms in a specific industry. The retail grocery industry has had low
growth over the past five years. The average growth for the retail grocery industry has
been about 4 percent per year since 2003. When industry growth is low like in the retail
grocery industry, firms are trying to take market share from each other which results in
very high price competition. According to First Research, the industry’s average growth
rate is about the same as the inflation rate of the entire US economy. To keep their
dollar value the industry must keep up with this amount of growth
(www.firstreseach.com).
The sales in some stores increased due to the diversification that the business
has gone into. Most groceries now offer service such as gas stations, commercial
banking, deli, florist, pharmacy and many other services that may attract customers.
This has lead to the industry trend that stores with this efficient product mix have been
increasing their identical store sales.
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In 2007, Safeway closed 38 stores and only opened 20, but they were still able
to grow their identical store sales. Wal-Mart continues to lead the industry in opening
new stores throughout the country, and they also manage to increase their identical
store sales. Many firms in the retail grocery industry have been closing more stores
than they are opening in order to get rid of stores that are less profitable and invest
that money back into stores that are operating more successfully.
For each firm to grow in an industry they must be able to move large quantities
of product. Therefore it is very important that each firm have the right product mix that
will contribute to the large movement. In the retail groceries industry large firms have
the advantage of efficiently buying and distributing their product. This makes it harder
for small groceries to enter the market and compete with the large firm on price.
Smaller firms have to find other methods to compete on. According to a report on First
Research, large firms have seen the majority of their growth from the acquisition if
small grocery stores and or chains.
Concentration
To calculate concentration in an industry, the number of firms and the relative
sizes are important. Therefore if there is high concentration, in other words one
dominating firm, price won’t be a problem. If there is low concentration and the
industry is fragmented, then there will be severe price competition (Palepu & Healy).
The retail grocery industry has high concentration. It includes 40,000 companies
that operate 70,000 stores in the United States. In this industry, 50 of the 40,000
companies have approximately 70% of the market (www.firstreseach.com). The
traditional stores have had to deal with the larger firms that came in to the industry
such as Wal-Mart, Costco, Sam’s and other larger firms. These firms have more efficient
distribution networks and purchasing, therefore they set lower prices which make it
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difficult for the smaller firms to do the same. The result is the smaller firms have price
competition even though they are in a high concentration industry.
The graph above displays the major competitors’ market shares in the retail
grocery industry over the past five years. Wal-Mart has continued to grow their market
share in the industry, and they have made themselves the undisputed leader in the
industry. The company with the next highest market share in the industry is Kroger.
Supervalu has appeared to barely pass Safeway in 2007 for the next highest market
share in the industry. Whole Foods holds a much smaller portion of the industry’s
market share, and the remaining percentage of the retail grocery industry concentration
is made up of many other smaller firms in the industry.
5 YEAR MARKET SHARE
0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00%
Safeway
Kroger
SuperVALU
Whole Foods
Wal-Mart
2007
2006
2005
2004
2003
2002
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Differentiation
Firms in an industry can avoid competition depending on how well they can
achieve their products and services differentiation. The products in the retail grocery
industry are homogeneous. This means that competitors basically sell the same
products in the industry (groceries). This also means that the retail grocery industry is
driven heavily on price. If a competitor in the industry sells a product at a lower price,
then a customer will usually buy it there because groceries are not really differentiated.
Switching Costs
Switching costs is a factor that determines the customer’s tendency to move
from one firm to another. The lower the switching cost, the easier it is to switch,
therefore the higher the competition over price in an industry. In the retail grocery
industry switching costs are low for customers. This is due to the fact that products are
not really differentiated, so customers want the best possible price.
Economies of Scale
The chart below shows total assets of firms within the retail grocery industry
from 2003-2007. The size of the firms is really important in determining each firm’s
profitability and success. In the retail grocery industry, an economy of scale lies within
the efficiency of distribution and purchasing.
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Total Assets
2003 2004 2005 2006 2007
Safeway 15,096 15,377 15,756 16,273 17,651
Wal-Mart 92,900 105,407 117,139 136,230 151,587
Kroger 20,349 20,767 20,491 20,482 21,215
SuperValu 5,896 6,162 6,274 6,151 21,702
Whole Foods 1,213 1,521 1,889 2,043 3,213
Numbers are in Millions Statistics provided by 10-k of each firm.
As mentioned before, the concentration of the market is high, where 50 of the
40,000 grocery companies represent 70 percent of the market (www.firstresearch.com),
this show that the larger firms have the domination over the industry. They own and
run their own distribution facilities and therefore can afford to run priced down. This
makes it harder for the smaller firms to compete, but it doesn’t make it impossible
because the small retail grocery firms can differentiate themselves from the larger
firms.
Fixed-Variable Costs
When the ratio of fixed to variable cost is high, firms have an incentive to reduce
prices to utilize installed capacity, in other words increase demand. As mentioned
before, most of the firms in the retail grocery industry operate and own their own
distribution facilities. This will increase firm’s costs, because of all the maintenance,
utilities, and overhead cost. The fixed costs are high, but that can be managed by the
variable cost of goods sold. In this type of industry grocery stores need to move large
quantities of products in order to be profitable because it’s an extremely low margin
industry; which may result in high inventory turnover and increased variable cost.
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Excess Capacity
Same Store Sales Growth
2003 2004 2005 2006 2007
Safeway -2.8% .3% 5.8% 4.1% 4.1%
Kroger 3.8% 4.8% 7.3% 6.4% 6.9%
Wal-Mart 12.6% 22.6% 9.8% 11.6% 10.3%
Supervalu 1.7% -3.1% 5.5% -5.6% .5%
WholeFoods 8.1% 14.5% 11.5% 10.3% 5.8%
The chart above shows same store sales growth for Safeway and its competitors
over the last five years. Most of the companies have been able to maintain a positive
same store sales growth every year. We have concluded that the retail grocery industry
has not yet met excess capacity because these established firms are still keeping a
positive same store sales growth every year. This is because firms are still finding ways
to grow same store sales every year.
If capacity in an industry is larger than customer demand there is a strong
incentive for firms to cut prices to fill capacity (Palepu & Healy). In other words it is “A
situation in which actual production is less than what is achievable or optimal for a firm.
This often means that the demand, in the market for the product, is below what the
firm could potentially supply to the market” (www.investopedia.com). The amount of
excess capacity within an industry is a signal of both the health of that industry and the
demand for the products it produces. Excess capacity is also seen as a good thing for
consumers, as it is not likely to lead to the price inflation that would be seen in periods
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of near-full capacity. A company with sizable excess capacity can often lose a
considerable amount of money if it is not able to meet the high fixed costs that are
associated with producers (www.investopedia.com). The retail grocery store industry is
saturated with large retail stores and is reaching excess capacity. A result of consumers
having many shopping choices, supply exceeds demand in the grocery store industry.
Demand limitation may also be caused by the population growth of 1% a year
(www.hoovers.com).
Exit Barriers
In an industry exit barriers are high when the assets are specialized or if there
are regulations which make it costly to exit (Palepu & Healy). Therefore if exit barriers
are high, there will be a high competition. In the retail grocery industry, exit barriers
are not high. Most of the firm’s own their buildings and distributions networks. So if
they needed to they could sell off those assets and leave the industry. In the retail
grocery industry there isn’t strict regulation on exiting.
Conclusion
The retail grocery industry has a very competitive environment. The obvious is
that the different firms have the differentiated product mix and very good distribution
networking. The larger firms have an advantage over the smaller firms when it comes
to the distribution networking. But, the smaller firm can compete in the industry by
selling specialty products and differentiation. The firms in the retail grocery also face a
low growth rate, high concentration, and high excess capacity.
Threat of New Entrants
The threat of new entrants into an industry, such as the retail grocery store
industry, is usually determined by how much potential the profitability the business
could earn. When these threats arise, it pushes the prices of other companies down
which in essence, supply and demand. However, it is vital for newly created companies
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who want to enter a certain industry to research the competition and how to actually
create a company that is profitable. Companies and investors that have large amounts
of money have a higher advantage to succeed over new entrants. There are five
factors that new entrant companies have to research before entering into the industry:
1) Scale Economics, 2) First mover advantage, 3) Distribution access, 4) Relationships,
and 5) Legal barriers.
Total Assets (numbers in millions)
2003 2004 2005 2006 2007
Safeway, INC. 15096 15377 15756 16273 17651
Kroger 20184 20767 20491 20482 21215
Wal-mart 92900 105407 117139 136230 151587
SuperValu 5896 6162 6274 6153 21702
Whole Foods 1213 1521 1889 2043 3213
Scale Economies
The chart above shows the number of total assets of the selected firms in the
retail grocery industry over the past five years. A company that is considering entering
the industry would analyze economies of scale to see if it would be advantageous to
enter the industry. When an industry has large economies of scale, it makes it difficult
for a new company to enter the industry because of the high cost of entry. This
particular industry has large economies of scale because there are many large firms in
the industry with efficient distribution systems and strong buying power. This allows
these large established firms to reduce prices that prevent potential entrants from being
able to compete in the industry.
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First Mover Advantage
If a firm enters the industry market early enough, those early entrant firms
usually have a major advantage over the late companies. This advantage may even be
greater to the first significant company to move into a new market. Basically, being a
first-mover only makes sense if the rewards justify the risks. Some industries reward
first-movers with near-monopoly status and high margins. Other industries do not offer
similar rewards, allowing late-movers the chance to compete more effectively and
efficiently against early entrants (www.marketingterms.com). It is extremely difficult to
gain a competitive advantage over another firm in the retail grocery industry due to the
similarity of products being sold at the individual stores. Because it is difficult to gain a
competitive advantage, there are highly aggressive price war’s that goes on in the
industry. Therefore, in order to create a better competitive advantage in the grocery
store industry, the new entrants may need to offer different quality products or services
than their competitors to differentiate themselves and increase profits. If a company
can’t compete on price then they must offer another reason for customers to shop at
their stores. This could be taking the groceries out to the car for customers, better in
store service, higher quality produce, or other qualities to set the firm above the
competition.
Distribution Access
Distribution access is a direct correlation to relationships in every industry in
every available market. New entrant firms have a disadvantage compared to
established firms when trying to enter a certain industry.
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In order for new entrants to establish a distribution and access chain, there will
be a high amount of capital involved, which is money that will be invested in a certain
business. A high amount of capital will need to be spent by these new entrant firms in
order to develop a distribution and access chain that will be able to serve the customer
base that they will be selling to.
Two main entry barriers that new entrant firms need to inspect before actually
trying to enter the market is limited capacity in existing distribution channels and high
costs of creating new channels (Palepu & Healy). It could be difficult for new firms to
enter the market if a limited number of distribution channels are available. If a new
firm does not have a distribution channel, it would be impossible for that firm to
succeed in the retail grocery industry. As mentioned in the paragraph above, having a
significant amount of capital is vital to create distribution centers and channels to get
the firms products from each location to the shelves of the firm, which leads to
relationships.
In the retail grocery industry, companies must distribute a variety of products
from different locations. These distribution centers need to also be close enough to
where the deliveries are made. These distribution centers are extremely important for
certain types of goods such as perishables. Firms need to own an efficient
transportation system that gets items where they need to be when they need to be
there. Firms also need to be able to transport the amount of inventory needed to a
specific store at the right time.
Relationships
The retail grocery industry depends on relationships to develop a distribution
process that will fulfill all the required details to make a profitable firm. The food supply
chain moves food from the farm gate to the consumer, transforming commodities into
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products that can be conveniently purchased, prepared, and consumed. The chain is
comprised of food procurement and manufacturing companies, wholesale/distribution
firms, brokers, food service firms and restaurants, and retail grocery firms. It is
remarkable for its efficiency, diversity of firm sizes and types, and responsiveness to
consumers (www.jstor.org) (King and Phumpiu). King and Phumpiu are stating that
relationships are the most important part of developing and creating a new firm. If
relationships are not developed the appropriate way and the firm does not have
relationships that will successfully make the firm profitable, than the new entrant firm
will not be successful. This is another disadvantage for new entrants for firms. If
existing firms already have developed relationships with customers and manufacturers,
it will be difficult for new entrants to enter the industry (Palepu & Healy).
Legal Barriers
Knowledge of legal barriers are extremely important for new entrants to enter an
industry. There are many industries in the United Stated, such as the retail grocery
industry, that have different laws and regulations they need to abide to. These laws
and regulations include FDA and state health departments. Not only do they have to
abide by these regulations, there are also legal barriers when it comes to taxes and
food inspections (www.nh.gov/revenue/business).
Conclusion
The threat of new entrants in the retail grocery industry is low. Depending if a
new entrant firm can create economies of scale, a low-cost distribution access, develop
relationships, and have knowledge of legal barriers, it will be difficult for a new entrant
to compete in the industry. Also, the first move advantage that Safeway, Kroger, Wal-
Mart, Supervalu, and Whole Foods have over new entrant firms will create a difficult
entry barrier.
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Threat of Substitute Products
Retail Grocery stores face the threat of substitute products on two fronts, both of
which are simply substitute means of getting food. “Relevant substitutes are not
necessarily those that have the same form as the existing products but those that
perform the same function.” (Palepu & Healy). Given this definition the only substitute
products found in the current market are restaurants or convenience stores, perishable
and non perishable foods, and substance farming. Even though these substitute
products exist the Retail Grocery Industry does not consider them relevant threats.
Restaurants and convenience stores often charge higher prices for similar or identical
products found in Retail Grocery stores and a large portion of the population do not
have the resources to grow enough food to replace the value Retail Grocery Industry
provides. Since Retail Grocery stores target both high and low income families with
limited resources the Industry does not consider substitute products a threat. Within
the industry every competitor sells relatively the same product.
Relative Price and Performance
One factor that contributes to the threat of substitute products is relative price
and performance. “The treat of substitutes depends on the relative price and
performance of the competing products or services and on customers’ willingness to
substitute.” (Palepu & Healy). It is important to understand this concept of substitute
products because it explains the existence of both name brand products and generic
products. The generic product such as “Great Value” of Wal-Mart is relatively cheaper
than the “Tide Bleach” from Proctor and Gamble. The customer’s preference is the
deciding factor in what product is purchased. Some customers prefer name brand
products from distributors such as Procter and Gamble or Johnson and Johnson, while
others prefer the less expensive generic products which have similar performance.
Since Safeway, and the rest of its competition in the industry, are in the industry to sell
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as much product as possible the companies can ill-afford to with hold either the generic
or name brand product from their shelves.
The Industry has a very small profit margin and operates on a large economy of
scale. It is so competitive 50 of the largest companies own 70% of the market.
(www.hoovers.com) Because of the high level of competition and the need to sell large
amounts of product the ability of a company to raise prices is inherently limited.
Buyers’ Willingness to Switch
The preference of the consumer is the deciding factor in wither or not generic
products are consumed. People chose to switch from name brand products to generic
brands for a variety of reasons. Regardless of the reasons, the Industry players must
be prepared to offer both types of products because large Retail Grocery stores don’t
cater to individual market segments. Everyone has to eat, it is much more cost efficient
to carry both types of items in the store.
There has been a growing market for natural foods and the Industry is begging
to adjust to the preference of the consumer. It is a great example of the tweaks the
individual companies within the industry makes to keep up with customer preferences.
The margin specialty stores are making on these types of foods is decreasing as major
Retail Grocery chains improve their gross margins. “Whole foods' costs increase and its
rivals beef up their higher-margin, natural-food offerings. Kroger's gross margins are
about 24% and Safeway's are about 28% in their most recent quarters; Whole Foods'
are about 35%.” (WSJ#2). Consumer’s preferences’ are changing and the industry is
adjusting accordingly.
Conclusion
Substitute products, by definition, are not a major threat to the Retail Grocery
Industry. The means to substitute products sold by the competing chains are is not
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economically efficient. The ability of the consumer to shop in another location, or
prepare his/her own food is not considered a major threat. Because of the high
competition and markets of scale found in the industry the large Retail Grocery chains
must be aware of customer’s preferences. The ability of the industry to adjust to the
changing purchasing behavior of the consumer is evident in the existence of generic
goods and the continued integration of health foods.
Bargaining Power of Buyers
The bargaining power of buyers is an extremely important factor in the Retail
Grocery Industry. Firms in this industry must figure out how costly it is to lose
customers. There are several categories like switching costs, differentiation, importance
of product for cost and quality, number of buyers, and volume per buyer to consider
when deciding how a certain firm should analyze the way they should do business in
respect to the power of their buyers.
First a firm needs to decide how they can best compete in the industry. A firm
can either compete on cost or by differentiation. If a firm competes on cost then they
must usually be a larger company. For example, a local grocery store cannot effectively
compete on price with Wal Mart. Therefore, it usually benefits the smaller or medium
size firms to compete by differentiation. This means that grocers compete by offering
special services like taking groceries to the car for customers, providing better produce,
or being more helpful to customers in the store.
Groceries are very important products that every person who eats has to
purchase, but more people are eating out these days. This choice that the consumer
has gives the customers significant muscle in terms of how they can control prices in
the Grocery Retail Industry. This explains why prices in the grocery retail industry have
only grown 20 percent over the last ten years. However food prices are expected to rise
in 2008 by between 4.5 and 5.5 percent (WSJ#4). Americans have also bought 5
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percent less of their food from grocery stores over the last decade (usda.gov). Since
people are purchasing less of their food from grocery stores today, price competition
has become the number one business strategy for the majority of firms in the industry.
If firms wanted to raise grocery prices, then people can just pick up fast food or go to a
restaurant. This is an example of bargaining power of buyers.
Price Sensitivity
Customers in the Grocery Retail Industry have very low switching costs. This
means, if customers can get a better price on the same item somewhere else, they will
go elsewhere. Groceries are undifferentiated which makes customers very price
sensitive. Price sensitivity determines the degree to which customers care to negotiate
on price.
Firms like Safeway INC., Wal Mart, and Kroger utilize their knowledge of price
sensitivity by offering their own brand of cheaper items that are similar (maybe
identical) to the more costly name brand item. Firms will also put their brand item next
to the name brand item on the shelf. This way the customer can decide whether they
would like the name brand item or the more affordable store brand version.
In the end, the customer has the decision of what they would like to spend their
money on. The stores must compete with other stores in the industry to win the
customers over to them. If a store/company can’t compete on cost with the
competition, then they probably won’t last in the Grocery Retail Industry.
Relative Bargaining Power
In the Grocery Retail Industry, customers have extremely high bargaining power.
Most grocery stores sell the same products which means that the grocers are basically
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at the mercy of the consumer decision to buy at their store or not. In this highly
competitive industry the customer can easily go to a different store if they offer a
cheaper price. Wal Mart has the most market share in the industry because they can
afford to offer the lowest prices. Stores in this industry must keep customers constantly
coming into their stores so that they can stay in business and hopefully turn a profit. If
stores can’t compete with their competitors and maintain customers, they will inevitably
go out of business. This is a result of the strong bargaining power the customers have
in the Grocery Retail Industry.
Conclusion
Large companies in the in the Grocery Retail industry have an immense
advantage. This is because the firms have to compete primarily on cost due to the high
bargaining power of customers in this mostly undifferentiated industry. Low
differentiation makes customers price sensitive. If small firms want to compete, then
they have to offer special services or better quality that customers might accept as a
substitute for the lack of the store being able to compete on cost. Firms must assess
their size and capabilities and then decide what strategy works best for them
individually.
Bargaining Power of Suppliers
The effective buying power of suppliers follows the same parameters of the
buyers. Downward price level pressure is only as significant as the relative bargaining
force suppliers place on firms. It is in these markets where efficiency will ultimately
decide the level of profits. Distribution effectiveness, switching costs, differentiation,
product importance and number of suppliers are the overall profit drivers.
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Switching Costs
Supplier switching costs is based on how specialized the products are. Typical
grocery stores that strictly focus on cost-cutting through supplier efficiency tend to have
relatively low switching costs due to the many alternatives available. When stores
begin to supply higher quality or specialty items, fewer and fewer suppliers are
available. This leads to very expensive switching costs.
Differentiation
Differentiation is directly correlated to the amount of substitutes. Lower costing
homogeneous products are easily reproduced providing a large amount of suppliers.
Having large numbers of suppliers provides many substitutes, thus reducing supplier
power. Higher-end specialty products have far fewer suppliers. Suppliers tend to have
more power over the specialty stores. These would be the stores that demand superior
quality products, but at the same time demand consumers to pay higher prices. Stores
like this tend to focus more on the individual customer than customers as a whole.
Many stores develop databases and seek closer partnerships with manufactures and
suppliers for individualistic customer promotions but do so at generally higher costs.
Importance of Product for Costs and Quality
The importance of a product to a customer has a highly significant impact on the
power suppliers can wield over the consumer. The more vital the products are to the
customer, the stronger the power of the merchant over that customer. Product quality
tends to put power more directly in the hands of suppliers. The higher the quality
product generally means the less substitutes there are. Inevitably, this means far few
suppliers giving the power to them.
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Number of Suppliers
The bargaining power of suppliers is the power of price setting. Ultimately, the
number of suppliers will set the price levels in the industry. Suppliers tend to lose their
bargaining power over customers as the supplier concentration grows. When there are
very few suppliers the power sits with suppliers and there ability to raise prices with a
lack of alternatives or their ability to produce superior products. As the volume of
suppliers increases, the power is in the hands of the firms. Many suppliers producing
the same products cannot control price levels as firms will chose lower prices to control
costs.
Volume per Suppliers
The grocery industry is highly competitive. Additionally, grocers are becoming
increasingly demanding of quality to insure customer satisfaction. With the threat of
losing large firms, suppliers are expected to provide superior quality products, in mass
quantities, at lower price levels. Cost efficiency is the most powerful tool in the grocery
industry. Most large operations deal directly with manufacturers and have set up
super-efficient distribution systems to ensure the lowest price levels.
Conclusion
Supplier bargaining power in this industry is mixed. However, the power truly
lies with the firms and their choice of inventory. If a firm chooses low-cost products
that can be produced by many different companies, then, all the power belongs with
the store. If the firm chooses highly specialized products, made by few, the power
belongs to the suppliers.
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Strategies for Creating a Value Chain
The grocery industry is concentrated with numerous competitors. To survive in a
competitive industry each individual firm must have efficient operations and the ability
to understand the customer’s need, thus creating a competitive advantage. According
to Palepu & Healy, “cost leaders cannot compete unless they achieve a least a minimum
level on key dimensions on which competitors might differentiate, such as quality and
service.” Understanding what a competitive advantage is will lead to the creation of an
efficient firm and lead to the creation of value. The Retail Grocery industry primarily
focuses on the strategy of cost leadership with an occasional attempt to incorporate the
strategy of differentiation. The industry is highly competitive with many firms selling
essentially the same product. The best strategy to undertake to achieve a competitive
advantage in this type of industry is Cost Leadership. However many firms often try to
incorporate pieces of the differentiation strategy to gain a competitive advantage over
firms unwilling to adjust strategies.
Cost Leadership
Cost leadership is a strategy, where firms gain the competitive advantage by
becoming the lowest cost supplier of goods or services in the industry. The grocery
industry becomes more and more competitive every year. The times of old saw small,
family-run markets control the grocery world. The industry would shift upon the
rationalization that larger store could purchase much larger quantities of inventory
lowering per unit cost, thus being able to sell for cheaper. This evolution has continued
to evolve from mom and pop market to supermarket to, the new industry leader, the
super-center. The lowest cost providers are from the newer super-centers and
warehouse stores. It is virtually impossible to compete with the scales and volume
these stores can produce. So another shift in the industry is occurring. Some of the
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industry leaders realize there is no way to compete for lowest cost with these giants.
They can now only compete for the remaining market share. These stores are looking
to be the #1 of the #2s so to say. Other stores have shifted their focus and some have
changes their strategy completely, looking for opportunities with customer service,
niche markets, and specialty goods.
Top 10 U.S. Food Retailers by Sales
1986 1996 2006
Safeway Kroger Wal-Mart^
Kroger Safeway Kroger
American Stores Albertsons Safeway
Winn-Dixie American Stores SUPERVALU
A&P Winn-Dixie Costco
Lucky Stores Publix Ahold USA
Albertsons A&P Publix
Supermarkets Gen. Food Lion Delhaize America
Publix Wal-Mart^ H.E. Butt
Vons Companies Costco Albertsons, LLC
^Includes Wal-Mart Supercenters and Wal-Mart subsidiary Sam’s Clubs Source: Food Marketing Institute
Firms are continuously trying to lower costs and maximize efficiency through:
economies of scale and scope, efficient production, simple product designs, lower input
costs, low-cost distribution, minimal spending on research and development, reduce
brand advertising costs, and a tight cost control system.
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Economies of Scale
The ultimate goal from economies of scale is to reduce the per unit price of
products. Fundamentally firms purchase products in mass quantities or bulk, which in
turn reduces production costs. Suppliers, gratefully, will lower prices as order volume
increases, thus reducing per/unit costs of the product. Generally, the larger and larger
the orders become, the more and more savings are received.
Median Average Store Size
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
40,483 44,843 44,600 44,000 44,000 44,000 45,561 48,058 48,750 47,500
(Source: Food Marketing Institute)
This concept has driven the competitiveness in this industry remarkably high. The
median average store size has grown nearly twenty percent in the last ten years.
Massive super-stores and warehouses have taken over the industry. Using their
immense square footage these companies can purchase incredible amounts of product
so that prices stay well below competitors.
Economies of Scope
Firms in this industry use economies of scope to increase efficiency ultimately to
increase profitability. This concept is utilized by firms carrying a broad scope of
different products. The similar nature of some of these products is the key factor.
Firms seek efficiency through marketing and distribution strategies. Bundling many like
items and selling them at discount is one example. The firms’ ability to provide mass
distribution for many products instead of a single product is another case of increased
efficiency.
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Low-cost Distribution and Production
All firms in this industry strive to provide their customers with fully stocked
shelves all the time. The goal is to replace purchased merchandise as quickly and cost
efficiently as possible. Efficiency in the entire supply chain is crucial in maintaining low
costs. Many firms in the industry produce their own products to lower costs. The can
minimize brand advertising or eliminate it altogether with their own product
manufacturing.
Differentiation
In the grocery store industry, a highbred strategy rooted on cost leadership with
pieces of differentiation incorporated into the overall strategy creates value.
Differentiation occurs when a firm seeks to bring a unique product into its industry
which is highly valuable to the consumer. In the Retail Grocery industry the goal is to
provide a unique product such as organic foods at the least possible retail cost while
satisfying the customer’s expectations. As the types of foods American consumers
consume continue to change the ability of a Retail Grocery store to adjust to the
changing demand shifts market share from those unwilling or unable to incorporate
differentiation strategies. Large stores compete on cost while medium sized stores
attempt to use differentiation strategies such as product quality, product variety,
customer service, and investment in brand image.
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Superior Product Quality
Superior product quality is critical for a firm competing on differentiation
strategies. Companies offer identical retail items with low profit margins. Since retail
prices of products are similar from store to store the customer must be given a reason
to pay a premium for a product. According to the Safeway Inc. 10K, “The award-
winning Safeway SELECT line is designed to offer premium quality products that the
Company believes are equal or superior in quality to comparable best-selling, nationally
advertised brands” (Safeway 10K). By selling these private brands companies in the
industry individual grocery stores develop a brand image.
Superior Product Variety
Grocery stores differentiate themselves by establishing greater product variety.
Everyone carries essentially the same product mix; produce poultry, perishable items,
and non-perishable items. Providing a variety of products can increase brand
awareness and increase customer loyalty. Providing a variety of unique products has
been extremely profitable for the medium sized firms. Specialty foods, one such
product, have already drawn considerable attention from the industry. The gross profit
margins of specialty foods have driven the larger retail grocery industry leaders to
incorporate them into their product mix. According to the Wall Street Journal, “Kroger's
gross margins are about 24% and Safeway's are about 28% in their most recent
quarters; Whole Foods' are about 35%.” (WSJ #2). As the industry changes large
companies are quick to capitalize on higher gross profits generated by new products in
the market.
In the grocery store industry it is critical to utilize shelf space and maximize the
variety of products sold. Products are separated into organized sections so that
customers’ can have relatively easy access to the products they wish to purchase. It is
crucial that stores utilize their shelf space to maximize the variety of products.
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Superior Customer Service
Excellent customer service is a strategy many corporations attempt to achieve
but seldom do because of the costs associated with maintaining superior customer
service. Midsized firms can differentiate themselves by implementing preferable
customer service. Industry leaders such as Wal-Mart develop competitive strategies
mainly through cost leadership. According to Wal-Mart’s 10K they strive to be the cost
leader in each market. As a result however their customer service has some
inefficiency. Other stores such as Whole Foods Inc are creating innovative ways to
increase customer service such as decreasing the weighting time in lines. According to
the New York Times, “The science of keeping lines moving, known as queue
management, is a big deal to big business. Since arriving in 2001, Whole Foods stores
in Manhattan have won bragging rights as the top sellers among grocery chains here,
with sales of $42 million per store last year, according to Modern Grocer, a trade
publication.” (NYT #1). Positive customer service improvements can be an effective
way to develop a competitive advantage.
Investment in Brand Image
Investment in brand image can be an important piece of any differentiation
strategy. In an industry where competitive strategies are built on cost leadership brand
image can be an important differentiation strategy. Every company in the industry tries
to portray themselves in a certain light. Wal-Mart attempts to “save people money so
they can live better” while companies like Safeway show corporate responsibility by
using renewable energy sources. According to Safeway.com, “The biodiesel initiative
makes Safeway one of the first major retailers in the United States to convert its entire
fleet of more than 1,000 trucks to cleaner-burning biodiesel fuel.” (Safeway News #1).
If used correctly, a positive brand image can help create a competitive advantage.
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Firm Competitive Advantage Analysis
A company in an industry can compete by cost leadership or by differentiation. If
a firm is competing on cost leadership, then products in the industry are very
comparable having to be produced at the most efficient cost. Competing on
differentiation means that products are different and/or firms try to compete by offering
specialty services or superior quality. Safeway definitely competes on cost, but are now
trying to lean towards more differentiation strategies.
Economies of Scale
The retail grocery industry is driven heavily by economies of scale. The objective
of economies of scale is to reduce the per unit price of goods. Safeway Inc. is one of
the largest food and drug retailers in North America, with 1,743 stores at year-end
2007. In support of its retail operations, the Company has an extensive network of
distribution, manufacturing and food-processing facilities (Safeway 10K). Being one of
the larger firms in the industry, it benefits Safeway to compete on cost in most cases.
As stated earlier, when Safeway purchase bulk items from suppliers they are creating a
better opportunity to lower costs and ultimately creating a better business strategy for
themselves.
Economies of Scope
In the retail grocery industry, economies of scope are useful to be successful in
the market. Economies of scope are when the average total cost of production
decreases as a result of increasing the number of different goods produced. It is an
efficiency tool that will better put Safeway in a position to save on costs. Safeway has
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17 distribution/warehousing centers (13 in the United States and 4 in Canada) which
they store all their products. This will help position Safeway to decrease costs of
production and increase efficiency.
Distribution and Production
U.S. CanadaMilk plants 6 3 Bakery plants 6 2 Ice cream plants 2 2 Cheese and meat packing plants – 2 Soft drink bottling plants 4 – Fruit and vegetable processing plants 1 3 Cake commissary 1 – Total 20 12
*information from Safeway-SWY 10K
As previously stated in the economies of scope section, Safeway has 17
distribution/warehouse centers. These centers are spread out all over the regions
where Safeway operates. The chart above shows how many different plants Safeway
has in United States and Canada. With the geographic placing of these distribution
centers, it gives Safeway a competitive advantage to always have products shipped to
each location when the store runs low. This will help Safeway keep costs low through
cheap distribution and quick production.
Superior Product Quality
Product quality is extremely important for Safeway because they are trying to
incorporated more differentiation strategies. Safeway offers their company brand
Safeway SELECT, which offers premium products that are equal in quality while cheaper
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in price than other name brand products. By selling these private brand products
Safeway can still compete on cost while also developing their store’s brand image.
Superior Product Variety
In late 2005, Safeway unveiled the line of O ORGANICS food and beverage
products. Everything in the O ORGANICS line, which includes more than 300 items,
comes from certified organic growers or processors and is USDA-certified organic. The
O ORGANICS line includes, among other products: milk, chicken, salads, juices and
entrees. Further expansion of the line is expected in 2008 (Safeway10K). By
incorporating different things like organic foods, Safeway has used product variety to
compete on differentiation with other firms in the industry. Offering healthier food
alternatives motivates people who are trying to live a healthier lifestyle to shop at
Safeway’s stores.
Investment in Brand Image
Safeway has begun to show corporate responsibility by using renewable energy
sources. This is important because when companies do things like conserving energy or
protecting the environment, they inevitably establish a more positive brand image.
Some people may shop at a specific store only because they respect and appreciate
what the company stands for. Therefore, brand image can be a very powerful
competitive advantage if utilized properly.
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Current Focus
Safeway is one of the largest energy consumers in the West. After the California
energy crisis pummeled the company bank account, they decided to go a different
route with energy. The need for new energy led them to natural gas. The new “green”
generators they purchased started a new trend for the company. The new generators
were cost-efficient along with environmentally friendly. The trend continued recently
when Safeway outfitted all there distribution trucks with environmentally friendly bio-
diesel fuels. Along with its “green” movement the company is about three quarters
away from completing the largest supermarket remodel ever. The company took on
the $1.6 Billion dollar renovation in 2003 in an effort to splinter away from the price
wars of the giants. The company is trying to make the transition into the specialty
goods market but still wants to keep some of the familiar supermarket feel.
Future Strategy
Safeway’s future strategy is all about the customer. Safeway has been compiling
years and years of its customers’ personal information in hopes of obtaining a much
deeper insight. They are hoping to distinguish their most loyal and profitable
customers. They want to know exactly why they chose the stores. They are also
focusing on these same customers behavior inside the store. The stores are now trying
to cater to the individual instead of the whole. Safeway has revamped and added
specialty sections to most stores. They also use the information to redevelop each
area’s store with more innovative lines. In an effort to draw them closer to Whole
Foods, Safeway has developed a higher-end organic line and has many other lines in
development.
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Accounting Analysis
There are many times that a company’s managers have incentives to make their
firm appear more presentable and valuable to potential investors. This is the reason
that it is essential to analyze a firm’s financial statements. The purpose of the flexibility
in GAAP (Generally Accepted Accounting Principles) is to allow managers to report the
underlying economic state of the firm. However, this allows managers to abuse this
flexibility to possibly better themselves. This is why analysts play such a vital role in
finding the truth in a company’s financial statements.
The accounting analysis will allow the reader to view a firm’s financial statements
as objectively as possible. The accounting analysis not only adds transparency to the
financial statements it also helps the reader understand the degree to which a
company’s accounting policies reflect the day to day operations of business. (Palepu &
Healy)
There are six steps in the accounting analysis. The analyst begins by identifying
the key accounting policies found in the retail grocery industry given the key success
factors identified earlier. The second step assess degree of potential accounting
flexibility’s purpose is to evaluate the degree of flexibility available to management.
The third step evaluate actual accounting strategy’s purpose is to evaluate how
managers exercise their accounting flexibility and the likely motivations behind
managers’ accounting strategy. The fourth step, evaluate the quality of discloser,
assesses the depth and quality of a firm’s disclosures. The fifth steps, identify potential
“red flags”, identifies and discusses any red flags uncovered by the accounting ratios
utilized. The final step, undo accounting distortions, breaks down the balance sheet
and income statements and takes into consideration any red flags uncovered
previously. (Palepu & Healy)
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Key Accounting Policies
The first step in the accounting analysis is deciding the key accounting policies
that are exercised by a company. It is important to an analyst that a firm’s accounting
policies line up with their key success factors. The key success factors of a business are
used in the company’s accounting process. A company’s industry characteristics and
their competitive strategy determine its key success factors and risks. A main goal of
financial statement analysis is evaluating how well the success factors and risks are
managed by the firm (Palepu & Healy).
Key success factors are used by a company in order to attain or increase their
competitive advantage in their industry. So companies need to be able to identify their
key success factors so that they can effectively compete in their industry. In the retail
grocery industry, key success factors are economies of scale, low cost distribution and
production, superior product quality, and superior product variety.
The products in the grocery retail industry are undifferentiated. This means that
the industry is highly competitive from selling very similar products and services.
Therefore, the largest strategy in the industry is cost leadership. When selling the same
products in an industry, the easiest way to differentiate your firm is to offer the lowest
price. In order to effectively compete on cost, a firm must have an efficient distribution
system and be large enough to compete on prices with other major players in the
industry.
The grocery retail industry is very concentrated. Seventy percent of the market is
owned by the 50 largest firms in the industry. This makes economies of scale an
extremely important factor to consider (Hoovers.com). This benefits the larger firms in
the industry, because they can reduce costs and set up their distribution centers much
easier.
The risks that the industry face are competitive industry conditions, labor
relations, food safety concerns, economic conditions that impact consumer spending,
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and unfavorable changes in government regulation (Safeway 2008 10-K). Risks can
definitely affect a company’s forward looking statements. Therefore, risks should always
be taken into account when analyzing a business or industry. The preceding risks and
success factors are major factors in concluding what key accounting policies that
Safeway INC. and their competitors use.
Economies of Scale
The retail grocery industry is extremely competitive. As mentioned in the
Industry overview and the Five Forces Model, there are 40,000 companies operating in
the 70,000 grocery stores in the $400 billion U.S. retail grocery industry. Seventy
percent of the market is held by the 50 largest companies in the grocery industry.
(Hoovers.com). With the retail grocery industry so highly concentrated around a
minimum number of companies, economies of scale creates a sense of survival and
urgency for grocery companies. Retail grocery companies have to fight for market
share within the industry in order to continue to grow each year. Market share is the
portion or percentage of sales of a particular product or service in a given region that
are controlled by a company (wisegeek.com). Market share and sales growth are two
substantial factors in order for the company to increase in size. Retail grocery
companies increase the size of their firm by having economies of scale.
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Safeway, INC.‐Sales Growth (in billions)
2003 2004 2005 2006 2007Stores Sales 35.7 35.8 38.4 40.2 42.3% of growth increase ‐‐‐‐ 2.80% 7.20% 4.60% 5.20%
(Information from Safeway 10k)
According to Doug Desjardins from BNET.com, Safeway says its Lifestyle
remodels are still the key to its long-term growth, but it's looking to drive sales with a
variety of non-food items, as competition heats up on its home turf in California
(findarticles.com). It is important for Safeway to continue to make strides to have a
good structure of economies of scale to better grow in the market.
As the sales growth states chart states above, Safeway has continued to increase
sales each year since 2003 and had a substantial increase from 2004 to 2005. Most of
their sales growth increase came from the Lifestyle store execution, increased fuel sales
and in 2007, part of the increase was in the Canadian dollar exchange rate. From 2003
through 2006, it was mainly the execution of the Lifestyle store execution and increased
fuel sales that sparked the sales growth for Safeway (10K). With the results the past
five years Safeway is making strides to continue to grow as a company.
Goodwill
According to investorwords.com, goodwill is an intangible asset which provides a
competitive advantage, such as a strong brand, reputation, or high employee morale.
In an acquisition, goodwill appears on the balance sheet of the acquirer in the amount
by which the purchase price exceeds the net tangible assets of the acquired company.
Safeway, INC. has an annual review to review goodwill and check for impairments.
Safeway, INC. has $2.4 billion of goodwill subject to periodic testing for impairment.
The long-lived assets, primarily stores, also are subject to periodic testing for
impairment. Failure to achieve sufficient levels of cash flow at specific stores or
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divisions could result in impairment charges on goodwill and/or long-lived assets.
Safeway, INC. has incurred significant impairment charges to earnings in the past for
goodwill and long-lived assets (10K).
Safeway, INC.‐ Goodwill
2003 2004 2005 2006 2007
Goodwill 2404.9 2406.6 2402.4 2393.5 2406.3
Goodwill Impairment 729.1 ‐‐‐‐ ‐‐‐‐ ‐‐‐‐ ‐‐‐‐
Goodwill Amortization ‐‐‐‐ ‐‐‐‐ ‐‐‐‐ ‐‐‐‐ ‐‐‐‐
During 2003, there was a total of 729.1 million dollars worth of impairment
charges which is the only year since 2007 that they had impairment charges. This is
the only year they have had goodwill impairment but have had no goodwill amortization
numbers to record. As previously stated, Safeway, INC. has $2.4 billion of goodwill that
is tested annually. Goodwill is part of assets on the balance sheet that is extremely
difficult to measure. Since Safeway’s goodwill does not represent a big percentage of
the company’s total assets, it is not considered significant when writing down
impairment charges.
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Capital vs. Operating Leases
This highly competitive market focuses on cost control. Controlling cost during
times of continued expansion is an increasingly difficult process. There is a popular
accounting policy that deals with this issue. It is the choice of firms to use either
capital leases or operating leases. Every firm in this industry utilizes this accounting
procedure.
Operating Lease Totals within the Industry
2008 2009 2010 2011 2012 Thereafter
Total min Lease Pmnts
Safeway $451.80 $410.40 $380.80 $346.30 $317.80 $3,089.10 $4,996.20
Kroger $774.00 $736.00 $693.00 $630.00 $578.00 $3,459.00 $6,870.00
Whole Foods $212.71 $269.39 $303.93 $311.79 $308.69 $4,622.94 $6,029.45
Wal-Mart $1,094.00 $1,051.00 $994.00 $866.00 $788.00 $8,966.00 $13,759.00
SuperValu $479.00 $397.00 $363.00 $330.00 $288.00 $2,196.00 $4,053.00
Operating leases usually deal with extremely large contracts. This is why they
are such an important disclosure item. In a normal capital lease, the leased building is
accounted as an asset and liability. This places high stress on the position of the firm’s
value. Typically these large debts are a significant portion of total liabilities. These
firms chose operating leases because it keeps the liabilities off the balance sheet.
Operating leases are treated as rent payments are expensed. These leases keep
earnings high, and the companies do not have the large liabilities on their books.
However, these numbers have a high level of distortion and paint an untrue picture of
the firm’s actual financial position.
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Post-Retirement Benefit Plans
The quality of accounting policies can be influenced by any long term liabilities
which management has the ability to adjust. One such policy is the employee benefit
plan. In a competitive industry such as the retail grocery industry any flux in the
liabilities of Post-Retirement spending can adversely change a company’s financial
statements.
According to FASB, “Employer’s are required to recognize in its statement of
financial position an asset for a plan’s over funded status or a liability for a plan’s
underfunded status, measure a plan’s assets and its obligations that determine its
funded status as of the end of the employer’s fiscal year, and recognize changes in the
funded status of a defined benefit postretirement plan in the year in which the changes
occur.” (Safeway 10K) Changing the discount rate, based on assumptions will change
the overall value of the post-retirement plan, switching it possibly from an asset to a
liability.
To grow its assets Safeway has adopted an investment policy based on
separating assets into equity and fixed income securities. “Equity returns were based
primarily on historical returns of the S&P 500 Index. Fixed-income projected returns
were based primarily on historical returns for the broad U.S. bond market.” (Safeway
10K) The allocation of assets is adjusted every year to keep the plan on target “The
following table summarizes actual allocations for Safeway’s plans at year-end 2007 and
year-end 2006:” (Safeway 10K)
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Asset category
Target 2007 2006
Equity 65 % 67.8 % 68.9 %
Fixed income 35 31.8 30.7
Cash and other – 0.4 0.4
Total 100 % 100.0 % 100.0 %
Based on the allocation of funds Safeway assumes an average discount of 5.9%
for 2007. “The actuarial assumptions used to determine year-end projected benefit
obligation were as follows:” (Safeway 10K)
2007 2006 2005
Discount rate:
United States plans 6.1 % 6.0 % 5.7 %
Canadian plans 5.3 5.0 5.0
Combined weighted-average rate 5.9 5.7 5.5
Rate of compensation increase:
United States plans 4.0 % 4.0 % 4.0 %
Canadian plans 3.5 3.5 3.5
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A lower discount rate increases the present value of benefit obligations and
increases pension expense. The consistent increase of the discount rate from 2005 to
2007 would suggest an increase in pension long term liabilities on the balance sheet.
In addition to the funded employee benefit plans Safeway also includes underfunded
benefit plans such as a Retirement Restoration Plan and a plan that covers medical
expenses exclusively for “certain employees”. These plans are part of the long term
obligation of Safeway. The chart below is the long term debt obligations for pension
and post retirement benefit obligations.
2007 2006 2005
Pension and post retirement benefit obligations
236.7 204.0 86.4
*Information from Safeway 10-K
The rest of the industry also has an average long term discount rate of (). How
did they calculate it? Is it more aggressive?
Companies such as Safeway have “Defined Benefit Plans” for retirees. A lot of
estimation goes into finding the present value of the long term liability. Other
companies in the industry such as Wal-Mart have “Defined Contribution Plans” which
are distinctly different in the essence Wal-Mart is not estimating a value of a fund.
Once Wal-Mart’s employees’ retire benefits are paid based on the value of the
contributions made by the company for the employee. The contributions are expensed
each year. Having a “Defined Benefit Plan” gives management a way to manipulate the
balance sheet.
Given the retirement benefit obligations increasing over time and the fact they
make up a large portion of the total long term debt, a management decision to alter the
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discount rate to show greater profits or losses could be a great temptation. However
the discount rate was derived from a logical source of equity and fixed income rates set
by current market conditions, management also updates the discount rate annually to
adjust for changes in the market. Compared to the discount rates of its competitors
Safeway is overstating their long-term liability which shows conservatism. In a
competitive industry such as the retail grocery the temptation to keep expenses low by
altering long term assets such as retirement benefits is great.
Keeping Costs Low
A company has to sell a lot of product in the retail grocery industry in order to
turn a profit. Therefore, firms in the grocery retail industry are focused on making their
distribution costs as low as possible. This also makes the industry very highly
competitive. Firms are trying to compete on cost with competitors in the industry gain
customers. Price competition makes it hard for companies to make money in a low
profit margin industry. In order to keep costs low, numerous companies have
established their own distribution centers. Since there is high price competition in a low
profit margin industry, it is imperative for firms in the grocery retail industry to state
their inventory purchasing and distribution costs. This is a key accounting policy for
firms in the grocery retail industry.
Purchase and distribution costs for Safeway include inbound freight charges,
purchasing and receiving costs, warehouse inspection costs, warehousing costs, and
other costs associated with Safeway’s distribution network. These items are a major
portion of the company’s cost of goods sold, which was about $30.1 billion in 2007,
$28.6 billion in 2006, and $27.3 billion in 2005. Only $551.8 million were in the
advertising and promotional expenses portion of Safeway’s cost of goods sold, making
the remaining portion purchasing and distribution costs (SWY-10K).
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It is very important for a company to account for purchasing and distribution
costs in the grocery retail industry, because firm’s managers want these costs to be as
low as they can get them. Sometimes there are incentives for managers to not include
these costs in incurred period if it might make their firm appear more profitable to the
investors. This is a possible way in which flexibility in GAAP can be abused to distort
information by accounting actions.
Conclusion
The grocery retail industry is highly competitive. The majority of competition in
the industry is based on price. This makes it extremely important for companies in the
in the industry to keep their costs low so they can compete on price and still turn profits
in an industry that sells, for the most part, undifferentiated products (groceries). Once a
firm in the retail grocery industry determines what it takes to run a profitable business
(key success factors) and the risk factors in the industry, they can determine their key
accounting policies. In the grocery retail industry important accounting policies are
economies of scale, keeping costs low, operating/capital leasing, and post-retirement
benefit plans. The value of a firm can be distorted by managers through their
accounting choices. This makes it very important to analyze a firms financial statements
and accounting choices more carefully to find the underlying truth about a company’s
worth.
Accounting Flexibility
All companies must reasonably follow the GAAP guidelines set forth by the
Securities and Exchange Commission (SEC). These standards limit management’s
capability to abuse accounting practices within the company. Firms provide us with a
certain level of disclosure about its’ financial information. Depending upon the
company’s level of disclosure, high or low, the company chooses what information and
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how much information to report and release. The most important term in the scope of
disclosure is assumption. Many accounting numbers are man-made estimates or
“guesses!” Typically these guesses are controlled by the management. It is within
their discretion to choose their general accounting policies. Unfortunately their
decisions do not always reflect the best interest of the firm or more importantly the
shareholder. Incentives provided by different accounting policies, especially those that
are compensation based, generally lead to distortion of financial data for their own
personal prosperity. The standards that monitor these accounting policies limit but do
not fully restrict all accounting practices.
There is always uncertainty from risk factors within any industry. Factors
controlled by governing bodies such as changes in accounting standards could have a
considerable effect on any company’s results. Economic factors also play a key role in
overall risk. Interest rate changes can substantially increase or reduce liabilities.
Minute changes, such as 25-basis-points, can adjust millions of dollars in book value
instantaneously. Translation of foreign currency is a constantly fluctuating risk involved
with international sales. Payments received 90 days after purchase will definitely have
a different value based on that country’s currency valuation. Also, most recently energy
cost risk, has companies exploring of price controls.
All firms have flexibility within certain areas to manipulate data within GAAP
guidelines! These are typically referred to as critical accounting policies or key
accounting policies. It is these areas where management’s estimates are most
subjective and essentially uncertain.
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Liquidity and Financial Resources
Managers can utilize many areas of earnings management to maneuver costs. It
is important to focus on analyzing the amount of information associated with costs.
The ability to locate reported expenses, liabilities, and assets with ease, along with
detailed facts and discussions/explanations of managers’ decisions is referred to as
transparent financial reporting. This gives us the most “true and fair” picture of the
firms positions and operating performance. (Healy)
Cost of Goods Sold includes cost of inventory sold, freight charges, advertising
and all merchandise/inventory expenses including purchasing costs, and distribution
costs. The largest of all costs on the income statement, cost of goods sold, is the
benchmark for establishing aggressive or conservative accounting within a low margin
industry such as this. The main concern is to keep costs low, reduce expenses,
reporting the highest net income. This is typically accomplished through the use of
economies of scale. Increasing sales to generate growth striving to control the largest
possible market share. Managers can help this process with many different accounting
tricks. The conservative, or lack thereof, reporting of expenses and the aggressive
reporting of sales will drive the highest reported net income that translates into
company value.
Depreciation, basically, is an expense that shows the using up of an asset over
its useful life. It is computed on the straight line method giving an equal expense each
year for an asset. Depreciation can be a greatly manipulated number. One year more
or less in computation can decrease or add expense. Again, management estimates
that can be used to boost suppress earnings. These cost manipulations are most
common and cleverly hidden by managers. Financial manipulation has the highest
degree of accounting flexibility.
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Impairments
Impairments or “write-offs,” are the accounting entries associated with
calculated loss of value from a given asset. Impairments represent a highly
manipulative accounting tool. Companies leave these devalued assets on the books,
and impairment charges are purposely not taken, as an instrument to keep perceived
value high, or to disguise poor performance.
Poor performing stores generally lead to lower cash flows. If these stores fail to
produce adequate cash flows, impairment charges on long term assets could be taken.
Based on market location, and with the help of local real estate brokers, Safeway
estimates future cash flows for several years out. If these net future cash flows are
less than the assets carrying values, then Safeway will recognize impairment losses.
Impairments have the ability to highly manipulated and so this is an area of high
accounting flexibility
Projected poor performance due to economic conditions and/or numerous other
internal/external factors, sometimes force the closings of stores. Most of these stores
are under long-term leases and if one closes, Safeway records a liability form the future
minimum lease payments. Due to set lease amount, future minimum lease payment
liability should be pretty accurate. However, managers tend to not report all costs
associated with the closings. Again there is a higher degree of flexibility.
Goodwill is the excess amount paid over the fair market value of an asset.
Companies may build goodwill until it is determined the original acquisition has fallen
below the purchase price. Goodwill was required to be amortized but now only when
management deems the asset purchased has lost value beyond the purchase price. It
is only then can they estimate loss of value to “write off,” a portion of the assets loss of
value. The fact that managers have complete discretion about when to impair an asset
or let goodwill continue to build up is another example of high degree flexible
accounting.
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Guarantees
Guarantees are contractual obligations the company must meet. These are
typically commercial holdings and real estate contracts, including operating leases.
Operating leases are an example of off balance sheet manipulation. The largest portion
of off balance sheet debt is in operating leases. Off the balance sheet practices are
accounting distortions which keep, typically very large, liabilities and assets off the firms
“books.” The main accounting goal is to keep expenses much lower in order to keep
earnings higher to make the company look much more valuable. It is also used to
lower the risk companies are exposed to with certain assets and liabilities. Operating
leases are treated as rental properties and all rights are transferred but no ownership
change occurs. This is done for the sole purpose of keeping large liabilities off the
financial statements. The building is treated as an operating expense on the income
statement and never placed on the balance sheet. Keeping this liability hidden gives
the company a much higher value.
Capital leases are considered financial debt contracts and area typically used if
firms are using the asset for long periods of time. It the financing of the asset over a
period of time with ownership rights transferring to the purchaser. The asset
purchased is immediately recorded by the present value of all future payments. Since it
is an asset, depreciation and interest expense are recorded throughout the life of the
asset providing tax benefits. Using operating leases vs. capital leases gives Safeway a
high degree of accounting flexibility in this area.
Workers Compensation
Workers compensation is benefits paid by companies to cover medical costs or
lost wages to employees that are hurt while on the job. These benefits are monetary
compensation given by the companies in exchange for the rights of the employee to
sue the employer. Projections of losses for companies are common in creating
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insurance liability costs. Extreme variability in these estimates can be caused by
numerous external factors. Safeway uses area demographics, number of claims in
previous years, claims actually filed, and approximates claims incurred but not filed to
calculate and estimate its recorded insurance liability. Due to the high variability from
projected numbers this is another area of high accounting flexibility.
Employee Benefit Plan
Defined-benefit pension is a plan where benefits are usually based on a worker’s
past salary or specific amount for each year of service. The scale of these plans makes
this one of the most easily manipulated areas of earnings management. Large market
companies typically deal with pension benefit obligations in the billions. Many of the
calculations performed in the determination of the obligation and expense are
assumptions of the managers. One key assumption made is the discount rate. This is
the rate of return that is anticipated for the plans assets. Changes in the discount rate
can have considerable impact benefit plans. Raising the discount rate would lower the
present value of the obligation and would lower the pension expense. Mangers can
raise their estimated discount rate, lowering the company’s overall obligation and by
lowering expenses by millions of dollars. This would raise the appearance of value of
the company by raising earnings. Another manipulated area is estimating the
obligations themselves. Guesstimates on how long people will work, how long people
will live, future wage rates and benefits all are approximated. There is such a wide
scope of manager speculation that this is considered a high degree of accounting
flexibility.
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Actual Accounting Strategy
Once again, firms have flexibility when choosing their accounting estimates,
accounting policies, and the level of disclosure they give. Companies can either abuse
this flexibility by being vague in their disclosing of information, or they can provide
investors with more specific information that is not manipulated. When analyzing a
business it is vital to know whether a firm uses conservative or aggressive accounting,
and to evaluate how much information a company is actually disclosing. Determining
these factors will aid in assessing a firm’s actual accounting strategy.
Post-Retirement Benefit Plan
Safeway operates a “Defined Benefits Retirement Plan”. These future obligations
to employees are shown on the balance sheet under long term liabilities. Safeway
helps analysis by disclosing a lot of information about the future liabilities it faces. The
discount rate used is supported by a myriad of information and logic. For example
Safeway estimates its growth rate of the current assets allocated to the fund by
diversifying a portfolio based on the S&P 500 and the bond markets. In the 10K
Safeway discloses the amount of assets in equity markets, US exchanges, at around
65%. This allocation might seem high, but when compared to Supervalu’s allocation.
Supervalu’s discount rate is calculated similar to Safeway’s with the exception of the
equity market choice and target allocation. Supervalu uses a Global Equity markets
which historically have greater volatility than the S&P 500. The target percentage of
assets allocated to the equity portion of Supervalu’s portfolio is 70%, compared to
Safeway’s 65%. The higher percentage of funds in riskier markets and the choice to
take a global outlook makes Supervalu’s portfolio riskier. The more risk taken by the
firm means it can assume a higher annual discount rate. Both of these firms however
might seem to be taking extra risk when compared to Kroger’s allocation of funds; they
assumed a discount rate based on a broad-market AA yield curve constructed by an
outside consultant (Kroger 10K). They annually have discount rates higher than most
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of the competitors but don’t explain fully why other than referring to an outside
consultant.
The table below shows the discount rates used to find the current liabilities of
“Defined Benefits Retirement Plans” for three competitors. Wal-Mart uses a “Defined
Contribution Plan”. According to Whole Foods, “The Company uses a combination of
insurance and self-insurance plans to provide for the potential liabilities for workers'
compensation…” (Whole Foods 10K). Both of these companies do not use discount
rates to guess the present value of future obligations.
Competitors with “Defined Benefits Retirement Plans”
2007 2006 2005 2004 2003
Safeway 5.90% 5.70% 5.50% 5.80% 6.00%
Supervalu 5.85% 6.00% 6.25% 7.00% 7.25%
Kroger 6.50% 5.90% 5.70% 5.75% 6.25%
The industry has shown a rates ranging from 7.25% to 5.50% over the past five
years. Safeway has shown a range of 6.00% in 2003 to 5.50% in 2005. The gradual
change of the discount rate mirrors Kroger’s change but stands in contrast to
Supervalu’s change from 7.25% to 5.85%, most notably a whole 750 basis points drop
from 2004 to 2005. Safeway and Kroger increases and decreases mirror each other,
demonstrating an industry wide change in the estimation of benefits or changes in the
market place. These changes are based on the portfolio allocation discussed earlier.
The fact Safeway has kept its discount rate below that of its competitors
demonstrates management’s ability to show a higher present value of future cash flows
on its balance sheet.
Safeway follows the GAAP when accounting for “Defined Benefits and Retirement
Plans”. According to the Safeway 10K, “Financial statements are prepared in
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accordance with accounting principles generally accepted in the United States. They are
subject to interpretation by various governing bodies, including the Financial Accounting
Standards Board (“FASB”) and the SEC, which create and interpret accounting
standards.” Safeway goes beyond just explaining the discount rate and provides full
discloser into what kinds of assets its pension plan fund is being placed into. For
example the 65% of equity it holds in its portfolio is only companies inside the US; its
competitor Supervalu invests 70% of its equity in global markets. Because of the
relative conservatism of its investments and the amount of discloser present in the 10K
in our opinion Safeway is demonstrating conservative accounting principles when
accounting for its “Defined Benefits and Retirement Plan”.
Capital Leases vs. Operating Leases
Managers utilize accounting flexibility in either one of two ways. They will
communicate transparent financial reports with clear, concise, unambiguous data. Or
they will conceal, hide, and manipulate data using pro-forma charts with minimal
discussions, only reporting the least amount of information that is required by GAAP.
They will either apply aggressive accounting policies to generate higher reported
earnings or exploit conservative accounting policies to generate lower reported
earnings. Initial data analysis from evaluating Safeway’s and its competitors’ 10-Ks
suggest a high level of disclosure. There is little segmentation, few pro forma charts,
and many footnotes assist questionable computations.
Safeway uses an aggressive strategy when comes to the accounting of its
operating leases. Safeway keeps earnings high by keeping a large portion of debt “off
the balance sheet.” Five billion in minimum lease payments is what has been calculated
to be the present value of all future minimum lease payments. This is a substantial
amount constituting 46% of total liabilities. Capitalizing these leases would obviously
have a significant impact on value. Comparatively, Safeway has a much higher
percentage of total lease payments to total liabilities to the other firms in the industry
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(excluding Wal-Mart due to its sheer size). This is due mainly to the fact that it does
not carry as much total liabilities as the other firms. All comparative firms carry
operating leases of the same magnitude as Safeway. Dramatic impact to value would
occur to all firms if operating leases were capitalized.
Conclusion
When effectively performing an accounting analysis, it is essential to assess the
actual accounting strategy companies apply to their flexible policies. It is important to
also assess how much information the firm discloses and if conservative or aggressive
accounting is being used. The degree of disclosure Safeway provides is better than
sufficient concerning their post-retirement benefit plan and use of operating leases. The
bulk of Safeway’s flexibility is in their choices to use operating versus capital leases as
well as the discount rate that decides their benefit responsibilities. In terms of these
two accounting policies (especially operating leases), Safeway uses aggressive
accounting strategies.
Disclosure Quality
Safeway, Inc. has a mandatory obligation to disclose certain information in their
accounting reports. The quality of disclosure is important to understand the accounting
reports in Safeway’s 10-K and verify the information is correct. The obligations to
correctly disclose certain information in the 10-K of Safeway falls on the managers.
However, managers have some leeway in how to disclose certain information and what
type of methods they use to determine what is in the 10-K. If the managers properly
disclose all information fully and to the best of their ability, investors will have a better
understanding about the overall company’s financial situation. Safeway, Inc. discloses
certain information that is vital in analyzing and understanding their financial
statements.
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Qualitative Analysis
Defined Benefit Plan
Safeway goes above and beyond the standard 10K’s discloser of defined benefits
plan. In an industry were speculation about the present value of the long term liability
can make or break a companies’ balance sheet it is imperative they disclose as much
information as possible. Other competitors, at least those who have defined benefit
plans, also disclose the appropriate information. It is very important to disclose how
defined benefit plans are calculated since they represent a large portion of the long
term liabilities.
Also inside the 10K Safeway addresses the subject of collective bargaining
agreements and the importance of the defined benefit plans. They are subject to 400
collective bargaining agreements with 102 scheduled to expire in 2008, 38% of union-
affiliated employees. Safeway acknowledges “In future negotiations with labor unions,
we expect that rising health care, pension and employee benefit costs, among other
issues, will be important topics for negotiation. If, upon the expiration of such
collective bargaining agreements, we are unable to negotiate acceptable contracts with
labor unions, it could result in strikes by the affected workers and thereby significantly
disrupt our operations. Further, if we are unable to control health care and pension
costs provided for in the collective bargaining agreements, we may experience
increased operating costs and an adverse impact on future results of operations.”
It is management’s best interest to disclose as much information as possible
about the post retirement obligations to keep employee’s informed and happy. If
anything it is advantageous to show a large current liability so union’s have less
bargaining power at the negotiation tables.
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Analysis of Pension Discount Rate
Safeway uses a market portfolio to estimate the discount rate. An allocation
targets of 65% and 35% for US equity markets and fixed income investments
respectively. The company finds a weighted average of these the investments and
comes up with a discount rate. Safeway understands the nature of estimating pension
obligations. According to the 10K, “We estimate the liabilities associated with the risks
retained by us, in part, by considering historical claims experience, demographic and
severity factors and other actuarial assumptions which, by their nature, are subject to a
high degree of variability.” (Safeway 10K) The table below shows the retirement plans’
benefit obligation and fair value of assets over the two-year period. 2007 2006 Change in projected benefit obligation:
Beginning balance $ 2,181.6 $ 2,110.1 Service cost 93.2 101.1 Interest cost 124.8 129.3 Plan amendments 8.8 29.7 Actuarial gain (7.0) (40.0)Benefit payments (148.4) (143.8)Currency translation adjustment 89.0 (4.8)
Ending balance $ 2,342.0 $ 2,181.6 2007 2006 Change in fair value of plan assets:
Beginning balance $ 2,214.7 $ 2,102.8 Actual return on plan assets 120.0 235.1 Employer contributions 33.8 25.0 Benefit payments (148.4) (143.8)Currency translation adjustment 75.5 (4.4)
Ending balance $ 2,295.6 $ 2,214.7 *Information from Safeway 10-K
Safeway discloses an ample share of information to back up its choice of a discount
rate.
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Inventory Disclosure
In the grocery retail industry, inventory valuation is an extremely important
factor to look at. Managers can have an immense impact on their company’s cash flows
by means of the accounting choices they choose to use in valuing their company’s
inventory. A firm’s true inventory value can be manipulated through the use of many
inventory valuation techniques.
Firms use LIFO (last in first out) and FIFO (first in first out) inventory accounting
techniques to demonstrate procedures regarding inventory in the grocery retail industry
(SFW-10K 2008). When analyzing the quality of inventory accounting disclosure, LIFO
and FIFO techniques are not significant. The division of Safeway’s inventory into
sections or groups is not viewable in its 10-K. Therefore, the system Safeway uses to
determine their inventory is very vaguely disclosed.
We can calculate Safeway’s inventory turnover ratio by dividing their cost of
goods sold by average inventory on hand. The inventory turnover ratio shows how
many times a company’s inventory is sold and replaced over a period. This ratio should
be compared against industry averages. A low turnover implies poor sales and,
therefore, excess inventory. A high ratio implies either strong sales or ineffective buying
(www.investopedia.com). Safeway has a steadily growing inventory turnover rate. This
is a good thing because it displays that Safeway’s money spent on inventory is
reimbursed quickly. This also shows a well-organized and working cash to cash cycle.
Safeway does not display detailed information regarding their actions in terms of their
inventory operations in their 10-K.
Ratio Analysis
According to investopedia.com, ratio analysis is a tool used by analysts to
conduct a quantitative analysis of information in a company’s financial statements.
Safeway, INC. has a cost of goods sold amount of 30,133.1 (in millions) in 2007. Also
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in 2007, Safeway, INC. had total sales and other revenue amount of $42,286.0 (in
millions) and total inventory in the amount of $264.6 (in millions) according to the 10-K.
Safeway, Inc. needs to ensure that they are utilizing inventory to the best of
their ability cut down on costs and stay ahead of competitors in the retail grocery
industry. The company takes a physical count of perishable inventory in stores every
four weeks and nonperishable inventory in stores and all distribution centers twice a
year. It is crucial for Safeway, Inc. to demonstrate good management of inventory to
minimize loss of perishable which will ultimately lose the company money. By taking a
physical count of inventory on a schedule explained above, Safeway, Inc. is taking great
strides in making the company better than their competitors.
Inventory Method Analysis
Inventory is a vital component in insuring a grocery store succeeds. If a grocery
store does not have a process in place to ensure placement of inventory where it needs
to be, the company could fail. According to Hoovers.com, inventory management is
very important to grocery retailers, both for efficiency and to identify products that are
selling well or poorly. To track inventory and sales, supermarkets and grocery stores
use computer technology such as scanners, and sophisticated point-of-sale, inventory,
and reorder systems, extensively (hoovers.com). Just like many of Safeway’s
competitors, they do not disclose what their inventory methods are except for how
often they take inventory throughout the year. As explained earlier, Safeway takes
perishable inventory in stores every four weeks and nonperishable inventory in stores
and distribution centers twice a year. This ensures that they keep up-to-date records
on what comes through the stores. For Safeway to keep costs low and ensure
inventory methods that has high standards, Safeway has 13 distribution/warehouses in
the United States and 4 in Canada which provides the majority of products to stores
operated by the Company (Safeway.com fact book 2007). This increases the possibility
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that Safeway will be able to sufficiently better serve their customer base while also
keeping costs low and increase efficiency throughout the entire company.
Quantitative Analysis of Disclosure
The managers in a firm can make many flexibly choices when making decisions
on how they want their company to “appear”. GAAP (Generally Accepted Accounting
Principles) allow for this flexibility so that managers can display a better picture of the
true (underlying) value of the business to investors. However, the trade-off is that
managers also have incentives to manipulate the books to appear more profitable by
abusing this flexibility in GAAP. This is why it is important to analyze a business’s
financials to see and possibly reconfigure what is truly happening in the company.
In order to analyze a firm’s conclusions it is imperative to consider Sales
Manipulation Diagnostic Ratios and Expense Manipulation Diagnostic Ratios. Sales
Manipulation Diagnostic Ratios asses a company’s sales in terms of what is going on
with warranty liabilities, inventories, accounts receivable, and unearned revenues. If
there are any abnormal findings in these ratios (numbers that are increasing or
decreasing very noticeably and don’t follow industry trends), then a firm may have
manipulated their books to appear more profitable to investors. Expense Manipulation
Diagnostic Ratio analysis looks into asset turnover, accruals, and expenses over a
period of time to make sure that deceptive actions haven’t taken place.
Any irregularities in these ratios (sales or expense) can display assumptions of
possible manipulations by managers of that firm. Managers want their company to
appear profitable as well as meet their goals. This is not always possible, so managers
sometimes “meet” their goals or keep the negatives off the books by abusing GAAP
flexibility. This is why it is important, once again, to analyze these ratios (and the
business as a whole).
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Sales Manipulation Diagnostic
It is possible for managers to distort or manipulate the view of their firm’s sales.
In order to check for this possibility we computed some key sales manipulation
diagnostic ratios. We used Safeway and its competitor’s financial statements (balance
sheet and income statement) to compute the sales manipulation diagnostic ratios for
the past five years in the industry. By using these ratios, we plan to analyze the
possibility of Safeway manipulating accounting numbers by comparing their ratio results
to the retail grocery industry (we are checking for potential red flags).
Net Sales/ Cash from Sales
Safeway and the rest of the retail grocery industry have net sales to cash from
sales ratio close to one (1:1). This is because the retail grocery industry runs on a cash
basis. This means that when people go to the grocery store, they buy their groceries
with cash (or purchase with credit or debit, which is treated the same as cash). The Net
Sales/ Cash from Sales ratio computation show what is really being received within the
accrual time period. Since the retail grocery industry is on a mainly cash basis, this ratio
is always close to one. The retail grocery industry doesn’t really have to worry about
customer defaulting or not making payments. Therefore is not a relevant ratio in the
retail grocery industry.
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Net Sales/ Accounts Receivable
Net Sales / Receivables
0.00
50.00
100.00
150.00
200.00
250.00
2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal Mart
The net sales/ accounts receivable ratio aides in measuring how much of a
company’s sales are truly credit transactions. Sales on credit are low in the retail
grocery industry. This is because the industry runs on a cash basis due to the fact that
customers by their groceries with cash. Low net sales/ accounts receivables ratios are
positive because it is a good thing to have a low amount of receivables.
The chart above displays Safeway and its competitors’ net sales/ accounts
receivables over the past five years. Safeway follows the industry trend for this ratio
and therefore doesn’t show any unexplained activity. The only company that does not
follow the industry trend is Wal-Mart. They have a larger increase for 2003 to 2004, but
then level down again from 2004 to 2005. Wal-Mart also sells more products than just
groceries (for instance televisions) which is why they have a larger amount of
receivables.
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Net Sales/ Inventory
Net Sales / Inventory
0.00
5.00
10.00
15.00
20.00
25.00
30.00
2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal Mart
The chart above displays the display that Safeway and the other firms in the
industry have shown consistency in their Net Sales to Inventory ratios over the past five
years. The inventory turnover ratio tells us that companies in the grocery retail industry
are maintaining enough in inventory to support the flow of sales. Sales can fluctuate in
a business that sells a lot of products like groceries. If sales drastically increase, then a
store must be able to have inventory to back up its sales. On the other hand, if their
sales decrease then an overstock of inventory can result. The graph above shows that
Safeway is following the industry trend of maintaining sufficient inventory levels that
support their sales. This probably means that the industry as a whole is being efficient
in using their inventories to help maximize their revenues.
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Net Sales/Unearned Revenue
In the retail grocery industry, revenue is earned when the transaction takes
place (groceries are bought on a cash basis). Therefore this ratio isn’t significant in the
retail grocery industry. In some industries managers can manipulate the books by
recognizing unearned revenues to soon (before payments are received) to increase
their net overall net income. This ratio is a good tool to use when analyzing many firms
revenue (and net income). However it is irrelevant in the retail grocery industry.
Net Sales/ Warranty Liabilities
The ratio of net sales to warranty liabilities is not applicable to the grocery retail
industry. All products in this industry are covered by the manufacturer’s warranties
which leave firms in the grocery retail industry free of that liability. So firms in this
industry do not give out company warranties on their products or services.
Conclusion
After analyzing Safeway using the sales manipulation diagnostic ratios, we did
not find any red flags which would show possible sales manipulations. We noticed that
Safeway is also performing average or better in respect to the retail grocery industry.
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Sales Manipulation Diagnostics
Safeway
SWY 2003 2004 2005 2006 2007
Net Sales / Cash from Sales 1.00 1.00 1.00 0.99 0.99 Net Sales / Receivables 93.23 105.67 109.57 87.13 73.17 Net Sales / Inventory 13.52 13.07 13.89 15.21 15.11 Net Sales / Unearned Revenue N/A N/A N/A N/A N/A Net Sales / Warranty Liability N/A N/A N/A N/A N/A
Kroger
KR Net Sales / Cash from Sales 0.99 1.00 1.00 1.00 0.99 Net Sales / Receivables 76.45 79.81 85.38 89.05 85.53 Net Sales / Inventory 11.59 11.97 11.93 12.39 13.07 Net Sales / Unearned Revenue N/A N/A N/A N/A N/A Net Sales / Warranty Liability N/A N/A N/A N/A N/A
SuperVALU
SVU Net Sales / Cash from Sales 1.00 1.00 1.00 1.00 1.00 Net Sales / Receivables 40.17 45.11 41.67 45.25 39.09 Net Sales / Inventory 18.27 18.75 18.94 20.82 13.61 Net Sales / Unearned Revenue N/A N/A N/A N/A N/A Net Sales / Warranty Liability N/A N/A N/A N/A N/A
Whole Foods
WFMI Net Sales / Cash from Sales 0.99 0.99 0.99 0.99 0.99 Net Sales / Receivables 68.45 59.46 70.17 68.38 62.78 Net Sales / Inventory 25.39 25.26 26.86 27.49 22.89 Net Sales / Unearned Revenue N/A N/A N/A N/A N/A Net Sales / Warranty Liability N/A N/A N/A N/A N/A
Wal Mart WMT
Net Sales / Cash from Sales 0.99 0.01 0.99 0.99 0.99 Net Sales / Receivables 146.35 204.41 164.13 119.98 121.48 Net Sales / Inventory 9.41 9.63 9.46 9.68 10.24 Net Sales / Unearned Revenue N/A N/A N/A N/A N/A Net Sales / Warranty Liability N/A N/A N/A N/A N/A
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Expense Manipulation Diagnostic
Expense manipulation diagnostics are ratios we used to try and find any
accounting expense distortions. We computed these ratios for Safeway and its
competitors in the retail grocery industry for the past five years. We then look for
industry trends and to see if a company has if a company deviates from the industry.
When a company deviates from the industry, we examine the situation for possible
accounting expense manipulation.
Asset Turnover
The asset turnover ratio is computed by dividing net sales by total assets. A
company’s asset turnover shows if the firm’s total assets support their net sales. This
ratio should usually be consistent and fairly flat. This is because companies will attain
more assets as their sales increase. The graph below displays Safeway and its
competitors’ asset turnover over the past five years.
Asset Turnover
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal Mart
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Safeway’s asset turnover has remained consistent and stable over the past five
years. Supervalu had an extreme drop between 2005 and 2006. This may be because
they could have purchased a lot of new stores (assets) and sales haven’t been able to
increase relative to the amount invested in new assets yet. Whole Foods may have
experienced something similar to this also in 2006. However, Safeway, Wal-Mart and
Kroger have managed to maintain a stable asset turnover and haven’t deviated much
from the industry average.
Operating Cash Flow / Operating Income
The chart below of operating cash flow / operating income illustrates the
relationship between cash generated by operations and operating income. Logic would
tell you if operating cash flows increase it would be followed by operating income,
however since operating income is an accrual accounting concept this number can be
distorted by recognizing expenses
Changes in CFFO / OI
-10.00-8.00-6.00-4.00-2.000.002.004.006.008.00
10.00
2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal Mart
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If a company wants to recognize more expenses to shrink the operating income
for the period the ratio will increase. Any increases in the ratio does not mean
management has recognized extra expenses it simply means the operating income
decreased or stayed constant relative to the operating cash flows. In the retail grocery
industry cash flows are very important and not easily manipulated because the profit
margins are so low.
As you can see from the chart Safeway has seen a dramatic drop in the ratio
which might suggests management has either improved operating income recognition
or expenses are not being recognized as readily as before. In layman’s terms why
would operating income be increasing more rapidly than operating cash flows?
There could be many explanations like accounts receivables have become more
efficient. The industry seems to be following the same trend, lead by Kroger who has
seen the greatest percent change the past few years.
Operating Cash Flow / Net Operating Assets
In order to see how well plant, property and equipment are sustaining income,
we looked at Safeway and its competitors’ change in cash flow from operations to net
operating assets ratio. If this ratio is high then added fixed assets are attaining a higher
return. This ratio shows how well a firm uses its equipment to generate money.
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Changes in CFFO / NOA
-20.00
-15.00
-10.00
-5.00
0.00
5.00
2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal Mart
Safeway has expensed a majority of its leases, keeping them off the assets
portion of the balance sheet. Essentially Safeway is hiding a large amount of money
from the denominator of this ratio, artificially making it much larger than it should be
assuming operating cash flows is a real number. By taking on more operating leases,
allowing Safeway to expense them annually, they are creating a higher ratio making it
seem they are more efficient at producing cash flows than they actually are.
Most of the industry also has large operating lease obligations compared to their
capital lease obligations. The table bellow shows the estimated operating and capital
lease agreements of Safeway and its competitors for the physical year 2009. The below
table is in millions of dollars.
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Capital Operating Total % Operating
Wal-Mart $5,997 $13,759 $19,756 69.64%
Kroger $53 $736 $789 93.28%
Supervalu $154 $4,380 $4,534 96.60%
Safeway $42.9 $410.4 $453.3 90.54%
Information pulled from 2008 10K’s of companies
Over 90% of the lease obligations in the retail grocery industry are operating
leases, with the exception of Wal-Mart. This practice allows the managers to keep
liabilities and the corresponding assets off the balance sheet. It also distorts the
operating cash flows/net operating assets chart skewing it up wards.
Total Accruals / Changes in Sales
The diagram below shows the relationship between total accruals and changes in
sales for Safeway and its competitors over the last five years. The relationship between
total accruals and changes in sales shows how accruals match the company’s income.
The operating cash flow is subtracted from the net income and divided by the
company’s sales change. Growth in net income and cash flows from operations should
also be consistent with growth in revenue.
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Total Accruals / Change in Sales
-7.00-6.00-5.00-4.00-3.00-2.00-1.000.001.002.003.004.00
2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal Mart
Safeway’s total accruals/ change in sales ratio has been steady over the past 5
years. Even though Safeway has shown a positive sales growth the ratio has not
jumped drastically. This means that Safeway has maintained consistent levels of growth
in net income, cash flows from operations and sales. This may allude to the fact
Safeway has grown its sales through internal activities. The only company in the
industry showing much volatility from the industry norm is Supervalu. They have a
drastic increase from 2003 to 2004, then a drastic decrease from 2004 to 2005,
followed by another drastic increase from 2006 to 2007.
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Pension / SG&A
Pension / S G & A Expense
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
2003 2004 2005 2006 2007
Safeway Kroger SuperVALU
Caution should be used when comparing the industries selling, general and
administrative expenses since not all the firms in the industry account for employee
benefits the same way. Safeway and Kroger have defined benefit plans while Wal-Mart
has a contribution plan. Wal-Mart pay’s as it goes while Safeway buffers the future
costs by allowing assets to grow at a stated market rate discussed earlier in the
analysis. However, pension plan expenses are constantly changing from year to year.
As the ratio drops the companies are paying more expenses for SG&A and less on the
pension expense. As the ratio inclines the companies are spending more money on
pensions. Due to the constant changing of these pension plans from year to year, this
ratio is not consistent when analyzing possible expense distortion. This ratio is not
significant in the retail grocery industry for this reason.
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Conclusion
In our expense diagnostic ratio analysis, we did not find any evidence that
Safeway tried to manipulate their expenses to understate or overstate net income.
Safeway is performing at right about the industry average by analysis of these expense
diagnostic ratios.
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Expense Manipulation Diagnostic
Safeway
SWY 2003 2004 2005 2006 2007
Asset Turnover 2.37 2.33 2.44 2.47 2.40
Changes in CFFO / OI 1.14 1.03 -8.24 0.76 0.09
Changes in CFFO / NOA -0.58 0.61 -0.32 0.19 0.01
Total Accruals / Change in Sales 0.32 -0.58 0.35 0.33 0.42
Pension Expense / SG&A 0.01 0.01 0.02 0.02 0.03
Other Employment Expenses / SG&A N/A N/A N/A N/A N/A
Kroger KR
Asset Turnover 2.59 2.75 2.96 3.12 3.15
Changes in CFFO / OI 0.79 -0.23 -0.12 0.79 3.54
Changes in CFFO / NOA -0.97 0.15 -0.24 0.13 0.16
Total Accruals / Change in Sales -0.95 -0.92 -0.30 -0.22 -0.34
Pension Expense / SG&A 0.14 0.18 0.20 0.21 0.20
Other Employment Expenses / SG&A N/A N/A N/A N/A N/A
SuperVALU SVU
Asset Turnover 3.28 3.11 3.23 1.72 2.09
Changes in CFFO / OI 8.37 -0.40 0.38 0.12 2.46
Changes in CFFO / NOA -4.75 -0.24 -1.46 0.01 -18.62
Total Accruals / Change in Sales -1.68 3.19 -5.64 -0.12 -0.35
Pension Expense / SG&A 0.25 0.28 0.31 0.08 0.05
Other Employment Expenses / SG&A N/A N/A N/A N/A N/A
Whole Foods WFMI
Asset Turnover 2.56 2.54 2.49 2.74 2.05
Changes in CFFO / OI 1.48 0.94 6.15 0.47 2.51
Changes in CFFO / NOA 0.17 0.25 0.30 0.14 -0.10
Total Accruals / Change in Sales -0.40 -0.28 -0.33 -0.27 -0.22
Pension Expense / SG&A N/A N/A N/A N/A N/A
Other Employment Expenses / SG&A N/A N/A N/A N/A N/A
Wal Mart WMT
Asset Turnover 2.43 2.34 2.24 2.28 2.29
Changes in CFFO / OI 1.73 -0.42 2.26 0.96 0.27
Changes in CFFO / NOA 0.29 -0.08 0.26 0.12 0.03
Total Accruals / Change in Sales -0.27 -0.19 -0.26 -0.24 -0.26
Pension Expense / SG&A N/A N/A N/A N/A N/A
Other Employment Expenses / SG&A N/A N/A N/A N/A N/A
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Potential Red Flags
The fifth step in the accounting analysis is identifying potential red flags. Red
flags suggest the possibility that specific items should be analyzed more carefully
because something doesn’t look normal or right in the data. It is important for investors
to analyze the accounting methods a company uses in order to check numbers that
may have been manipulated. Managers may manipulate their company’s numbers in
order to appear more profitable to investors. The sales and expense manipulation
diagnostic ratios computed earlier are important numbers to assess for red flags. It is
extremely important to identify red flags in order to get a more honest picture of the
company.
Diagnostic Ratios
The expense and sales diagnostic ratios for Safeway have been analyzed and
some conclusions have been drawn. Safeway’s CFFO/ OI ratio showed inconsistency
amongst industry standards and led to a deeper research within the company’s 10-K to
ensure that there were no irregularities with their accounting. Analyzing the balance
sheet produced support to show that this wasn’t an accounting irregularity. Safeway
amortized a large portion of its good will over a three year period, which resulting in the
abnormally low diagnostic. This shows that they were willing to take a hit on their value
in order for a future benefit.
It would be difficult for a company in the retail grocery industry to have distorted
sales diagnostic ratios. This is because customers purchase products on a cash basis,
and items are marked sold as they are scanned. The expenses are the major factor to
look into for most manipulations in the grocery retail industry.
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Operating Leases
Safeway has about five billion in operating leases which represents 46% of its
total liabilities. This definitely represents a significant distortion of the true accounting
picture. These costs represent hugely understated assets and liabilities, which once
corrected will significantly alter the overall financials of this firm. Even though there is
a noteworthy distortion within the accounting policies, if you compare this to the
industry, it would be considered quite normal. Safeway has one of the lower
percentages of operating leases, compared to total liabilities, within the industry. So as
an industry comparison, Safeway’s accounting numbers are considered standard.
Defined Benefit Plans
Defined benefit plans are a large liability for firms, especially those competing in
a competitive market. The behavior with which a firm operates and addresses its
defined benefit should be clear to investors. Any aggressive account could result in
large swings in the present value of the future obligations. The liability can potentially
be a large red flag for investors. If Safeway does something out of the ordinary with its
discount rate it must disclose the change in its 10-K or investors should be wary of any
changes in expenses or revenues. Because of the logical construction of the discount
rate and the information annually found within the 10-K Safeway seems to handle their
defined benefit plan responsibly. Also Safeway is subject to 400 collective bargaining
agreements with unions. If the plan begins to show any abnormalities the issue will
surely be addressed by the union leaders, indirectly helping investors. Investors should
have confidence Safeway’s defined benefit plans are not being distorted for accounting
purposes; the costs of distortion are simply too high.
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Conclusion
Safeway does a good job of disclosing most of their key accounting policies to
potential investors. However, they do have a few red flags. The red flag discovered that
is of highest concern is their operating leases. Safeway’s operating leases drastically
understate their liabilities. This off-balance sheet financing causes them to appear more
profitable to investors. It is important to analyze a business’s manipulation diagnostic
ratios to look for potential red flags that may cause distorted information that is
deceiving to investors.
Undo Accounting Distortion
Once accounting distortions are found the final step is to restate the financial
statements as if the distortions where not present. A firm can use a number of
methods to artificially inflate the financial statements theses need to be removed to get
a good picture of the company.
After further analysis it has been concluded Safeway used off balance sheet
financing by using operating leases when capital leases should have been used. This
aggressive use of accounting has understated the liabilities of Safeway and made the
company look much less indebt than it currently admits. This is an interesting find
because the company actually addresses the topic of “Substantial Indebtedness” in its
10-K. According to the 2008 10-K, We currently have, and expect to continue to have,
a significant amount of debt, which could adversely affect our financial health… This
substantial indebtedness could increase our vulnerability to general adverse economic
and industry conditions. If debt markets do not permit us to refinance certain maturing
debt… we may be required to… reducing the availability of our cash flow to fund
working capital, capital expenditures, acquisitions, development efforts and other
general corporate purposes.” (Safeway 10-K) Safeway has also been upgraded from a
BBB rating by Fitch, who also revised its outlook to stable from negative. On July 23,
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2007, S&P affirmed the Company’s BBB-credit rating and revised its outlook to positive
from stable. (10-K)
Over the past few years the company has been under a lot of pressure from
creditors to improve the financial statements. In an industry where changing capital
leases to operating leases are common Safeway has accepted a way to increase its
credit ratings. However the amount of operating leases the company holds is in well
excess of the 10% of current liabilities which automatically leads us to assume the
company should have capitalized its lease obligations. It seems the company is trying
to appear more valuable to potential investors by using this aggressive accounting
strategy (off-balance sheet financing). We have restated Safeway’s income statement
and balance sheet in detail to show the underlying truth of their financial situation.
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INCOME STATEMENT (Restated) 52 Weeks 53 Weeks 52 Weeks 52 Weeks 52 Weeks 52 Weeks
(In millions, except per-share amounts) 2002 2003 2004 2005 2006 2007
Sales $34,767.50 $35,552.70 $35,822.90 $38,416.00 $40,185.00 $42,286.00
Cost of goods sold ($23,955.50) ($25,018.90) ($25,227.60) ($27,303.10) ($28,604.00) ($30,133.10)
Gross profit $10,812.00 $10,533.80 $10,595.30 $11,112.90 $11,581.00 $12,152.90
Operating and administrative expense ($8,576.40) ($9,230.80) ($9,422.50) ($9,898.20) ($9,981.20) ($10,380.80)
===>PROVISION FOR LESE PAYMENT<=== $342.00 $400.00 $406.00 $426.00 $425.00 $452.00Operating and administrative expense (ADJ) ($8,234.40) ($8,830.80) ($9,016.50) ($9,472.20) ($9,556.20) ($9,928.80)
Impairment charge ($1,288.00) ($729.10)
Goodwill amortization
===>PROVISION FOR DEPRECIATION<=== ($173.44) ($202.00) ($198.86) ($197.82) ($199.31) ($228.66)Operating profit (ADJ) $1,116.16 $771.90 $1,379.94 $1,442.88 $1,825.49 $1,995.44
Operating profit $947.60 $573.90 $1,172.80 $1,214.70 $1,599.80 $1,772.10
Interest expense ($430.80) ($442.40) ($411.20) ($402.60) ($396.10) ($388.90)
===>PROVISION FOR INTEREST<=== ($225.47) ($262.60) ($258.51) ($257.16) ($259.11) ($252.66)
Other income net $15.50 $9.60 $32.30 $36.90 $36.30 $20.40
Income before income taxes $532.30 $141.10 $793.90 $849.00 $1,240.00 $1,403.60
Income before income taxes (ADJ) $475.39 $76.50 $742.53 $820.02 $1,206.58 $1,374.28
Income taxes ($660.40) ($310.90) ($233.70) ($287.90) ($369.40) ($515.20)
===>PROVISION FOR TAXES <=== $20.03 $22.57 $18.01 $22.36 $11.59 $10.33
Income before extraordinary loss ($128.10) ($169.80) $560.20 $561.10 $870.60 $888.40
Income before extraordinary loss (ADJ) ($164.98) ($211.83) $526.84 $554.48 $848.77 $869.41
Cumulative effect of accounting change ($700.00)
Net Income / (Loss) ($828.10) ($169.80) $560.20 $561.10 $870.60 $888.40
===>ADJ TO NET INCOME<==== ($37.19) ($41.92) ($33.45) ($41.52) ($21.53) ($19.19)Net Income (ADJ) ($865.29) ($211.72) $526.75 $519.58 $849.07 $869.21
2002 2003 2004 2005 2006 2007
Sales $34,768 $35,553 $35,823 $38,416 $40,185 $42,286Gross profit $10,812 $10,534 $10,595 $11,113 $11,581 $12,153
Operating profit $948 $574 $1,173 $1,215 $1,600 $1,772Income before income taxes $532 $141 $794 $849 $1,240 $1,404
Net Income ($828) ($170) $560 $561 $871 $888
2002 2003 2004 2005 2006 2007
Sales $34,767.50 $35,552.70 $35,822.90 $38,416.00 $40,185.00 $42,286.00Gross profit $10,812.00 $10,533.80 $10,595.30 $11,112.90 $11,581.00 $12,152.90
Operating profit $1,116.16 $771.90 $1,379.94 $1,442.88 $1,825.49 $1,995.44Income before income taxes $475.39 $76.50 $742.53 $783.12 $1,206.58 $1,374.28
Net Income ($865.29) ($211.72) $526.75 $519.58 $849.07 $869.21
2002 2003 2004 2005 2006 2007
Sales $0.00 $0.00 $0.00 $0.00 $0.00 $0.00Gross profit $0.00 $0.00 $0.00 $0.00 $0.00 $0.00
Operating profit $168.56 $198.00 $207.14 $228.18 $225.69 $223.34Income before income taxes ($56.91) ($64.60) ($51.37) ($65.88) ($33.42) ($29.32)
Net Income ($37.19) ($41.92) ($33.45) ($41.52) ($21.53) ($19.19)
Before Restatement
After Restatement
Change
94
Year-end Year-end Year-end Year-end Year-end Year-endBALANCE SHEET (Restated) 2002.00 2003.00 2004.00 2005.00 2006.00 2007.00
AssetsCurrent assets:
Cash and equivalents $76.00 $174.80 $266.80 $373.30 $216.60 $277.80Receivables 431.60 383.20 339.00 350.60 461.20 577.90
Merchandise inventories, net of LIFO reserve 2,717.80 2,642.20 2,740.70 2,766.00 2,642.50 2,797.80Prepaid expenses and other current assets 233.10 307.50 251.20 212.50 245.40 354.00
Total current assets 3,458.50 3,507.70 3,597.70 3,702.40 3,565.70 4,007.50
Property:Land 1,348.70 1,384.90 1,396.00 1,413.90 1,497.90 1,597.10
Buildings 3,597.10 3,847.20 4,269.70 4,419.10 4,829.30 5,461.90Leasehold improvements 2,467.70 2,494.80 2,621.90 2,958.00 3,336.90 3,700.00Fixtures and equipment 5,195.30 5,539.80 5,981.30 6,558.70 7,199.00 7,898.20
Property under capital leases 684.30 758.10 773.80 779.10 777.40 767.0013,293.10 14,024.80 15,042.70 16,128.80 17,640.50 19,424.20
Less accumulated depreciation and amortization -4762.30 -5619.00 -6353.30 -7031.70 -7867.20 -8802.208,530.80 8,405.80 8,689.40 9,097.10 9,773.30 10,622.00
===>ADJUSTMENT TO PROP, PLANT, & EQUIP<=== 2,081.30 2,423.97 2,386.24 2,373.82 2,391.78 2,743.86
Total property, net 10,612.10 10,829.77 11,075.64 11,470.92 12,165.08 13,365.86
Goodwill 3,125.70 2,404.90 2,406.60 2,402.40 2,393.50 2,406.30Prepaid pension costs 535.20 418.70 321.00 179.40 137.30 73.20
Investments in unconsolidated affiliates 208.30 191.80 187.60 201.80 219.60 216.00Other assets 188.70 167.80 175.10 173.80 184.40 326.00
Total non-current assets 14,670.00 14,012.97 14,165.94 14,428.32 15,099.88 16,387.36
Total assets 18,128.50 17,520.67 17,763.64 18,130.72 18,665.58 20,394.86
Liabilities and Stockholders EquityCurrent liabilities:
Current maturities of notes and debentures $780.50 $699.50 $596.90 $714.20 $790.70 $954.90Current obligations under capital leases 42.50 50.50 42.80 39.10 40.80 42.50
Accounts payable 1,811.50 1,509.60 1,759.40 2,151.50 2,464.40 2,825.40Accrued salaries and wages 400.90 406.00 426.40 526.10 485.80 506.70
Other accrued liabilities 757.20 664.70 696.30 708.80 719.10 718.90===>ADJUSTMENT TO DEFFERED TAX LIABILITY<=== (20.03) (22.57) (18.01) (22.36) (11.59) (10.33)
Total current liabilities 3,772.57 3,307.73 3,503.79 4,117.34 4,489.21 5,038.07
Total debt 8,435.60 7,822.30 6,763.40 6,358.60 5,868.10 5,655.10Long-term debt:
Notes and debentures 7,009.90 6,404.00 5,469.70 4,961.20 4,428.70 4,093.50191.5 299.8 785.3 338.9 238.0 245.7
===>ADJUSTMENT TO LONG-TERM LEASE<=== 2138.51 2488.46 2437.70 2437.70 2424.90 2773.39Total non-current liabilities 10,765.61 10,610.56 9,986.40 9,135.20 8,531.00 8,674.19
Total liabilities 14,538.19 13,918.29 13,490.19 13,252.54 13,020.21 13,712.25
3,627.50 3,644.30 4,306.90 4,919.70 5,666.90 6,701.80===>ADJUSTMENT TO STOCKHOLDERS EQUITY<=== ($37.19) ($41.92) ($33.45) ($41.52) ($21.53) ($19.19)
Total stockholders equity 3,590.31 3,602.38 4,273.45 4,878.18 5,645.37 6,682.61
Total liabilities & equity $18,128.50 $17,520.67 $17,763.64 $18,130.72 $18,665.58 $20,394.86
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2002 2003 2004 2005 2006 2007Total current assets 3,458.50 3,507.70 3,597.70 3,702.40 3,565.70 4,007.50Total non-current assets 12,588.70 11,589.00 11,779.70 12,054.50 12,708.10 13,643.50Total assets $16,047.20 $15,096.70 $15,377.40 $15,756.90 $16,273.80 $17,651.00Total current liabilities 3,792.60 3,464.30 3,792.10 4,263.90 4,601.40 5,136.40Total non-current liabilities 8,627.10 7,988.10 7,278.40 6,573.30 6,005.50 5,812.80Total stockholders equity 3,627.50 3,644.30 4,306.90 4,919.70 5,666.90 6,701.80Total liabilities & equity $16,047.20 $15,096.70 $15,377.40 $15,756.90 $16,273.80 $17,651.00
2002 2003 2004 2005 2006 2007Total current assets 3,458.50 3,507.70 3,597.70 3,702.40 3,565.70 4,007.50Total non-current assets $14,670.00 $14,012.97 $14,165.94 $14,428.32 $15,099.88 $16,387.36Total assets $18,128.50 $17,520.67 $17,763.64 $18,130.72 $18,665.58 $20,394.86Total current liabilities 3,772.57 3,307.73 3,503.79 4,117.34 4,489.21 5,038.07Total non-current liabilities 10,765.61 10,610.56 9,986.40 9,135.20 8,531.00 8,674.19Total stockholders equity 3,590.31 3,602.38 4,273.45 4,878.18 5,645.37 6,682.61Total liabilities & equity 18,128.50 17,520.67 17,763.64 18,130.72 18,665.58 20,394.86
2002 2003 2004 2005 2006 2007Total current assets 0.00 0.00 0.00 0.00 0.00 0.00Total non-current assets (2,081.30) (2,423.97) (2,386.24) (2,373.82) (2,391.78) (2,743.86)Total assets (2,081.30) (2,423.97) (2,386.24) (2,373.82) (2,391.78) (2,743.86)Total current liabilities 20.03 156.57 288.31 146.56 112.19 98.33Total non-current liabilities (2,138.51) (2,622.46) (2,708.00) (2,561.90) (2,525.50) (2,861.39)Total stockholders equity 37.19 41.92 33.45 41.52 21.53 19.19Total liabilities & equity (2,081.30) (2,423.97) (2,386.24) (2,373.82) (2,391.78) (2,743.86)
Before Restatement
After Restatement
Change
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Financial Analysis, Forecasting Financials,
and Cost of Capital Estimation
The goal of financial analysis is to assess the performance of a company in the
context of its stated goals and strategy. It is essential to also collect financial
information about other companies in the industry to be able to compare the company’s
performance relative to its competition.
The Financial analysis section is split into two strategies used to examine the
firm. Ratio analysis and cash flow analysis. Ratio analysis allows us to assess how
various line items on a company’s financial statements relate to one another. Cash flow
analysis allows us to examine the firm’s liquidity and to assess the management of
operating, investment, and financing cash flows. (Palepu & Healy) To accomplish this
goal we had to collect the last five, on some ratios six years of financial statements.
This was necessary in order to draw appropriate conclusions about our firm and how it
operates within the retail grocery industry.
Once done with the financial analysis section we applied what we learned to the
forecasting section. Once we identified trends in the market and the reactions of
Safeway we were able to project Safeway’s future financial statements up to ten years
out. We then conducted
The final portion of the analysis is estimating the cost of capital. The cost of
capital for all publicly traded firms is the cost of debt plus the cost of equity. To
estimate the cost of capital all sorts of data about interest rates and pricing data was
compiled. We then found the cost of capital using the CAPM Model and regression
analysis.
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Financial Ratio Analysis
Financial ratio analysis uses ratios gathered by using line items from the balance
sheet, income statement, and statement of cash flows. These ratios measure the
liquidity, profitability, and capital structure of the company. All three types of ratios will
be discussed in further detail later on in the report. Trend analysis and benchmark
analysis sections have also been created. They are both important when evaluating
Safeway. Trend analysis determines Safeway’s ratios over five year period. These
ratios allow analysis of historical trends. The benchmark analysis uses the same ratios
as the trend analysis but the ratios are taken of the other companies in the industry to
develop industry wide trends. Comparison of Safeway and its competitors is possible
using trend analysis and benchmark analysis.
Liquidity Analysis
A company’s liquidity ratios are derived from their income statement and balance
sheet. Liquidity ratios attempt to measure a company's ability to pay off its short-term
debt obligations (www.investopedia.com). Generally the higher the liquidity ratio the
more efficient the company is. However, the ratios must be closely analyzed to assess
how the particular ratio should look in that specific industry. If a firm’s liquidity ratios
get too low, especially when compared to the industry average, creditors might not
want to lend that company money. The liquidity ratios used in our analysis of Safeway
and the retail grocery industry are the current ratio, quick asset ratio, accounts
receivable turnover, inventory turnover, and working capital turnover.
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Current Ratio
The current ratio is an indicator of a firm’s short-term liquidity. This means that
the ratio measures the company’s capability of paying the money that it owes. The
formula for calculating a firm’s current ratio is current assets over current liabilities. The
ideal current ratio is supposed to be 2:1, but the best way to analyze whether a firm
has a good current ratio is by comparing the ratio to the other competitors in the same
industry. The chart below displays the Current Ratios of Safeway as well as its main
competitors in the retail grocery industry over the last six years.
Current Ratio
0.000.200.400.600.801.001.201.401.601.80
2002 2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal-Mart
CURRENT RATIO
2002 2003 2004 2005 2006 2007
Safeway 0.91 1.01 0.95 0.87 0.77 0.78
Kroger 0.99 1.00 1.01 0.96 0.89 0.82
SuperVALU 1.10 1.12 1.30 1.41 0.95 0.90
Whole Foods 0.98 1.50 1.45 1.61 1.22 0.85
Wal-Mart 0.94 0.91 0.90 0.90 0.90 0.81
99
Between the years 2002 and 2007 Safeway’s current ratio has been slowly
declining which matches the industry. Whole Foods and Supervalu have had relatively
higher fluctuating current ratios than the rest of the industry. This could be because
they are actually holding too many short term assets and not expanding their business.
In 2007 Whole Foods and Supervalu seem to have leveled back down to the rest of the
industry. In the grocery retail industry, these current ratios tend to be low. Safeway’s
current ratio has been the lowest in the industry for the past few years. This means
that Safeway is the furthest in the industry from the regular 1:1 ratio. Safeway has
fewer current assets to cover its short term debts, but this is not a major worry.
Safeway generates large amounts of cash from customers, and they are paid on a cash
basis from their customers. Safeway meets their short term obligations regularly, so the
company is on track in terms of their current ratio.
Quick Asset Ratio
Also known as the acid-test ratio, the quick asset ratio is another ratio that
evaluates liquidity. To compute the quick asset ratio, subtract inventory from a
company’s current assets and divide that by their current liabilities. By taking inventory
out of the formula, the ratio can concentrate on a company’s more liquid assets.
Analysts can use the quick asset ratio to help decide if the firm is able to cover their
current liabilities with their liquid assets if they were to have no more sales. A
corporation is considered reliable when they have more money in their liquid assets
than in current liabilities. The higher the quick asset ratio, the stronger the firm is
financially. The chart below shows the quick asset ratio for Safeway and its major
competitors in the grocery retail industry over the past six years.
100
Quick Asset Ratio
0.000.100.200.300.400.500.600.700.800.901.00
2002 2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal-Mart
QUICK ASSET RATIO
2002 2003 2004 2005 2006 2007
Safeway 0.13 0.16 0.16 0.17 0.15 0.17
Kroger 0.15 0.15 0.15 0.13 0.13 0.12
SuperVALU 0.34 0.41 0.57 0.76 0.26 0.26
Whole Foods 0.34 0.56 0.90 0.78 0.87 0.34
Wal-Mart 0.13 0.17 0.17 0.18 0.20 0.16
Between 2002 and 2007 Safeway has maintained a stable quick asset ratio. This
means that Safeway usually has liquid assets of about $0.16 for every $1 of liabilities. If
any firm in the retail grocery industry were to have no more sales, then none of them
would be able to cover their current liabilities. But the retail grocery industry usually
operates with a low quick asset ratio. This is because grocers usually In relation to the
industry, Safeway seems to have a fairly normal ratio. However, Whole Foods and
Supervalu have had much larger numbers that have fluctuated more radically than
Safeway and the rest of the industry. These fluctuations could be explained be a
number of different business activities. It might be because of stores closings or the
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selling of some of their assets. Safeway’s low quick asset ratio is still right where it
should be in terms of the retail grocery industry.
Inventory Turnover Ratio
The inventory turnover ratio is computed by dividing a company’s cost of goods
sold by their inventory. When the ending and beginning inventory balances are added
and then divided by two, the average inventory is calculated (the denominator). This
ratio displays how often a company's inventory is sold and replenished over a period of
time. “This ratio should be compared against industry averages. A low turnover implies
poor sales and, therefore, excess inventory. A high ratio implies either strong sales or
ineffective buying (investopedia.com).” Therefore, a business is more supposed to be
more efficient with a high inventory turnover ratio. The graph below shows the
inventory turnover ratio for Safeway and the competitors in the industry for the past six
years.
Inventory Turnover
0.002.004.006.008.00
10.0012.0014.0016.0018.0020.00
2002 2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal-Mart
102
INVENTORY TURNOVER
2002 2003 2004 2005 2006 2007
Safeway 8.80 9.46 9.20 9.87 10.82 10.77
Kroger 9.06 9.51 9.67 10.16 10.87 11.08
SuperVALU 15.79 16.11 16.16 17.80 10.65 12.23
Whole Foods 16.25 16.71 16.51 17.46 17.90 14.91
Wal-Mart 7.31 7.47 7.29 7.45 7.84 8.14
Between 2002 and 2007 Safeway has had a steadily increasing inventory
turnover. This is a good thing since a higher ratio is better as discussed above.
However, Safeway does have one of the lowest inventory turnovers in the industry. This
is not a concern to potential investors because a steady growth in inventory turnover is
a good sign. As stated above, if the inventory turns over more then the business is
usually more efficient because more products are being sold and inventories have to be
restocked more quickly. Whole Foods and Supervalu have the best inventory turnovers
over the past six years, but have both experienced large recent decreases in inventory
turnover which shows inconsistency. Safeway keeps a high volume of inventory in order
to meet customer demands and not let any sales pass them by. This high inventory
level lets Safeway generate more sales revenue. This is why Safeway has a smaller
inventory turnover compared to the rest of the industry.
Days’ Supply of Inventory Ratio
The days supply of inventory is computed by dividing 365 (the number of days in
a year) by the previously explained inventory turnover ratio. The days’ supply of
inventory ratio displays how many days a firm’s inventory is on hand before the
company can refill their inventory. The more often companies have to refill inventory,
the more often the firm is selling off their products. Therefore, the smaller the ratio
number the better the firm is doing. This is because firm’s want their inventory to be
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sold and replenished as soon as possible (in the fewest number of days). The chart
below displays Safeway and its competitor’s days’ supply of inventory ratios over the
past six years.
Days Supply Inventory
0.00
10.00
20.00
30.00
40.00
50.00
60.00
2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal-Mart
DAYS SUPPLY INVENTORY
2002 2003 2004 2005 2006 2007
Safeway 41.47 38.57 39.65 36.98 33.72 33.89
Kroger 40.30 38.39 37.73 35.94 33.57 32.95
SuperVALU 23.12 22.66 22.58 20.51 34.28 29.85
Whole Foods 22.46 21.84 22.11 20.91 20.39 24.48
Wal-Mart 49.95 48.87 50.10 49.01 46.55 44.82
Between 2002 and 2007 Safeway has had a steadily decreasing days’ supply of
inventory. This ratio corresponds to the inventory turnover ratio, so a consistent
decrease in the amount of days a company’s inventory on hand is also a positive thing.
The fewer days a firm has inventory on hand means the more inventory turnovers.
Therefore, if a company wants to be more efficient, then they try to cut down the
104
number of days their inventory is on hand. Wal-Mart has a larger days’ supply of
inventory simply because they are so large and have so much more inventory than the
other firms. The reason that Safeway’s Days’ supply of inventory is a little higher than
the rest of the industry (besides Wal-Mart) is the same reason that their inventory
turnover is a smaller. They keep a lot of inventory on hand to support sales.
Receivables Turnover
Calculating a firm’s receivables turnover ratio is done by dividing the net sales by
accounts receivable. The receivables turnover ratio shows how fast customers are
paying the company. A company wants this ratio high; because that means the firm is
collecting cash from sales sooner. If the company collects cash from debtors faster,
they have more cash to use for running the business. The graph below shows Safeway
and its competitor’s receivable turnover ratios for the past six years.
Account Receivables Turnover
0.00
50.00
100.00
150.00
200.00
250.00
2002 2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal-Mart
105
accounts receivable turnover
2002 2003 2004 2005 2006 2007
Safeway 80.90 93.23 105.67 109.57 87.13 73.17
Kroger 76.45 72.69 68.16 88.27 84.98 89.36
SuperVALU 40.13 45.12 42.10 45.25 39.09 46.32
Whole Foods 87.10 68.52 59.49 70.51 64.17 24.39
Wal-Mart 147.60 206.28 165.78 121.20 122.76 103.67
Between 2002 and 2007 Safeway has managed to keep its receivables a little
above the average of the industry. Kroger’s accounts receivable turnover has been
steadily increasing, while Whole foods’ ratio has been drastically declining. Whole foods
has been losing market share and this probably explains why their receivables turnover
has gotten so low. The retail grocery industry operates on a cash basis, so receivables
aren’t usually too big of a problem. Safeway has proven to be very efficient in their
accounts receivable turnover in the past, and they have managed to keep this ratio
decently high. A high accounts receivable ratio is a good thing, because a firm wants to
collect money from debtors as fast as possible. Since the products at a grocery store
are bought with cash or debit or credit cards, grocers usually have high accounts
receivable turnover ratios.
Days’ Sales Outstanding
When computing the days’ sales outstanding ratio divide 365 (the number of
days in a year) by the previously calculated accounts receivable turnover. This
computation shows how long it is taking a company to collect cash from preceding
sales. If the ratio is low, then a firm is collecting its receivables quickly. Therefore, in
terms of the days’ sales outstanding ratio a low ratio means that you are getting money
owed faster. The graph below displays Safeway and its competitor’s days’ sales
outstanding ratios over the last six years.
106
Days Supply Receivables
0.00
2.004.006.00
8.00
10.0012.00
14.0016.00
2002 2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal-Mart
DAYS SUPPLY RECEIVABLES
2002 2003 2004 2005 2006 2007
Safeway 4.51 3.91 3.45 3.33 4.19 4.99
Kroger 4.77 5.02 5.36 4.14 4.30 4.08
SuperVALU 9.09 8.09 8.67 8.07 9.34 7.88
Whole Foods 4.19 5.33 6.14 5.18 5.69 14.96
Wal-Mart 2.47 1.77 2.20 3.01 2.97 3.52
Between 2002 and 2007 Safeway has maintained a stable days’ supply of
receivables ratio that is under the industry average. For the days’ supply of receivables
ratio the lower the better. This makes being under the industry average a good thing.
The smaller this ratio the quicker a company is collecting receivables. The reason that
Whole Foods’ day’s supply of receivables has been increasing so much is probably due
to their loss of market share once again. This ratio corresponds to the previously
explained accounts receivable ratio. This ratio is typically lower in the grocery retail
industry once again because customers pay for products with cash. Safeway and the
other companies in the retail grocery industry can recognize their credit sales
107
immediately, because they pay third party collection agencies to handle credit
problems.
Working Capital Turnover
The working capital turnover ratio is a,” measurement comparing the depletion
of working capital to the generation of sales over a given period. This provides some
useful information as to how effectively a company is using its working capital to
generate sales (ivestopedia.com).” Therefore, if this ratio is high then a company is
spending less money to fund sales than the firm is making in sales. The graph below
represents the working capital turnover ratios of Safeway and its competitors over the
past six years.
Working Capital Turnover
-400.00
-200.00
0.00
200.00
400.00
600.00
800.00
1000.00
2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal-Mart
WORKING CAPITAL TURNOVER
2003 2004 2005 2006 2007
Safeway 823.21 -184.27 -68.42 -38.80 -37.46
Kroger 3842.21 794.85 -243.18 -80.04 -44.59
SuperVALU 89.57 39.49 30.05 -152.68 -95.76
Whole Foods 25.96 25.57 18.50 49.10 -56.57
Wal-Mart -75.66 -65.69 -62.42 -67.49 -34.85
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The working capital for Safeway has routinely been negative with the exception
of 2003 when Safeway and many other competitors generated positive working capital
turnover. Safeway has managed stay around the average in the industry consistently
while its competitors jump around above and below. Safeway however is consistently
negative.
As an industry the retail industry has mixed working capital turnovers. When the
industry was undergoing drastic changes in 2003 and 2004 most of the industry saw
large swings between positive and negative ratios. Since 2005 the industry’s volitity
has decreased to show many of the firms sustaining a ratio around 0. The industry
average is negative with the leaders barely positive.
Cash to Cash Cycle
The cash to cash cycle can be computed by adding the days’ supply of inventory
and days’ supply of receivables together. This financial ratio shows how long a company
has to finance its own stocks for. It measures the number of days between the initial
cash outflow (when the company pays its suppliers) to the time it receives cash from
customers (www.finance-glossary.com). The graph below shows the cash to cash cycles
for Safeway and its competitors over the last six years.
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Cash to Cash Cycle
0.00
10.00
20.00
30.00
40.00
50.00
60.00
2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal-Mart
CASH TO CASH CYCLE
2002 2003 2004 2005 2006 2007
Safeway 45.98 42.49 43.11 40.31 37.91 38.88
Kroger 45.08 43.41 43.09 40.07 37.86 37.04
SuperVALU 32.21 30.75 31.25 28.58 43.62 37.73
Whole Foods 26.65 27.17 28.25 26.09 26.07 39.45
Wal-Mart 52.42 50.64 52.30 52.02 49.52 48.34
Between 2002 and 2007 Safeway has a steadily declining cash to cash cycle. This
is a positive thing because a lower cash to cash cycle ratio means that cash is actually
being ran through the business more quickly and efficiently. Safeway’s cash to cash
cycle is right around average in the industry with the exception of Wal-Mart. Wal-Mart is
much larger and sells many different products so they aren’t going to have as low of a
cash to cash cycle. Safeway has had an average cash to cash cycle of 41.4 days. This
means that it takes 41.4 days for money invested in the business to go through
inventory, a sale to be made, and the cash be collected.
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Liquidity Conclusion
Safeway is not a very liquid company. Its current ratio which measures its
current assets divided by its current liabilities is routinely less than one, which means it
is unable to liquidate today and pay off all its creditors. The quick ratio is an
unimportant ratio in the retail grocery industry because inventory is subtracted from
assets. Since most of our inventory is liquid anyway, the ratio means much less in our
industry than in others. However Safeway has the lowest liquidity ratio in the industry.
Another more important ratio is the Cash to Cash cycle ratio. It measures the time it
takes for cash to enter the company and receive cash from customers; Safeway has
seen little change in this cycle the past few years which enforces stability in the
company. Another ratio which points to the liquidity of business operations is the
inventory turnover ratio. Safeway has managed to sustain an average turnover ratio
when compared to its competitors. It is not an industry leader but is around the
industry average. If the company were to liquidate today the ratios suggest stock
holders would be left out in the cold. When it comes to liquidating inventory and
turning sales into cash Safeway has been able to sustain average ratios in the industry.
Safeway is one of the worst companies to liquidate today and receive a profit but is
consistently shown its ability to sustain liquidity ratios which are important to business
operations. Safeway seems to be the benchmark or average company for the retail
grocery industry.
Profitability Analysis
Profitability ratios give analysts a better understanding of how well the company
utilizes its resources in generating profit and shareholder value.(www.investopedia.com)
The profitability analysis uses six ratios to evaluate both the company and the industry.
The six used in this analysis are: Gross Profit Margin, Operating Income to Net Sales,
Net Profit Margin, Asset Turnover, Return on Assets (ROA), and Return on Equity
(ROE). Ratios are taken of Safeway, its competitors, and the industry averages. By
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comparing these ratios an analyst is able to draw conclusions about the potential for
growth for the company and industry.
Restatement of Financials
Due to accounting distortions, from the use of many operating leases, it was
deemed necessary to restate Safeway’s financial statements. These leases were
capitalized to give us a clearer picture allowing for a more accurate financial analysis.
The overall effect played a significant role in the profitability section of our analysis.
This was a direct effect of off-balance sheet financing that resulted in the disclosure of
additional assets and liabilities being returned to the balance sheet. The results
affected profitability margins but not too severely. The results had no change to the
liquidity section previously discussed. Not all areas of profitability were affected;
however the key areas that were will be discussed in their sections. Mostly these
discussions are in the asset related areas of the financials.
Gross Profit Margin
The graph and chart below show the gross profit margins for Safeway and its
competitors in the retail grocery industry. The gross profit margin is used to analyze
how efficiently a company is using its raw materials, labor and manufacturing-related
fixed assets to generate profits. A higher margin percentage is a favorable profit
indicator. (www.investopedia.com). It is computed by dividing gross profit by total
revenue. A high gross profit margins means less revenue is being stripped by the cost
of goods sold.
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Gross Profit Margin
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40
2002 2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal-Mart
GROSS PROFIT MARGIN
2002 2003 2004 2005 2006 2007
Safeway 0.31 0.30 0.30 0.29 0.29 0.29
Kroger 0.27 0.26 0.25 0.25 0.24 0.23
SuperVALU 0.14 0.14 0.15 0.15 0.22 0.23
Whole Foods 0.35 0.34 0.35 0.35 0.35 0.35
Wal-Mart 0.22 0.22 0.23 0.23 0.23 0.23
Even though Safeway increases its gross profit the past six years its revenues
also kept pace at a consistent rate. In 2002 Safeway reported a gross profit margin of
0.31 but at the end of 2007 reported a gross profit margin of 0.29. The reported
earnings for the 2002 were 34 thousand and in 2007 were 42 thousand. Even though
the gross profit margin is declining, Safeway has managed to grow revenues. This can
be attributed to the fact Safeway has been able to grow its revenues by increasing its
operating costs slightly. Simply put the gross profit margin ratio is showing a trend of
increased costs leading to rising revenues. The margins are changing but not a rapid
pace.
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The rest of the industry also seems to be mirroring Safeway with the exception
of Supervalu and Whole Foods. Supervalu saw a jump in gross profit margin during
2005 up near the industry average; they have been able to sustain this margin since
the end of 2006. Whole Foods however has been able to keep its margin a full 0.10
above most of its competitors over the past six years, deviating little from the industry
best 0.35. It is interesting to note Wal-Mart historically has a gross profit margin
between 0.22 and 0.23. Both Supervalu’s and Kroger’s ratios have risen and fallen to
match that of Wal-Mart’s.
Operating Profit Margin
The graph and chart below show the operating income margins for Safeway and
its competitors in the retail grocery industry. The operating income margin is calculated
by dividing operating income by sales. The operating margin is a measurement of what
proportion of a company’s revenue is left over after paying for variable costs of
production such as wages and raw materials. It gives an analyst an idea of how much
a company makes before interest and taxes on each dollar of sales
(www.investopedia.com). The higher the ratio the more income is generated per sale.
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Operating Profit Margin
0.00
0.01
0.02
0.03
0.04
0.05
0.06
0.07
2002 2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal-Mart Safeway (Res)
OPERATING PROFIT MARGIN
2002 2003 2004 2005 2006 2007
Safeway 0.03 0.02 0.03 0.03 0.04 0.04
Kroger 0.05 0.02 0.01 0.03 0.03 0.03
SuperVALU 0.03 0.03 0.04 0.02 0.03 0.04
Whole Foods 0.05 0.05 0.06 0.05 0.06 0.05
Wal-Mart 0.06 0.06 0.06 0.06 0.06 0.06
Safeway (Res) 0.03 0.02 0.04 0.04 0.05 0.05
Safeway has never been an industry leader in this area but has slowly improved
its margins every year. This improvement was due to a complete remodel of all stores
including addition of several new higher end product lines. The significance of the
product lines is that they are Safeway’s own product lines. This results in much lower
costs and higher overall efficiency. Since operating profit margin is an indication of cost
management you could infer from this graph Safeway has become much more effective
over the past six years of managing its costs of business. An increasing trend in
operating profit margin from 0.03 to 0.04 is a trend Safeway hopes it can continue to
improve upon. The only two competitors which have better ratio’s are Whole Foods
and Wal-Mart, with Wal-Mart holding steadily holding onto a 0.06 margin and whole
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foods in a nose dive it is only a matter of time before Safeway will be in position to
challenge Wal-Mart for the lead position in the industry.
The industry has seen a lot of volatility in their operating profit margin’s the past
6 years, with only Wal-Mart able to claim stability. Kroger has seen the most volatility
with a drop of a whole 0.04 points over two years. Since this drop Kroger along with
the rest of the industry has settled down to an industry profit margin of around 0.04.
Whole Foods along with Wal-Mart is relatively stable. Kroger is next with a slight
decline; this change could be considered constant when compared to the fall the ratio
saw during 2003. Wal-Mart is the industry leader at controlling costs it seems as the
company has been able to sustain an industry best 0.06 operating profit margin the
past six years.
This is the first of the ratios that saw a direct effect from financial restatement.
The reduced operating costs due to a reduction in lease payments improved the
operating margin. This is a good sign that Safeway’s restructuring goal is having good
success. The attempt to cross over into the specialty market has been met with
positive results.
Net Profit Margin
The table and graph below show the net profit margins for Safeway and its
competitors in the retail grocery industry. The net profit margin is calculated by
dividing net income by revenue. The ratio measures how well a company controls its
costs compared to its competitors. (www.investopedia.com). The higher the margin the
better. If the ratio is shrinking, revenues are growing faster than net income. The
company may be experiencing increasing costs. This would lead to a lower net profit
margin even though revenues are increasing. The ratio is very important to
shareholders and managers alike because it describes the company’s ability to generate
dividends and earnings from operations.
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Net Profit Margin
-0.03
-0.02
-0.01
0.00
0.01
0.02
0.03
0.04
2002 2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal-Mart Safeway (Res)
NET PROFIT MARGIN
2002 2003 2004 2005 2006 2007
Safeway -0.02 0.00 0.02 0.01 0.02 0.02
Kroger 0.02 0.01 0.00 0.02 0.02 0.02
SuperVALU 0.01 0.01 0.02 0.01 0.01 0.01
Whole Foods 0.03 0.03 0.03 0.03 0.04 0.03
Wal-Mart 0.03 0.04 0.04 0.03 0.03 0.03
Safeway (Res) -0.02 -0.01 0.01 0.01 0.02 0.02
Net profit margin is similar to operating profit margin in that it is a ratio
describing the ability of a firm to control its costs of business. However the net profit
margin is a ratio which takes into account taxes by using net income. As you can see
from the chart, Safeway had a negative net profit margin during 2002 and 2003. This
was the result of accounting change that led to a large write down. The company
quickly recovered and has sustained a net profit margin well in line with industry
averages of around 0.02. Similar to the last graph Safeway has pulled into the third
position among its competitors in respect to controlling the costs of business. Wal-Mart
is the unquestionable leader with a margin above 0.03 and Whole Foods seems to be in
a free fall similar to the operating margin discussed earlier.
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The two margins, net profit margin and operating profit margin, should and have
mirrored one another. It is interesting to note an important difference in Safeway’s
position in the two graphs. During 2002 Safeway’s net profit margins were on the rise
while the operating profit margins were falling. The graphs become much more similar
from 2003 to the present. This disparity can be explained by the variability of taxes or
other income sources. Safeway’s operating margins were in a decline while the net
profit margins were ascending most likely from tax incentives or tax breaks the
company was receiving, it is possible however the company had abnormal gains from
investments or financing activities as well. Whatever the disparity the adjustments
Safeway made has put it into the third best position behind Wal-Mart and Whole Foods.
The industry over the past 6 years has shown a fragmented industry, the portion
from 2002 to 2005 looks dramatically different than the portion from 2005 to present.
2002 to 2004 showed a dramatic drop in Kroger’s net profit margin and a dramatic rise
in Safeway’s net profit margin with Supervalu hovering between 0.01 and 0.02 and
Wal-Mart and Whole Foods each in excess of 0.03. 2005 to present day has shown
both inclines and declines flatten out showing stability in the industry. Wal-Mart is still
the industry leader at above 0.03 and Whole Foods seems to be dropping down to
towards the rest of the competition led by Safeway setting just above 0.02. The
stability in the industry after 2005 has helped Safeway, Kroger, and Supervalu,
seemingly at the cost of Whole Foods who over the past 2 years has seen a slight
decline in its net profit margin. This again is a restructuring effect as stores are not
trying to compete with the super-centers price battles but are focusing on the customer
experience.
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Asset Turnover
The table and graph below show the asset turnover ratios for Safeway and its
competitors in the retail grocery industry. The asset turnover ratio is computed by
dividing revenues by total assets. The asset turnover ratio measures the company’s
efficiency of using its assets to generate revenue. (www.invstopedia.com) The higher
the ratio the more units of revenues are generated by a single unit of assets. The
higher the asset turnover the better a firm is at generating revenues. Typically a
company with a high asset turnover has a low profit margin, which is true in the
grocery store industry. A firm with the highest asset turnover ratio has a distinct
advantage over its competition.
Asset Turnover
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal-Mart Safeway (Res)
ASSET TURNOVER
2003 2004 2005 2006 2007
Safeway 2.23 2.37 2.50 2.55 2.60
Kroger 2.65 2.72 2.96 3.23 3.31
SuperVALU 3.43 3.17 3.17 6.08 2.03
Whole Foods 3.34 3.14 3.09 2.97 3.23
Wal-Mart 2.73 2.70 2.60 2.52 2.50
Safeway (Res) 1.97 2.04 2.16 2.22 2.27
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The asset turnover ratio is very important to management and investors alike
because it measures the ability of a firm to generate revenue from its assets. It shows
how much revenue is produced per dollar of assets. Safeway has again improved its
position relative to its competition the last 6 years. In 2003 it had an industry low asset
turnover ratio of 2.23 while Supervalu lead the industry with a ratio of 3.43. Gradually
Safeway has increased its ratio to 2.60 while the rest of the industry with the exception
of Kroger has shown a downward trend. Safeway now stands second only to Kroger.
The industry as a whole has seen little change in the asset turnover but an
extreme changing of the guard so to speak within the industry. Safeway which once
was the worst at producing revenue from its assets is now second best to Kroger who is
dominating its competition with a whole 0.75 lead over its next best competitor. It is
interesting to note Kroger; the second largest company in the industry in terms of
assets approximately 22 million has the highest asset turnover ratio. Supervalu who
once held a ratio of 3.25 now is the worst with a rapid decline to a ratio of 2.03. It
seems Supervalu is improving their ratio yet again as it is slowly on the rise towards the
likes of Wal-Mart and Safeway.
Restatements provided a much more accurate view of a company’s ability to
mask actual results for the purpose of image. The actual turnover for Safeway is
actually closer to 2 dollars produced for every dollar of assets than 3 dollars as the non-
restated numbers imply.
Return on Assets
The table and graph below show the return on assets ratios for Safeway and its
competitors in the retail grocery industry. Return on assets is calculated by dividing net
income by total assets. The ROA is an indicator of how profitable a company is relative
to its total assets. It tells you the earnings generated from invested capital.
(www.investopedia.com) It is important to note that the assets are financed by both
debt and equity. The higher the ROA the more efficient management is at generating
income per unit of asset.
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Return on Assets
-2.000%
0.000%
2.000%
4.000%
6.000%
8.000%
10.000%
12.000%
2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal-Mart Safeway (Res)
RETURN ON ASSETS
2003 2004 2005 2006 2007
Safeway -1.1% 3.7% 3.6% 5.5% 5.5%
Kroger 1.4% -0.5% 4.7% 5.4% 5.6%
SuperVALU 4.8% 6.3% 3.3% 7.3% 2.7%
Whole Foods 10.5% 10.5% 8.9% 10.8% 8.9%
Wal-Mart 9.6% 9.7% 9.3% 8.2% 8.4%
Safeway (Res) -0.9% 3.2% 3.2% 4.8% 4.8%
Similar to asset turnover ratio the return on assets takes into account the value
of assets. However to find the proper ROA you must divide net income by total assets.
It is important to associate the changes in ROA with the changes in asset turnover and
profit margin. Notice how the increase in 2005’s ROA is connected with the increase in
the net profit margin.
Safeway had a large jump of 0.05 points from 2003 to 2004, a nice recovery
after the large write down, and has kept its ratio relatively constant around 0.04 the
past four years. Most of the industry in this case has been relatively consistent with the
acceptation of Supervalu who tends to jump around.
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Return on Equity
The table and graph below show the return on equity ratios for Safeway and its
competitors in the retail grocery industry. Return on equity is calculated by dividing net
income by shareholders equity. The ROE measures how much profit a company
generates with the money shareholders have invested. (www.investopedia.com). The
higher the ROE the more net income is being generated per dollar invested in the
company by the share holders. ROE is extremely useful when comparing companies in
the same industry.
Returnn on Equity
-0.10
-0.05
0.00
0.05
0.10
0.15
0.20
0.25
0.30
2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal-Mart Safeway (Res)
RETURN ON EQUITY
2003 2004 2005 2006 2007
Safeway -0.05 0.15 0.13 0.18 0.16
Kroger 0.07 -0.03 0.26 0.25 0.24
SuperVALU 0.14 0.17 0.08 0.17 0.11
Whole Foods 0.17 0.17 0.14 0.15 0.13
Wal-Mart 0.23 0.24 0.23 0.21 0.21
Safeway (Res) -0.06 0.15 0.12 0.17 0.15
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The return on equity for Safeway was rather bleak during 2003. It has since
rebounded to a positive number around 0.16. Safeway along with the rest of the
industry has seen a drastic change in the ROE of both Safeway and Kroger, industry
leaders. The last three years has been relatively consistent with Kroger above the rest
of the industry. There seems to be a steady trend for Safeway and the rest of the
industry.
Conclusion
After looking at all the profitability ratios we are able to determine the overall
effectiveness of Safeway when compared to its competitors. Safeway has seen a
drastic turn around in profitability ratios from 2002 to 2007 but was never the best in
the industry in any instance. Safeway was however consistently inside or close to the
top three in all of the profitability ratios computed. Only Wal-Mart and Whole Foods
have a better net profit margin and only Kroger had a higher asset turnover ratio. Also
Safeway is second in gross profit margins to Whole Foods.
The retail grocery industry is one that competes on low profit margins and thus
requires a high asset turnover ratio. Thus asset turnover ratio is the most important
profitability ratio in the industry. Kroger is the best followed by Safeway with Wal-Mart
right on its tail.
To succeed in this industry a firm cannot rely on a high net or gross profit
margin to generate a high return on assets. Since Safeway is clearly inside the top 3 in
asset turnover ratio it can afford to weaken its position in profit margin to gain a higher
asset turnover ratio. For example, Kroger an industry leader in asset turnover ratio has
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one of the lowest gross and net profit margins and its ROA is right around the industry
average.
Notice Whole Foods leads the industry in gross profit margin and is second in net
profit margin but is the worst in the industry at turning over its assets. If its profit
margins dry up Whole Foods could be in trouble. Also it is interesting to note Wal-Mart
leads the industry in net profit margin and is near the average in asset turnover ratio.
Wal-Mart is also second in ROA to a falling Whole Foods.
Safeway ability to generate a high asset turnover ratio with slightly higher profit
margins is unique to the industry. Over the past three years Safeway has managed to
stay in the middle of the pack. While Whole Foods feasted on high profit margins and
less than average asset turnover margins Kroger accelerated their asset turnover
margins and cut down on profit margins. The strategies have propelled Whole Foods
near the top of the industry and Kroger slightly higher than Safeway, using ROA as a
measure.
Safeway has shown the ability to keep an average ROA when compared to its
competition. Its ability to sustain a consistent asset turnover ratio while slightly
increasing its profit margins will lead to a better ROA in the future.
Capital Structure Analysis
Capital structure analysis is shows how a firm is financed, through a percentage
of debt financing and equity financing. There are two main reasons capital structure is
important. The first is probably the most obvious; understand how a firm is paying for
its assets. Through the use of equity or primarily debt, each has their own set of risks.
A company’s proportion of short and long term debt is considered when analyzing
capital structure. (www.investopedia.com) The second is to assess the ability of a firm
to pay back its total interest charges. The capital structure analysis includes three
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ratios; debt to equity, times interest earned, and debt service margin. Each ratio brings
to light a different aspect of the capital structure.
Debt to Equity Ratio
The debt to equity ratio shows how much debt relative to equity a firm has in its
capital structure. Typically the higher the debt equity ratio the more likely it is the
company will default on loans. Also the higher the debt equity ratio the more likely it is
the company has a high credit rating. A company with a high credit rating pays less for
debt than those with low credit ratings. This ratio is very important to equity holders
because if a company is liquidated the assets are used to pay off any debts first before
any earnings are paid to equity holders. Below is the debt to equity graph and charts
for Safeway and its competitors the past six years. Also below are the current S&P
credit ratings for each company.
Credit RatingSafeway BBWal-Mart AA
Kroger BBBSupervalu BB-
Whole Foods BB+
Debt to Equity Ratio
0.000.501.001.502.002.503.003.504.004.505.00
2002 2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal-Mart Safeway (Res)
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DEBT TO EQUITY RATIO
2002 2003 2004 2005 2006 2007
Safeway 3.42 3.14 2.57 2.20 1.87 1.63
Kroger 4.31 4.10 4.66 3.67 3.31 3.54
SuperVALU 1.93 1.79 1.50 1.35 3.09 2.54
Whole Foods 0.60 0.62 0.60 0.38 0.45 1.20
Wal-Mart 1.40 1.42 1.43 1.60 1.46 1.53
Safeway (Res) 4.05 3.86 3.16 2.72 2.31 2.05
As you can see from the chart and the graph the over the past few years
Safeway has gotten rid of debt financing and replaced it with equity financing. Thus
the ratio is getting smaller. Safeway seems to be following an industry trend of
reducing debt financing. The relative credit risk associated with higher debt is the
number one reason companies drastically try to improve their debt to equity ratio. The
recent upgrades to Safeway, from market analysts, were mainly due to its reduction of
overall debt. The credit rating of Supervalu has not stopped the company from
increasing its debt equity ratio substantially the past 2 years. Only Wal-Mart seems to
hold a consistent debt to equity ratio of around 1.45.
According to the chart it appears the industry has seen a drastic change of
thought relating to debt financing. In 2002 the competition was consistently spread
out. Over the past two years every company has held constant or reduced its debt to
equity ratio with the exception of Whole Foods and Kroger who seem to be increasing
their ratios. It is interesting to note that both of these companies also currently have
the highest net profit margin and highest asset turnover ratio respectively. They may
be using debt financing to expand their operations.
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Restating the financials had a slight impact on these numbers. Even though it
raised the debt to equity ratio, the numbers had no true negative impact. The relevant
issue is that the overall debt to equity ratio is still declining reducing credit risk.
Times Interest Earned
Times interest earned is computed by dividing Net Income before Interest and
Taxes by interest expensed. This ratio gives an analyst an opportunity to see the ability
of a firm to pay off its interest before taxes, the higher the ratio the better for a debtor
of the firm. This ratio is very important for any debtor because it highlights the ability
of a company to pay back its debt. Below are a graph and table of Safeway and its
competitors the past six years.
Times Interest Earned
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
2002 2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Safeway (Res)
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TIMES INTEREST EARNED
2002 2003 2004 2005 2006 2007
Safeway 2.20 1.30 2.85 3.02 4.04 4.56
Kroger 4.15 2.22 1.51 3.99 4.58 4.85
SuperVALU 3.52 4.10 6.23 4.10 2.34 2.38
Whole Foods 13.92 20.64 29.88 103.48 10633.67 70.65
Wal-Mart 14.34 18.06 17.65 15.89 13.41 12.23
Safeway (Res) 2.59 1.74 3.36 3.58 4.61 5.13
Safeway has increased its times interest earned ratio from 2.20 to 4.56 in a
matter of six years. That means the ability of Safeway to cover its interest obligations
has doubled since 2002. Two things could have triggered this event. Safeway was able
to increase its operating income through other means of financing besides debt or
Safeway’s operating income growth outpaced that of its interest payments. The second
seems much more likely.
Relative to the industry Safeway seems to have improved its position. It came
from the bottom in 2003 to almost tie for second with Kroger. Wal-Mart’s and Whole
Food’s ability to pay its interest payments far outpaces that of its competitors in the
retail grocery industry, therefore they were intentionally left off the graph to give a
more accurate picture of the industry. Wal-Mart also happens to be a much larger
corporation than even the second largest company Kroger. Kroger and Safeway are
almost the same size so the fact Safeway has closed the gap with its rival is a good sign
for its debtors. Whole Foods has very little interest expense and this gives them
extremely high ratios not comparable or relative to the industry.
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Debt Service Margin
Debt service margin tells the analyst the ability of a company to repay is long
term debt from its current cash flows from operating. This ratio is computed by
dividing operating cash flows by current notes payable. It demonstrates the company’s
ability to pay its current portion of long term debt with only cash generated from
operating activities. Below are the debt service margins for Safeway and its
competitors the last six years.
Debt Service Margin
0.00
5.00
10.00
15.00
20.00
25.00
30.00
35.00
2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Wal-Mart
DEBT SERVICE MARGIN
2003 2004 2005 2006 2007
Safeway 1.96 2.97 2.94 2.89 2.63
Kroger 6.29 9.40 30.87 4.24 2.85
SuperVALU 13.75 2.62 6.99 7.15 6.06
Whole Foods 49.06 56.86 68.81 76.33 7972.00
Wal-Mart 2.76 2.36 2.34 2.31 2.46
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The debt service margin for Safeway has again improved dramatically from 2003
to 2007. Safeway’s ability to pay its current portion of long term debt is well below the
standards set by the industry. The only positive that can be concluded from this graph
is Safeway has consistently been able to pay its current portion of long term debt.
However since the ratio is very low Safeway stands a better chance of defaulting than
most of its competition.
The retail grocery industry as a whole seems able to pay of its debt financing
regularly. Whole Foods keeps has a very low amount of current debt which keeps its
debt margin much higher than the rest of the competitors. The competitive nature of
the market has pushed the company’s to look for different ways to expand or solidify
their market shares. Those with ample room in the debt service margin can afford to
take on more debt and be more aggressive in the market.
IGR and SGR
IGR or the internal growth rate is the maximum level of growth achievable for a
business without outside financing. It is typically accomplished by the expansion of
existing assets and businesses. It is a value derived from taking a company’s return on
assets ratio and multiplying it by one minus the dividend paid out ratio. The higher
this ratio is, the higher the ability of the firm to grow from using only internal resources.
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Internal Growth Rate
-2.00%
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal-Mart Safeway (Res)
Internal Growth Rate
2003 2004 2005 2006 2007
Safeway -1.06% 3.71% 3.65% 5.52% 5.46%
Kroger 1.40% -0.50% 4.68% 5.44% 5.56%
SuperVALU 4.74% 6.25% 3.28% 7.34% 2.73%
Whole Foods 10.49% 10.51% 8.93% 10.65% 8.91%
Wal-Mart 9.55% 9.74% 9.35% 8.17% 8.40%
Safeway (Res) -0.94% 3.20% 3.16% 4.80% 4.76%
Safeway has had a fairly constant IGR and due to an extensive remodeling
project, it has raised its IGR from a steady increase of cash flow. This is believed to be
a direct result of the expansion of its product range with the addition of higher end
product lines. Whole Foods is a specialty dealer with much higher profit margins
explaining the higher growth rate. The many supercenters Wal-Mart has give the
company a higher IGR by volume of sales from amount of floor space.
SGR or sustainable growth rate is the maximum a firm can grow without
depleting its capital. It is calculated by multiplying the IGR by its return on equity.
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Sustainable Growth Rate
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Whole Foods Wal-Mart Safeway (Res)
SUSTAINED GROWTH RATE
2003 2004 2005 2006 2007
Safeway -4.68% 15.37% 13.02% 17.69% 15.67%
Kroger 7.45% -2.56% 26.47% 25.39% 23.98%
SuperVALU 13.91% 17.43% 8.19% 17.23% 11.16%
Whole Foods 16.79% 16.98% 14.31% 14.73% 12.96%
Wal-Mart 22.94% 23.53% 22.74% 21.22% 20.67%
Safeway (Res) -4.14% 13.25% 11.27% 15.38% 13.66%
Safeway had an SGR of 15.67% in 2007. This means that 15.67% is the
maximum Safeway can grow without having to borrow any money. If they increase
growth by any amount greater than that, then they will have to increase their debt
leverage by borrowing more. The restatement had no real impact on growth rates.
Even though it dropped Safeway a bit, was not substantial enough to hinder growth
through internal financing.
Although we are analyzing Safeway, and talk about the off-balance sheet
financing that led to restatements, this should not be looked negatively on the firm.
This is a very common practice in this industry and it is important to note that all
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competitors in this analysis take part in these practices. Safeway has one of the higher
percentages of operating leases to total liabilities but by no means has the largest
amount of off-statement debt.
Operating Leases
2008 2009 2010 2011 2012 Thereafter
Total min lease
payments
Total Current
Total Long
Total Liabilities
% of Total
Liabilities Safeway 452 410 381 346 318 3089 4996 5136 5813 10949 46%
Kroger 774 736 693 630 578 3459 6870 8689 8696 17385 40% Whole Foods 213 269 304 312 309 4623 6029 785 970 1754 344%
Wal-Mart 1094 1051 994 866 788 8966 13759 58454 40452 98906 14%
SuperValu 479 397 363 330 288 2196 4053 4607 10502 15109 27%
Credit Risk
There are several credit rating systems to asses a company’s credit risk. There
are credit ratings Moody’s, Standard and Poor's (S&P's) and Fitch IBCA. Each of these
agencies aims to provide a rating system to help investors determine the risk associated
with investing in a specific company, investing instrument or market
(www.investopedia.com). One of the most highly trusted of banks and other lending
institutions is the Altman Z-Score. The Altman Z-Score was created by Dr. Edward L.
Altman in 1968 to assess the possibility of bankruptcy.
Altman Z
The Altman Z-score predicts bankruptcy when the score is lower than 1.81.
Firms with a score between 1.81 and 2.67 are considered to be border-line.
Firms are considered to be healthy and to have a low risk of bankruptcy if they score
above a 3. The Altman Z-score is calculated using the following formula:
Z-Score = 1.2(Working Capital/Total Assets) + 1.4(Retained Earnings/Total
Assets) + 3.3(Earnings before Interest and Taxes/Total Assets) + .6(Market
Value of Equity/Book Value of Debt) + 1.0(Sales/Total Assets)
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ALTMAN Z - SCORE
2
3
4
5
6
2003 2004 2005 2006 2007
Safeway Kroger SuperVALU Wal-mart Safeway (Res)
ALTMAN - Z SCORE 2003 2004 2005 2006 2007
Safeway 3.38 3.47 3.70 4.10 4.04
Kroger 3.55 3.60 4.09 4.41 4.23
SuperVALU 4.80 4.98 5.03 2.73 4.02
Whole Foods 13.84 16.01 15.46 9.03 4.87
Wal-Mart 5.64 5.21 4.54 4.51 4.26
Safeway (Res) 2.88 2.93 3.03 3.23 3.56
The chart above displays Safeway and its competitors Altman Z-Scores over the last five
years. Safeway’s creditworthiness is strong according to the Z-Score evaluation. The
company has been well above creditworthiness for some time. This would correspond
to its recent multiple upgrades. Whole Foods scores were incomparable for almost
every year, because of this they were left off the graph to get a true industry
comparison. The rest of the industry is also well above credit worthiness in terms of
the Altman Z-Score. An overall view of how the Altman Z score is computed is
displayed in the chart below.
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Computing Altman Z Score
Total Current Assets
Net Working Capital
X1 Liquidity
Total Current Liabilities
W = 1.2 Total Assets
Total Assets
Retained Earnings
Retained Earnings
X2 Profitability W = 1.4
Total Assets
Total Assets
Operating Income
EBIT
X3 ROA W = 1.4
Total Assets
Total Assets
Stock Price x
Market Value of Equity
X4 Leverage
# Outstanding Shares
W = 3.3 BV of Total Liabilities
Total Liabilities
Total Revenue
Sales
X5 Asset Potential W = 1
Total Assets
Total Assets
Conclusion
The majority of the retail grocery industry is financed with debt. The debts to
equity ratios drive this point home. With an average routinely above 1 it is evident the
choice of financing for the industry is debt. The times interest earned shows that the
companies in the industry are able to pay back their interest payments by operating
their businesses at normal levels. Because the industry is extremely competitive and
debt financing is the financing of choice companies with higher credit ratings can fetch
lower interest rates. Therefore it is reasonable to conclude a company who can pay
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back its debt obligations quicker than its competition has a competitive advantage.
Safeway however is near the bottom in terms of healthy capital structure ratios. The
only positive thing a lender can point to is the ability of Safeway to increase its
profitability ratios while maintaining its capital structure ratios. The industry as a whole
shows very little credit risk even upon restated financials. The significant amounts of
off-balance sheet financing was of concern, however none of the adjustments were
significant enough to change Safeway’s competitive position in the industry.
Financial Statement Forecasting
When companies prepare their financial reports, investors are able to view the
operations of that particular business. The financial statements reflect past performance
of the corresponding firm. Analysts use financial statements to try to assess how the
company will do in the future. Financial statements are forecasted in order to get the
best possible picture of where the company is headed. When forecasting an analyst
attempts to determine the future values on the income statement, balance sheet, and
the statement of cash flows. The best way to begin the forecasting process is to start
with the income statement. After the income statement, move on to the balance sheet
and the statement of cash flows. In our forecasting, we used Safeway’s monthly
reports, quarterly reports, and also their annual reports.
Income Statement Analysis
The income statement is an extremely critical tool when forecasting a company’s
future earnings. We used the past five year’s data for most of the line items on the
income statement as well as some critical financial ratios to forecast Safeway’s future
income statements out to 2017. When forecasting Safeway’s income statement, we
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started by creating a common sized report in which we figured the percentage of sales
of each line item on the income statement. This enabled us to see company trends
which we used during our forecasting. It was also important for us to look at and
compare the firm’s data to the overall industry trends when doing these income
statement forecasts.
The corner stone in the forecasting of the income statement is the future sales
growth. We chose to use a growth rate for sales of 4.3%. This growth rate is very
close to the average growth over the past five years. We considered throwing out the
lowest growth rate which was between 2003 and 2004, but did not because we do not
feel that Safeway can sustain quite the growth rate it has experienced in the last few
years. For the first quarter of 2008 Safeway has reported sales of about
$10,000,000,000. This is a little off pace with our estimated sales of $44,104,300,000
for the year, but we believe this is because of the first quarter slowdown of the
economy and expect the next three quarters to produce the desired amount of sales.
The next line item forecasted was the cost of goods sold. Any change in cost of
goods sold for a company is very important in an industry with high competition and a
low profit margin. We decided the cost of goods sold should represent 71.4% of total
sales. The percentage of sales for 2007 was 71.3%; we expect the upward trend in the
cost of goods sold Safeway has shown over the past 5 years to continue at a slow and
steady rate. During 2005 there was a slightly sharper jump in the cost of goods sold,
but since then the growth rate has tapered off into what we feel will be an appropriate
percentage of net sales to forecast.
The third line item forecasted was the gross profit. Gross profit for Safeway over
the past five years has shown a slow downward trend, opposite that of cost of goods
sold. This makes perfect sense because the gross profit and cost of goods sold must
add up to 100% of the net sales. We estimated the gross profit relative to sales to be
28.6%. We feel this is appropriate because of Safeway’s past five years of steady
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decrease in gross profit. This trend of increasing cost of goods sold and decreasing
gross profit matches the trend in the retail grocery industry.
The next line item we estimated was the SG&A expense. Sales, general and
administrative expenses for Safeway have been decreasing over the past five years.
However we don’t believe they can continue this trend and expect their expenses to
return to and maintain a reasonable percentage of sales. Over the past five years
Safeway has seen three years with expenses accounting for a percentage of sales
slightly in excess of 25.0% and two years slightly below 25.0%. Because of this
disparity and our expectations of an increase in these expenses, we assume expenses
will count for about 25.0% of sales in the future. We do not believe that these expenses
can keep going down in the long run, especially with our economy’s current condition.
The next line item we forecasted was operating profit. We estimated this
percentage of sales to drop to 3.7%. In 2006 and 2007 Safeway experienced an
operating profit percentage of sales around 4.0%, but we don’t believe Safeway can
continue this growth in operating profit. We believe 3.7% of net sales is a much more
realistic forecast for estimating future operating profits for Safeway.
Next we estimated the interest expense. We noticed the interest expense
accounted for around 1.0% of sales consistently over the last five years. This
consistency was ample reason for us to forecast interest expense to be 1.0% of sales
over the next 10 years.
Finally we estimated net income by computing the past five years net profit
margins. We took the average of the last four years net profit margins because of the
inconsistency of 2003’s net income. We forecasted net income to be 1.9% of net sales.
By removing this abnormal year (2003), we feel our forecasted percentage is more
accurate in terms of the future performance of Safeway’s net income
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Income Statement (in millions)
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Sales 35,553 35,823 38,416 40,185 42,286 44,104.3 46,000.8 47,978.8 50,041.9 52,193.7 54,438.0 56,778.9 59,220.4 61,766.8 64,422.8
COGS 25,019 25,228 27,303 28,604 30,133 31,490.5 32,844.6 34,256.9 35,729.9 37,266.3 38,868.8 40,540.1 42,283.3 44,101.5 45,997.9
Gross Profit 10,534 10,595 11,113 11,581 12,153 12,613.8 13,156.2 13,721.9 14,312.0 14,927.4 15,569.3 16,238.8 16,937.0 17,665.3 18,424.9
S,G,&A Exp. 9,421 9,423 9,898 9,981 10,381 11,026.1 11,500.2 11,994.7 12,510.5 13,048.4 13,609.5 14,194.7 14,805.1 15,441.7 16,105.7
Operating Profit 574 1,173 1,215 1,600 1,772 1,631.9 1,702.0 1,775.2 1,851.6 1,931.2 2,014.2 2,100.8 2,191.2 2,285.4 2,383.6
Interest Expense 442 411 403 396 389 441.0 460.0 479.8 500.4 521.9 544.4 567.8 592.2 617.7 644.2
EBT 141 794 849 1,240 1,404
Income Tax Exp. 311 234 288 369 515
Net Income -170 560 561 871 888 838.0 874.0 911.6 950.8 991.7 1,034.3 1,078.8 1,125.2 1,173.6 1,224.0
Common Size 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Sales 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
COGS 70.0% 70.4% 71.1% 71.2% 71.3% 71.4% 71.4% 71.4% 71.4% 71.4% 71.4% 71.4% 71.4% 71.4% 71.4%
Gross Profit 30.0% 29.6% 28.9% 28.8% 28.7% 28.6% 28.6% 28.6% 28.6% 28.6% 28.6% 28.6% 28.6% 28.6% 28.6%
S,G,&A Exp. 26.4% 26.3% 25.8% 24.8% 24.5% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0%
Operating Profit 1.6% 3.3% 3.2% 4.0% 4.2% 3.7% 3.7% 3.7% 3.7% 3.7% 3.7% 3.7% 3.7% 3.7% 3.7%
Interest Expense 1.2% 1.2% 1.0% 1.0% 0.9% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0%
EBT 0.4% 2.2% 2.2% 3.1% 3.3%
Income Tax Exp. 0.9% 0.7% 0.7% 0.9% 1.2%
Net Income -0.5% 1.6% 1.5% 2.2% 2.1% 1.9% 1.9% 1.9% 1.9% 1.9% 1.9% 1.9% 1.9% 1.9% 1.9%
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Restated Income Statement
(common size) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Sales 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
COGS 70.0% 70.4% 71.1% 71.2% 71.3% 71.4% 71.4% 71.4% 71.4% 71.4% 71.4% 71.4% 71.4% 71.4% 71.4%
Gross Profit 30.0% 29.6% 28.9% 28.8% 28.7% 28.6% 28.6% 28.6% 28.6% 28.6% 28.6% 28.6% 28.6% 28.6% 28.6%
S,G,&A Exp. 24.8% 25.2% 24.7% 23.8% 23.5% 24.0% 24.0% 24.0% 24.0% 24.0% 24.0% 24.0% 24.0% 24.0% 24.0%
Operating Profit 2.2% 3.9% 3.8% 4.5% 4.7% 4.2% 4.2% 4.2% 4.2% 4.2% 4.2% 4.2% 4.2% 4.2% 4.2%
Interest Expense 1.2% 1.2% 1.0% 1.0% 0.9% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0%
EBT 0.2% 2.1% 2.0% 3.0% 3.2%
Income Tax Exp. 0.9% 0.7% 0.7% 0.9% 1.2%
Net Income -0.6% 1.5% 1.4% 2.1% 2.1% 1.8% 1.8% 1.8% 1.8% 1.8% 1.8% 1.8% 1.8% 1.8% 1.8%
Restated Income Statement 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Sales 35,553 35,823 38,416 40,185 42,286 44,104.3 46,000.8 47,978.8 50,041.9 52,193.7 54,438.0 56,778.9 59,220.4 61,766.8 64,422.8
COGS 25,019 25,228 27,303 28,604 30,133 31,490.5 32,844.6 34,256.9 35,729.9 37,266.3 38,868.8 40,540.1 42,283.3 44,101.5 45,997.9
Gross Profit 10,534 10,595 11,113 11,581 12,153 12,613.8 13,156.2 13,721.9 14,312.0 14,927.4 15,569.3 16,238.8 16,937.0 17,665.3 18,424.9
S,G,&A Exp. 8831 9017 9472 9556 9929 10585 11040.2 11514.9 12010.1 12526.5 13065.1 13626.9 14212.9 14824 15461.5
Operating Profit 772 1,380 1,443 1,825 1,995 1852.38 1932.03 2015.11 2101.76 2192.14 2286.4 2384.71 2487.26 2594.21 2705.76
Interest Expense 442 411 403 396 389 441.0 460.0 479.8 500.4 521.9 544.4 567.8 592.2 617.7 644.2
EBT
76
743
783
1,207
1,374
Income Tax Exp. 311 234 288 369 515
Net Income -212 527 520 849 869 793.877 828.014 863.619 900.754 939.487 979.885 1022.02 1065.97 1111.8 1159.61
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Balance Sheet
The financial forecasting of the balance sheet is directly related to the income
statement. The projection of sales is the key figure from the income statement. Sales
along with assets together form the link between the two. The use of the key ratio
asset turnover is the starting point. Asset turnover is calculated by taking total sales
and dividing by the previous year’s total assets. We found Safeway had a consistent
asset turn of about 2.5. To ensure the closest accuracy, we next utilized net income.
This gave us the ability to use multiple line items to tweak projections. Return on
assets uses net income and divides it by sales. We found this ratio to be right around
5% which when we compared it to our entire projections, it matched well. Net income
was then used to project total equity. Return on equity was found to consistently be a
little more than 15.5%. So we took it a little bit conservatively and used 15%. We
went conservative from having to restate financials. Knowing the off-balance sheet
practices led to mostly conservative projections. Once we had total equity we could
take the two to find current liabilities. Taking total assets and subtracting total equity
gives us total liabilities. Now a good accuracy check is debt to equity. We had found
that our debt to equity had recently fallen to a little below 2. The current projections
we have give a debt to equity of a little over 2. We also decrease debt to equity
gradually about a tenth every couple years because we believe Safeway will continue to
improve its debt reduction. This actually is fine with our conservative estimates.
Now that we have the three main totals: Total Assets, Total Liabilities, and Total
Equity we can begin the components that make these up. We began with current
assets. We took sales again and used the receivables turnover ratio to project out
account receivables. The collectable period was consistently 90 for receivables turnover
which would lead us to believe that Safeway has a 90 day collection policy for
receivables and so we left this ratio perfectly consistent. Next we looked at inventory.
We now brought in cost of goods sold from the income statement. This divided by
inventory gives inventory turnover. Safeway seems to have a pretty constant turnover
of about ten days. So this was our target for estimating. Another measure of
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accountability we used was current assets to current liabilities or current ratio. We
found that the current ratio was consistent throughout our projections at .75 to .85.
This matches Safeway over the last few years. Now we look at non-current assets.
The property turnover is the most essential here. The ratio of total property to sales
was right at 25% for many years. This seemed an accurate degree of measure to
safely project out property additions. Overall we seem to have consistent projections
with our check ratios.
Conclusion
The final stage in our forecasting was to use a couple other ratios to make sure
our estimates were not overcast. A couple of the most important ratios to compare is
the internal growth rate and sustainable growth rate of the company. If projections are
growing faster than your company possibly can than they will be severely skewed. We
found that we were consistently under both growth rates so can relatively conclude that
our projections are accurate as we could make them. We believe that Safeway has
found a profitable and efficient strategy in the grocery market. We also believe they
will continue to prove they can improve sales growth over the next ten years. Their
efficiency and operating productivity will support our forecast.
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Actual Balance Sheet Year-end Year-end Year-end Year-end Year-end Year-end2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
AssetsCurrent assets:
Cash and equivalents $76.00 $174.80 $266.80 $373.30 $216.60 $277.80 $281.38 $293.48 $306.10 $319.26 $332.99 $361.20 $376.74 $392.94 $409.83 $427.45Receivables $431.60 $383.20 $339.00 $350.60 $461.20 $577.90 $484.66 $505.50 $527.24 $549.91 $573.56 $598.22 $623.94 $650.77 $678.76 $707.94
Merchandise inventories, net of LIFO reserve $2,717.80 $2,642.20 $2,740.70 $2,766.00 $2,642.50 $2,797.80 $3,149.05 $3,284.46 $3,425.69 $3,572.99 $3,726.63 $3,886.88 $4,054.01 $4,228.33 $4,410.15 $4,599.79Prepaid expenses and other current assets $233.10 $307.50 $251.20 $212.50 $245.40 $354.00
Total current assets $3,458.50 $3,507.70 $3,597.70 $3,702.40 $3,565.70 $4,007.50 $4,019.76 $4,192.61 $4,372.89 $4,560.93 $4,757.05 $5,160.06 $5,381.95 $5,613.37 $5,854.75 $6,106.50Property:
Land $1,348.70 $1,384.90 $1,396.00 $1,413.90 $1,497.90 $1,597.10Buildings $3,597.10 $3,847.20 $4,269.70 $4,419.10 $4,829.30 $5,461.90
Leasehold improvements $2,467.70 $2,494.80 $2,621.90 $2,958.00 $3,336.90 $3,700.00Fixtures and equipment $5,195.30 $5,539.80 $5,981.30 $6,558.70 $7,199.00 $7,898.20
Property under capital leases $684.30 $758.10 $773.80 $779.10 $777.40 $767.00$13,293.10 $14,024.80 $15,042.70 $16,128.80 $17,640.50 $19,424.20
Less accumulated depreciation and amortization ($4,762.30) ($5,619.00) ($6,353.30) ($7,031.70) ($7,867.20) ($8,802.20)
Total property, net $8,530.80 $8,405.80 $8,689.40 $9,097.10 $9,773.30 $10,622.00 $11,026.07 $11,500.20 $11,994.70 $12,510.48 $13,048.43 $13,609.51 $14,194.72 $14,805.09 $15,441.71 $16,105.70
Goodwill $3,125.70 $2,404.90 $2,406.60 $2,402.40 $2,393.50 $2,406.30Prepaid pension costs $535.20 $418.70 $321.00 $179.40 $137.30 $73.20
Investments in unconsolidated affiliates $208.30 $191.80 $187.60 $201.80 $219.60 $216.00Other assets $188.70 $167.80 $175.10 $173.80 $184.40 $326.00
Total non-current assets $12,588.70 $11,589.00 $11,779.70 $12,054.50 $12,708.10 $13,643.50 $13,672.85 $14,260.78 $14,873.99 $15,513.58 $16,180.66 $17,551.49 $18,306.20 $19,093.37 $19,914.38 $20,770.70Total assets $16,047.20 $15,096.70 $15,377.40 $15,756.90 $16,273.80 $17,651.00 $17,692.61 $18,453.39 $19,246.89 $20,074.50 $20,937.71 $22,711.55 $23,688.15 $24,706.74 $25,769.13 $26,877.20
Liabilities and Stockholders EquityCurrent liabilities:
Current maturities of notes and debentures $780.50 $699.50 $596.90 $714.20 $790.70 $954.90Current obligations under capital leases $42.50 $50.50 $42.80 $39.10 $40.80 $42.50
Accounts payable $1,811.50 $1,509.60 $1,759.40 $2,151.50 $2,464.40 $2,825.40Accrued salaries and wages $400.90 $406.00 $426.40 $526.10 $485.80 $506.70
Other accrued liabilities $757.20 $664.70 $696.30 $708.80 $719.10 $718.90
Total current liabilities $3,792.60 $3,464.30 $3,792.10 $4,263.90 $4,601.40 $5,136.40 $5,283.07 $5,510.25 $5,555.61 $5,794.51 $6,043.67 $6,396.16 $6,671.20 $6,958.06 $7,257.26 $7,569.32Total non-current liabilities $8,627.10 $7,988.10 $7,278.40 $6,573.30 $6,005.50 $5,812.80 $4,988.50 $4,774.56 $4,745.78 $4,527.15 $4,302.27 $4,851.99 $4,648.02 $4,439.10 $4,225.25 $4,006.52
Long-term debt:Notes and debentures $7,009.90 $6,404.00 $5,469.70 $4,961.20 $4,428.70 $4,093.50
Total debt $8,435.60 $7,822.30 $6,763.40 $6,358.60 $5,868.10 $5,655.10 $4,890.69 $4,680.94 $4,652.72 $4,438.38 $4,217.91 $4,756.85 $4,556.89 $4,352.06 $4,142.40 $3,927.97Total liabilities $12,419.70 $11,452.40 $11,070.50 $10,837.20 $10,606.90 $10,949.20 $10,271.57 $10,284.81 $10,301.39 $10,321.65 $10,345.94 $11,248.16 $11,319.22 $11,397.16 $11,482.50 $11,575.84
proof $3,457.70 $4,204.50 $4,823.10 $5,694.30 $6,443.80 $7,421.03 $8,168.58 $8,945.49 $9,752.85 $10,591.77 $11,463.39 $12,368.92 $13,309.58 $14,286.62 $15,301.35Total stockholders equity $3,627.50 $3,644.30 $4,306.90 $4,919.70 $5,666.90 $6,701.80 $7,421.03 $8,168.58 $8,945.49 $9,752.85 $10,591.77 $11,463.39 $12,368.92 $13,309.58 $14,286.62 $15,301.35
Net Income/Starting Line ($828.10) ($169.80) $560.20 $561.10 $870.60 $888.40 $837.98 $874.01 $911.60 $950.80 $991.68 $1,034.32 $1,078.80 $1,125.19 $1,173.57 $1,224.03 Total Cash Dividends Paid - $0.00 $0.00 ($44.90) ($96.00) ($111.50) ($118.75) ($126.47) ($134.69) ($143.44) ($152.76) ($162.69) ($173.27) ($184.53) ($196.53) ($209.30)
Retained Earnings (Accumulated Deficit) $4,287.60 $4,117.80 $4,678.00 $5,171.70 $5,943.50 $6,829.50 $7,548.73 $8,296.28 $9,073.19 $9,880.55 $10,719.47 $11,591.09 $12,496.62 $13,437.28 $14,414.32 $15,429.05$4,117.80 $4,678.00 $5,194.20 $5,946.30 $6,720.40 $7,548.73 $8,296.28 $9,073.19 $9,880.55 $10,719.47 $11,591.09 $12,496.62 $13,437.28 $14,414.32 $15,429.05
Total liabilities & equity $16,047.20 $15,096.70 $15,377.40 $15,756.90 $16,273.80 $17,651.00 $17,692.61 $18,453.39 $19,246.89 $20,074.50 $20,937.71 $22,711.55 $23,688.15 $24,706.74 $25,769.13 $26,877.20
143
Consolidated Balance Sheet Year-end Year-end Year-end Year-end Year-end Year-end2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
AssetsCurrent assets:
Cash and equivalents 0.5% 1.2% 1.7% 2.4% 1.3% 1.6% 1.6% 1.6% 1.6% 1.6% 1.6% 1.6% 1.6% 1.6% 1.6% 1.6%Receivables 2.7% 2.5% 2.2% 2.2% 2.8% 3.3% 2.7% 2.7% 2.7% 2.7% 2.7% 2.6% 2.6% 2.6% 2.6% 2.6%
Merchandise inventories, net of LIFO reserve 16.9% 17.5% 17.8% 17.6% 16.2% 15.9% 17.8% 17.8% 17.8% 17.8% 17.8% 17.1% 17.1% 17.1% 17.1% 17.1%Prepaid expenses and other current assets 1.5% 2.0% 1.6% 1.3% 1.5% 2.0%
Total current assets 21.6% 23.2% 23.4% 23.5% 21.9% 22.7% 22.7% 22.7% 22.7% 22.7% 22.7% 22.7% 22.7% 22.7% 22.7% 22.7%Property:
Land 8.4% 9.2% 9.1% 9.0% 9.2% 9.0%Buildings 22.4% 25.5% 27.8% 28.0% 29.7% 30.9%
Leasehold improvements 15.4% 16.5% 17.1% 18.8% 20.5% 21.0%Fixtures and equipment 32.4% 36.7% 38.9% 41.6% 44.2% 44.7%
Property under capital leases 4.3% 5.0% 5.0% 4.9% 4.8% 4.3%82.8% 92.9% 97.8% 102.4% 108.4% 110.0%
Less accumulated depreciation and amortization -29.7% -37.2% -41.3% -44.6% -48.3% -49.9%
Total property, net 53.2% 55.7% 56.5% 57.7% 60.1% 60.2% 62.3% 62.3% 62.3% 62.3% 62.3% 59.9% 59.9% 59.9% 59.9% 59.9%
Goodwill 19.5% 15.9% 15.7% 15.2% 14.7% 13.6%Prepaid pension costs 3.3% 2.8% 2.1% 1.1% 0.8% 0.4%
Investments in unconsolidated affiliates 1.3% 1.3% 1.2% 1.3% 1.3% 1.2%Other assets 1.2% 1.1% 1.1% 1.1% 1.1% 1.8%
Total non-current assets 78.4% 76.8% 76.6% 76.5% 78.1% 77.3% 77.3% 77.3% 77.3% 77.3% 77.3% 77.3% 77.3% 77.3% 77.3% 77.3%Total assets 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Liabilities and Stockholders EquityCurrent liabilities:
Current maturities of notes and debentures 6.3% 6.1% 5.4% 6.6% 7.5% 8.7%Current obligations under capital leases 0.3% 0.4% 0.4% 0.4% 0.4% 0.4%
Accounts payable 14.6% 13.2% 15.9% 19.9% 23.2% 25.8%Accrued salaries and wages 3.2% 3.5% 3.9% 4.9% 4.6% 4.6%
Other accrued liabilities 6.1% 5.8% 6.3% 6.5% 6.8% 6.6%
Total current liabilities 30.5% 30.2% 34.3% 39.3% 43.4% 46.9% 51.4% 53.6% 53.9% 56.1% 58.4% 56.9% 58.9% 61.1% 63.2% 65.4%Total non-current liabilities 69.5% 69.8% 65.7% 60.7% 56.6% 53.1% 48.6% 46.4% 46.1% 43.9% 41.6% 43.1% 41.1% 38.9% 36.8% 34.6%
Long-term debt:Notes and debentures 56.4% 55.9% 49.4% 45.8% 41.8% 37.4%
Total debt 67.9% 68.3% 61.1% 58.7% 55.3% 51.6% 47.6% 45.5% 45.2% 43.0% 40.8% 42.3% 40.3% 38.2% 36.1% 33.9%Total liabilities 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%Total liabilities 77.4% 75.9% 72.0% 68.8% 65.2% 62.0% 58.1% 55.7% 53.5% 51.4% 49.4% 49.5% 47.8% 46.1% 44.6% 43.1%
Total stockholders equity 22.6% 24.1% 28.0% 31.2% 34.8% 38.0% 41.9% 44.3% 46.5% 48.6% 50.6% 50.5% 52.2% 53.9% 55.4% 56.9%
Total liabilities & equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
144
Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end
Restated Balance Sheet 2002.00 2003.00 2004.00 2005.00 2006.00 2007.00 2008.00 2009.00 2010.00 2011.00 2012.00 2013.00 2014.00 2015.00 2016.00 2017.00Assets
Current assets:Cash and equivalents $76.00 $174.80 $266.80 $373.30 $216.60 $277.80 291.60 292.73 316.10 329.69 347.96 362.92 374.07 390.16 406.93 424.43
Receivables 431.60 383.20 339.00 350.60 461.20 577.90 484.66 505.50 527.24 549.91 573.56 598.22 623.94 650.77 678.76 707.94Merchandise inventories, net of LIFO reserve 2,717.80 2,642.20 2,740.70 2,766.00 2,642.50 2,797.80 3,149.05 3,284.46 3,425.69 3,572.99 3,726.63 3,886.88 4,054.01 4,228.33 4,410.15 4,599.79
Prepaid expenses and other current assets 233.10 307.50 251.20 212.50 245.40 354.00
Total current assets 3,458.50 3,507.70 3,597.70 3,702.40 3,565.70 4,007.50 4,165.70 4,181.89 4,515.65 4,709.83 4,970.83 5,184.57 5,343.89 5,573.68 5,813.35 6,063.32
Property:Land 1,348.70 1,384.90 1,396.00 1,413.90 1,497.90 1,597.10
Buildings 3,597.10 3,847.20 4,269.70 4,419.10 4,829.30 5,461.90Leasehold improvements 2,467.70 2,494.80 2,621.90 2,958.00 3,336.90 3,700.00Fixtures and equipment 5,195.30 5,539.80 5,981.30 6,558.70 7,199.00 7,898.20
Property under capital leases 684.30 758.10 773.80 779.10 777.40 767.0013,293.10 14,024.80 15,042.70 16,128.80 17,640.50 19,424.20
Less accumulated depreciation and amortization -4762.30 -5619.00 -6353.30 -7031.70 -7867.20 -8802.20
8,530.80 8,405.80 8,689.40 9,097.10 9,773.30 10,622.00
===>ADJUSTMENT TO PROP, PLANT, & EQUIP<=== 2,081.30 2,423.97 2,386.24 2,373.82 2,391.78 2,743.86
Total property, net 10,612.10 10,829.77 11,075.64 11,470.92 12,165.08 13,365.86 13,231.29 13,800.23 14,393.64 15,012.57 15,658.11 16,331.41 17,033.66 17,766.11 18,530.05 19,326.84
Goodwill 3,125.70 2,404.90 2,406.60 2,402.40 2,393.50 2,406.30Prepaid pension costs 535.20 418.70 321.00 179.40 137.30 73.20
Investments in unconsolidated affiliates 208.30 191.80 187.60 201.80 219.60 216.00Other assets 188.70 167.80 175.10 173.80 184.40 326.00
Total non-current assets 14,670.00 14,012.97 14,165.94 14,428.32 15,099.88 16,387.36 16,539.11 18,400.31 19,191.53 20,016.76 20,877.48 21,775.21 22,711.55 23,688.15 24,706.74 25,769.13
Total assets 18,128.50 17,520.67 17,763.64 18,130.72 18,665.58 20,394.86 20,828.48 20,909.45 22,578.27 23,549.13 24,854.15 25,922.87 26,719.47 27,868.41 29,066.75 30,316.62
Liabilities and Stockholders Equity
Current liabilities:Current maturities of notes and debentures $780.50 $699.50 $596.90 $714.20 $790.70 $954.90
Current obligations under capital leases 42.50 50.50 42.80 39.10 40.80 42.50Accounts payable 1,811.50 1,509.60 1,759.40 2,151.50 2,464.40 2,825.40
Accrued salaries and wages 400.90 406.00 426.40 526.10 485.80 506.70
Other accrued liabilities 757.20 664.70 696.30 708.80 719.10 718.90
===>ADJUSTMENT TO DEFFERED TAX LIABILITY<=== (20.03) (22.57) (18.01) (22.36) (11.59) (10.33)
Total current liabilities 3,772.57 3,307.73 3,503.79 4,117.34 4,489.21 5,038.07 4,900.82 4,919.87 5,312.53 5,540.97 5,848.03 6,099.50 6,286.93 6,557.27 6,839.23 7,133.32
Total debt 8,435.60 7,822.30 6,763.40 6,358.60 5,868.10 5,655.10Long-term debt:
Notes and debentures 7,009.90 6,404.00 5,469.70 4,961.20 4,428.70 4,093.50191.5 299.8 785.3 338.9 238.0 245.7
===>ADJUSTMENT TO LONG-TERM LEASE<=== 2138.51 2488.46 2437.70 2437.70 2424.90 2773.39
Total non-current liabilities 10,765.61 10,610.56 9,986.40 9,135.20 8,531.00 8,674.19 5,971.24 5,321.57 5,622.24 5,863.99 6,143.44 6,407.60 6,653.44 6,939.54 7,237.94 7,549.17Total liabilities 14,538.19 13,918.29 13,490.19 13,252.54 13,020.21 13,712.25 14,908.48 15,322.90 16,751.50 17,471.82 18,515.51 19,311.67 19,823.98 20,676.42 21,565.50 22,492.82
3,627.50 3,644.30 4,306.90 4,919.70 5,666.90 6,701.80
===>ADJUSTMENT TO STOCKHOLDERS EQUITY<=== ($37.19) ($41.92) ($33.45) ($41.52) ($21.53) ($19.19)
Total stockholders equity 3,590.31 3,602.38 4,273.45 4,878.18 5,645.37 6,682.61 5,920.00 5,586.54 5,826.77 6,077.32 6,338.64 6,611.20 6,895.48 7,191.99 7,501.25 7,823.80
Total liabilities & equity $18,128.50 $17,520.67 $17,763.64 $18,130.72 $18,665.58 $20,394.86 20,828.48 20,909.45 22,578.27 23,549.13 24,854.15 25,922.87 26,719.47 27,868.41 29,066.75 30,316.62
145
CONSOLIDATED BALANCE SHEET Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end Year-end
(RESTATED) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017Assets
Current assets:Cash and equivalents 0.4% 1.0% 1.5% 2.1% 1.2% 1.4% 1.4% 1.4% 1.4% 1.4% 1.4% 1.4% 1.4% 1.4% 1.4% 1.4%
Receivables 2.4% 2.2% 1.9% 1.9% 2.5% 2.8% 2.3% 2.4% 2.3% 2.3% 2.3% 2.3% 2.3% 2.3% 2.3% 2.3%Merchandise inventories, net of LIFO reserve 15.0% 15.1% 15.4% 15.3% 14.2% 13.7% 15.1% 15.7% 15.2% 15.2% 15.0% 15.0% 15.2% 15.2% 15.2% 15.2%
Prepaid expenses and other current assets 1.3% 1.8% 1.4% 1.2% 1.3% 1.7%
Total current assets 19.1% 20.0% 20.3% 20.4% 19.1% 19.6% 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% 20.0%
Property:Land 7.4% 7.9% 7.9% 7.8% 8.0% 7.8%
Buildings 19.8% 22.0% 24.0% 24.4% 25.9% 26.8%Leasehold improvements 13.6% 14.2% 14.8% 16.3% 17.9% 18.1%Fixtures and equipment 28.7% 31.6% 33.7% 36.2% 38.6% 38.7%
Property under capital leases 3.8% 4.3% 4.4% 4.3% 4.2% 3.8%73.3% 80.0% 84.7% 89.0% 94.5% 95.2%
Less accumulated depreciation and amortization -26.3% -32.1% -35.8% -38.8% -42.1% -43.2%
47.1% 48.0% 48.9% 50.2% 52.4% 52.1%
===>ADJUSTMENT TO PROP, PLANT, & EQUIP<=== 11.5% 13.8% 13.4% 13.1% 12.8% 13.5%
Total property, net 58.5% 61.8% 62.4% 63.3% 65.2% 65.5% 63.5% 66.0% 63.8% 63.8% 63.0% 63.0% 63.8% 63.8% 63.8% 63.8%
Goodwill 17.2% 13.7% 13.5% 13.3% 12.8% 11.8%Prepaid pension costs 3.0% 2.4% 1.8% 1.0% 0.7% 0.4%
Investments in unconsolidated affiliates 1.1% 1.1% 1.1% 1.1% 1.2% 1.1%Other assets 1.0% 1.0% 1.0% 1.0% 1.0% 1.6%
Total non-current assets 80.9% 80.0% 79.7% 79.6% 80.9% 80.4% 79.4% 88.0% 85.0% 85.0% 84.0% 84.0% 85.0% 85.0% 85.0% 85.0%
Total assets 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Liabilities and Stockholders EquityCurrent liabilities:
Current maturities of notes and debentures 5.4% 5.0% 4.4% 5.4% 6.1% 7.0%Current obligations under capital leases 0.3% 0.4% 0.3% 0.3% 0.3% 0.3%
Accounts payable 12.5% 10.8% 13.0% 16.2% 18.9% 20.6%Accrued salaries and wages 2.8% 2.9% 3.2% 4.0% 3.7% 3.7%
Other accrued liabilities 5.2% 4.8% 5.2% 5.3% 5.5% 5.2%
===>ADJUSTMENT TO DEFFERED TAX LIABILITY<=== -0.1% -0.2% -0.1% -0.2% -0.1% -0.1%
Total current liabilities 25.9% 23.8% 26.0% 31.1% 34.5% 36.7% 32.9% 32.1% 31.7% 31.7% 31.6% 31.6% 31.7% 31.7% 31.7% 31.7%
Total debt 58.0% 56.2% 50.1% 48.0% 45.1% 41.2%Long-term debt:
Notes and debentures 48.2% 46.0% 40.5% 37.4% 34.0% 29.9%1.3% 2.2% 5.8% 2.6% 1.8% 1.8%
===>ADJUSTMENT TO LONG-TERM LEASE<=== 14.7% 17.9% 18.1% 18.4% 18.6% 20.2%
Total non-current liabilities 74.1% 76.2% 74.0% 68.9% 65.5% 63.3% 40.1% 34.7% 33.6% 33.6% 33.2% 33.2% 33.6% 33.6% 33.6% 33.6%
Total liabilities 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
20.0% 20.8% 24.2% 27.1% 30.4% 32.9%
===>ADJUSTMENT TO STOCKHOLDERS EQUITY<=== -0.2% -0.2% -0.2% -0.2% -0.1% -0.1%
Total stockholders equity 19.8% 20.6% 24.1% 26.9% 30.2% 32.8% 28.4% 26.7% 25.8% 25.8% 25.5% 25.5% 25.8% 25.8% 25.8% 25.8%
Total liabilities & equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
146
Statement of Cash Flows
The final financial statement we forecasted was the statement of cash flows. The
statement of cash flows is extremely important information to analyze for potential
investors. The statement of cash flows was forecasted using the same starting point the
other financials do. Sales are the key forecasting number. Sales along with cash flow
from operations provide the starting ratio for forecasting. We took CFFO and divided it
by sales to find CFFO to Sales. We found that this was an extremely consistent ratio.
Our CFFO/Sales was .05 for almost every year. We used this to project cash flow from
operation through the next ten years. Next was the projection of retained earnings. In
order to estimate this we took: the dividends paid for the last years, net income from
previous years plus projected net income through ten years, and retained earnings of
the previous years. In order to be as accurate as possible we did not attempt to
forecast dividends but merely used the last paid dividend and forecasted that out for
the ten year period. Then to find retained earnings you take the previous years
retained earnings add the present years net income add finally subtract off our
dividends.
We believe Safeway will be profitable throughout the next ten year period. Since
we forecasted out dividends by only using the latest dividend paid then it safe to
assume that dividends will most likely be understated in the future. This will ultimately
lead to overestimated retained earnings.
147
In Millions of (except for per share items)
Statement Of Cash Flows
Net Income/Starting Line (828.10) (169.80) 560.20 561.10 870.60 888.40 837.98 874.01 911.60 950.80 991.68 1,034.32 1,078.80 1,125.19 1,173.57 1,224.03
Depreciation/Depletion 888.30 863.60 894.60 932.70 991.40 1071.20
Amortization - - - - - -
Deferred Taxes 64.90 (77.90) (29.20) (215.90) 1.10 130.80
Non-Cash Items 2220.10 1256.70 262.60 292.20 130.50 54.50
Changes in Working Capital (310.50) (263.00) 538.20 310.90 181.40 45.60
Cash from Operating Activities 2034.70 1609.60 2226.40 1881.00 2175.00 2190.50 2205.21 2300.04 2398.94 2502.10 2609.69 2721.90 2838.94 2961.02 3088.34 3221.14
Capital Expenditures (1467.40) (935.80) (1212.50) (1383.50) (1674.20) (1768.70)
Other Investing Cash Flow Items, Total 71.70 140.80 142.20 70.00 (60.50) 82.30
Cash from Investing Activities (1395.70) (795.00) (1070.30) (1313.50) (1734.70) (1686.40) (1764.17) (1840.03) (1919.15) (2001.68) (2087.75) (2177.52) (2271.15) (2368.81) (2470.67) (2576.91)
Financing Cash Flow Items (14.20) (3.60) (6.60) 5.50 265.40 38.10
Total Cash Dividends Paid 0.00 0.00 0.00 (44.90) (96.00) (111.50)
Issuance (Retirement) of Stock, Net (1471.10) 24.40 17.40 (272.60) (119.30)
Issuance (Retirement) of Debt, Net 854.00 (739.50) (1095.40) (444.90) (493.10) (261.30)
Cash from Financing Activities (631.30) (724.00) (1077.60) (466.90) (596.30) (454.00) (490.18) (465.30) (463.41) (459.72) (466.90) (500.58) (524.99) (547.56) (571.11) (595.67)
Foreign Exchange Effects (0.20) 8.20 13.50 5.90 (0.70) 11.10
Net Change in Cash 7.50 98.80 92.00 106.50 (156.70) 61.20
Total Cash Dividends Paid 0.00 0.00 0.00 (44.90) (96.00) (111.50) (123.77) (137.38) (152.49) (169.26) (187.88) (208.55) (231.49) (256.96) (285.22) (316.60)
Retained Earnings 4,287.60 4,117.80 4,678.00 5,171.70 5,943.50 6,829.50 7,543.72 8,280.35 9,039.46 9,820.99 10,624.79 11,450.56 12,297.87 13,166.10 14,054.44 14,961.88
Net Income/Starting Line (828.10) (169.80) 560.20 561.10 870.60 888.40 837.98 874.01 911.60 950.80 991.68 1,034.32 1,078.80 1,125.19 1,173.57 1,224.03
4117.80 4678.00 5194.20 5946.30 6720.40 7,543.72 8,280.35 9,039.46 9,820.99 10,624.79 11,450.56 12,297.87 13,166.10 14,054.44 14,961.88
CFFO/Sales 0.06 0.05 0.06 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05CFFO / NI (2.46) (9.48) 3.97 3.35 2.50 2.47 2.63 2.63 2.63 2.63 2.63 2.63 2.63 2.63 2.63 2.74
CFFO / Operating Income 2.15 2.80 1.90 1.55 1.36 1.24 1.35 1.35 1.35 1.35 1.35 1.35 1.35 1.35 1.35 1.35
CFFO / Gross Profit 0.19 0.15 0.21 0.17 0.19 0.18 0.17 0.17 0.17 0.17 0.17 0.17 0.17 0.17 0.17 0.17
Sales 34767.50 35552.70 35822.90 38416.00 40185.00 42286.00 44104.30 46000.78 47978.82 50041.91 52193.71 54438.04 56778.87 59220.36 61766.84 64422.81Net Income/Starting Line (828.10) (169.80) 560.20 561.10 870.60 888.40 837.98 874.01 911.60 950.80 991.68 1,034.32 1,078.80 1,125.19 1,173.57 1,173.57
Gross Profit 10,996.40 10,724.00 10,595.00 11,113.00 11,581.00 12,153.00 12,613.83 13,156.22 13,721.94 14,311.98 14,927.40 15,569.28 16,238.76 16,937.02 17,665.32 18,424.92Operating Profit 947.6 574.000 1173.000 1215.000 1600.000 1772.000 1631.859 1702.029 1775.216 1851.551 1931.167 2014.207 2100.818 2191.153 2285.373 2383.644
CFFO/CFFI (820.40) (79.20) 638.70 661.70 714.60 938.50 788.84 868.73 927.97 991.50 1046.72 1078.12 1121.60 1169.83 1220.13 1272.60Net Property 8530.8 8405.8 8689.4 9097.1 9773.3 10622 11026.075 11500.1957 11994.7041 12510.4764 13048.4269 13609.509 14194.7181 14805.091 15441.7099 16105.7035
Total current liabilities 3792.6 3464.3 3792.1 4263.9 4601.4 5136.4 4567.9099 4764.33003 4969.19622 5182.87166 5405.73514 5863.709 6115.84851 6378.82999 6653.11968 6939.20383Total non-current liabilities 8627.1 7988.1 7278.4 6573.3 6005.5 5812.8 5703.6647 5520.47798 5332.19647 5138.78195 4940.20631 5384.4466 5203.37464 5018.32851 4829.38511 4636.64073
-125 283.6 407.7 676.2 848.7 404.0745 474.121203 494.508415 515.772277 537.950485 561.08236 585.208897 610.37288 636.618914 663.993527TL & OE 16,047.20 15,096.70 15,377.40 15,756.90 16,273.80 17,651.00 17,692.61 18,453.39 19,246.89 20,074.50 20,937.71 22,711.55 23,688.15 24,706.74 25,769.13 26,877.20
(950.50) 280.70 379.50 516.90 1,377.20 41.61 760.78 793.50 827.62 863.20 1,773.84 976.60 1,018.59 1,062.39 1,108.07
Retained Earnings (Proof) BB RE + NI - DIV
2014 2015 20162006 2007 2008 20092002 2003 2004 2005 20172010 2011 2012 2013
148
In Millions of (except for per share items)
Statement of Cashflows (consolidated)
Net Income/Starting Line (828.10) (169.80) 560.20 561.10 870.60 888.40 837.98 874.01 911.60 950.80 991.68 1,034.32 1,078.80 1,125.19 1,173.57 1,224.03
Depreciation/Depletion 43.7% 53.7% 40.2% 49.6% 45.6% 48.9%
Amortization
Deferred Taxes 3.2% -4.8% -1.3% -11.5% 0.1% 6.0%
Non-Cash Items 109.1% 78.1% 11.8% 15.5% 6.0% 2.5%
Changes in Working Capital -15.3% -16.3% 24.2% 16.5% 8.3% 2.1%
Cash from Operating Activities 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Capital Expenditures 105.1% 117.7% 113.3% 105.3% 96.5% 104.9%
Other Investing Cash Flow Items, Total -5.1% -17.7% -13.3% -5.3% 3.5% -4.9%
Cash from Investing Activities 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Financing Cash Flow Items 2.2% 0.5% 0.6% -1.2% -44.5% -8.4%
Total Cash Dividends Paid 9.6% 16.1% 24.6%
Issuance (Retirement) of Stock, Net 233.0% -2.3% -3.7% 45.7% 26.3%
Issuance (Retirement) of Debt, Net -135.3% 102.1% 101.7% 95.3% 82.7% 57.6%
Cash from Financing Activities 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Total Cash Dividends Paid 0.0% 0.0% 0.0% -0.9% -1.6% -1.6% -1.6% -1.7% -1.7% -1.7% -1.8% -1.8% -1.9% -2.0% -2.0% -2.1%
Retained Earnings 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Net Income/Starting Line -19.3% -4.1% 12.0% 10.8% 14.6% 13.0% 11.1% 10.6% 10.1% 9.7% 9.3% 9.0% 8.8% 8.5% 8.4% 8.2%
0.96 1.12 1.10 1.13 1.11 1.09 1.09 1.08 1.08 1.08 1.07 1.07 1.07 1.06 1.06
2004 2005 20172010 2011 2012 2013
Retained Earnings (Proof) BB RE + NI - DIV
2014 2015 20162006 2007 2008 20092002 2003
149
Cost of Capital
Valuation of a firm begins with one of the most complex and intricate processes
of the financial world. It utilizes conceptual as well as analytical processes that can
take up incredible amounts of time. First of all we need to understand exactly what we
are valuing. Companies are composed of two major cost structure forms, which can be
funded by either debt or equity. This funding is referred to as capital. Capital is the
boilerplate term for all resources including cash, machinery, property even people. So,
theoretically it is the overall value of a given firm. This is exactly what we are looking
for. This is the starting place of all firm valuations. The first goal we seek is that of
finding the cost of capital. It is unarguably a difficult procedure, with many analytical
elements. We will use these elements to try to establish an overall value of the
company. We begin by breaking down the elements of cost; in this case, it is what we
refer to as the cost of capital. Essentially there are two major elements, first the cost of
debt. This is the interest rates given to all liabilities which is then weighted and
averaged. Next there is the cost of equity. The cost of equity is found by using the
Capital Asset Pricing Model or (CAPM) as it will be referred. We begin with the
tangibles.
Cost of Debt
Debt is what we typically know as a loan. This form is commonly structured by
securing some form of collateral, in the exchange of financial funds that will help
someone establish their new firm. All funds are given an interest rate in which they will
be paid back. This is the cost incurred by the firm; hence this is the cost for debt that
we are looking for. You have seen many references to the 10K already. It is kind of
beginner’s guidebook to valuation, so to speak, only not really for beginners. This is
usually a couple hundred page document required by the SEC of publicly traded
companies. It is a wealth of information, sometimes too much and some times too
little. We discussed this in the Accounting disclosure section earlier. Fortunately many
rates we are looking for are disclosed in Safeway’s 10K. For those not disclosed we
used the Commercial Paper Rates provided from the St. Louis Federal Reserve. Rates
provided in the 10K include: Long-term debt, current portion of long-term debt, capital
150
lease obligations and the largest rate from the 10K figures was used for other liabilities.
Those not included in the 10K include accounts accrued expenses, and deferred income
taxes. The Fed Rates were used in these instances. After assigning an appropriate rate
for each line item of liabilities each line was then weighted against total liabilities. Once
all weights are found we then multiply the weights by the rates to find the weighted
rate. These are finally all added to compute our cost of debt. A complete breakdown
of average weighted rates is provided in the appendix portion. Cost of debt was found
on an as stated and restated basis. These were found to be 4.792% and 5.228%
respectively.
Cost of Equity
Equity financing is the raising of capital through the sale of common stock. The
firm exchanges stock shares to investors, which are perceived as ownership interest, for
monetary funds (typically cash). Stockholders have a rate of return required for them
to purchase shares of common stock. This return is the firms cost of equity. Equity
funding carries more risk to the investors and therefore will almost certainly have a
higher rate than that of debt. The Capital Asset Pricing Model (CAPM) is used to derive
this rate. The CAPM pricing model is defined as:
Ri = Rf + β * Rm
Rf = The Risk Free Rate β= the Beta or systematic risk Rm = Market Risk Premium
There are three parts when figuring CAPM. First the risk free rate (Rf). This is
the rate given to treasury securities that has little to no risk. The most current post of
the 10year US treasury rate was 3.88%, which was the rate used in our computation.
The Rm or market risk premium is that amount investor’s demand in assuming the
extra risk. It is stated in Palepu & Healy that this market premium, over the last 80
years has been about 6.8. This has been the excess of returns over the S & P 500 for
this time period. They also suggest that because of this, most analysts assume the
market risk premium around 7.0%. This is the rate which was used within our
calculations. The β or Beta which it is referred, is a volatility factor given to a stock. It
151
is also known as systematic risk and explains how well the stock moves with the
market. A stock with a beta of 1 indicates its price will move with the market
(www.investopedia.com). Anything over 1 is considered more volatile than the market
and anything lower than 1 is considered less volatile. Beta is figured through a series of
statistical analysis regressions using the actual stock’s returns and the market risk
premium. The first step in our regression analysis was to download the closing stock
prices for 1st of every month since Jan. 1, 2000. Next the S&P 500 returns along with
were downloaded for the exact same time frame. In order to find the most accurate
estimation, 5 different variations of the US Treasury rates were downloaded. These
included rates from the 3 month, 6 month, 2 Year, 5 Year, and 10 Year treasuries. All
prices downloaded corresponded to the dates used for Safeway and the S&P 500. Each
S&P return was matched with its treasury (Rf) return. The Rf was then subtracted from
the S&P to come up with a market return. These market returns along with the
corresponding stock’s returns were then run in a regression program 5 times for each
time horizon. Each regression lowered the number of monthly observations by 12. A
total of 25 regressions were conducted in all. Statistical output is then recorded and
analyzed. In order to understand the regression results, a few basic statistical terms
are necessary. First the result, what we were estimating for, the X variable 1. This is
the estimated beta the regression produced. Next the Adjusted R² is the % of variation
in the dependant variable that is explained by the variation in the dependant variable.
If we have a .94 X variable with a .163 Adjusted R², than we can say; for a estimated
beta of .94 only 16.3% of the stock price variation is explained by the market risk
variation. So the model is only 16.3% sure the beta is .94 using these variables. We
used the following overall regression results to estimate our beta used.
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3 Month Rate
Adjusted R
Square X Variable 1 t Stat P-value Lower 95% Upper 95%
72 0.163 0.940 3.846 0.000 0.453 1.428 60 0.104 0.919 2.797 0.007 0.261 1.577 48 0.161 1.077 3.162 0.003 0.391 1.763 36 0.207 1.055 3.188 0.003 0.383 1.728 24 0.165 0.949 2.354 0.028 0.113 1.786
12 0.629 1.250 4.434 0.001 0.622 1.877
6 Month Rate
Adjusted R
Square X Variable 1 t Stat P-value Lower 95% Upper 95%
72 0.162 0.939 3.841 0.000 0.452 1.427 60 0.104 0.919 2.796 0.007 0.261 1.576 48 0.161 1.077 3.160 0.003 0.391 1.763 36 0.207 1.055 3.184 0.003 0.382 1.728 24 0.164 0.948 2.349 0.028 0.111 1.785
12 0.627 1.250 4.419 0.001 0.620 1.880
2 Year Rate
Adjusted R
Square X Variable 1 t Stat P-value Lower 95% Upper 95%
72 0.164 0.942 3.858 0.000 0.455 1.430 60 0.104 0.922 2.802 0.007 0.264 1.581 48 0.161 1.080 3.168 0.003 0.394 1.766 36 0.207 1.056 3.183 0.003 0.382 1.730 24 0.164 0.948 2.347 0.028 0.110 1.787
12 0.627 1.254 4.412 0.001 0.621 1.888
5 Year Rate
Adjusted R
Square X Variable 1 t Stat P-value Lower 95% Upper 95%
72 0.170 0.957 3.939 0.000 0.472 1.441
60 0.109 0.941 2.863 0.006 0.283 1.600
48 0.167 1.090 3.223 0.002 0.409 1.770 36 0.207 1.048 3.188 0.003 0.380 1.716 24 0.167 0.943 2.366 0.027 0.116 1.770
12 0.623 1.252 4.379 0.001 0.615 1.888
10 Year Rate
Adjusted R
Square X Variable 1 t Stat P-value Lower 95% Upper 95%
72 0.167 0.952 3.908 0.000 0.466 1.438 60 0.106 0.932 2.831 0.006 0.273 1.590 48 0.164 1.085 3.200 0.002 0.403 1.768
======> 36 0.208 1.053 3.192 0.003 0.383 1.724 <====== 24 0.166 0.948 2.362 0.027 0.116 1.780
12 0.626 1.254 4.406 0.001 0.620 1.889
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It was determined from our statistical analysis that the 36 month slice from our
10 Year comparable results produced the highest R² result. Our 36 month result gave
us an estimated beta of 1.053. It was consistently evident the 36 month slice to
produce the highest possible R². Even though the 12 month projections are listed, it
was deemed too short a time span to accurately depict a beta coefficient. (Full
regression analysis statistics are available in the appendix section). We now have an
estimated beta of 1.053. There is one final value we will need to estimate the Cost of
Equity. It is the “size effect” premium modification to CAPM which adjusts for smaller
firm volatility in long-run average returns. As stated in table 8-1 from Palepu & Healy,
Safeway’s market capitalization of 12.9 Billion, places the firm in the 9th decile range
making the adjustment +0.7 to CAPM. We can now use the CAPM to estimate Ke given
all estimates. When we plug all factors into the CAPM formula we derive:
Ri = Rf + β * Rm + Size Prem
11.952 3.88 1.053 7 + 0.07
When we take the regression statistics a bit further we notice there is also an upper
bound and lower bound determination. These are lower and upper estimates of beta
within the 95th percentile. When we plug out upper and lower bound estimates into
CAPM the following calculations occur:
Lower 95% Ri = Rf + β * Rm + Size Prem 0.383 6.561 3.88 0.383 7 + 0.07
Upper 95% Ri = Rf + β * Rm + Size Prem 1.724 15.948 3.88 1.724 7 + 0.07
These calculations state that with 95% accuracy we can determine beta to be above
.383 and 95% accurate that beta is under 1.724. Our initial estimate of 1.053 is well
within this parameter.
154
Back Door Cost of Equity
In the world of analysts accuracy is your credibility and not many analysts would
provide such important figures with such little (21%) degree of accuracy. At this time
we decided to utilize a back door method of determining beta. This is known as the
price to book method. The formula is given as:
MVE = BVE ( 1 +
(ROE-Ke) ) (Ke – g)
Where: MVE = Market Value of Equity BVE = Book Value of Equity
ROE = Return on Equity Ke = cost of Equity g = growth rate
To solve for Ke basic algebra will construct a cost of equity formula given as:
Ke = ROE + ( P/B - 1 ) g
P/B
Where: P = MVE and B = BVE
Utilizing financial information provided from the 10K and our own ratio analysis; we can
derive Ke using assumptions of:
ROE = 0.157 P = 31.87 B = 6701.8
Shares = 441.3 PPS = 15.1865
g = 0.046
When we plug all these into our formula we derive Ke = 12.145.
This back door derivation has provided an essential element of our cost estimates.
With the new estimate of 12.145 we can safely conclude that the original beta
regression estimates were much closer than 21% explanation power, and can safely
assume original estimations of CAPM to be accurate.
155
Weighted Average Cost of Capital
We have all numerical values necessary to compute our Weighted Average Cost
of Capital also known as (WACC). If we recall Kd was found to be 4.792% as stated
and 5.228% restated. Ke has now been determined at 11.952. The weighted average
cost of capital is an overall cost of capital using both cost of equity and cost of debt.
The estimated costs we have determined will be the weights factored into the WACC
formula. There are two WACC formulas, a before tax WACC and an after tax WACC.
Which one used depends on the raw data used to compute Kd. If we determine all
figures used were raw not yet taxed, we then use the before tax WACC and derive:
WACC BT Vd (Kd) + Ve (Ke)
= Vf Vf
WACC BT As Stated WACC BT Restated Vd = $ 10,949.20 Vd = $ 13,712.25 Kd = 0.05 Kd = 0.05 Ve = $ 14,064.20 Ve = $ 14,064.23 Ke = 0.12 Ke = 0.12 Vf = $ 25,013.40 Vf = $ 27,776.48
9.01% 8.42%
If it determined that the after tax WACC is used then the computation is:
WACC AT Vd (Kd) * (1- T) + Ve (Ke)
= Vf Vf
WACC AT As Stated WACC AT Restated Vd = $ 10,949.20 Vd = $ 13,712.25 Kd = 0.05 Kd = 0.05 1-T = 0.65 1-T = 0.65 Ve = $ 14,064.20 Ve = $ 14,064.23 Ke = 0.12 Ke = 0.12 Vf = $ 25,013.40 Vf = $ 27,776.48
8.21% 7.59%
156
Valuation Analysis
We are now ready to estimate the value of the firm using pricing models
developed to determine such value. There are two distinct forms of pricing models we
will be using. The first will be a set of comparables. These are used to determine value
from industry competitors. Typically an industry average is determined and then used
as the benchmark multiplier of the firm being valued. There are eight different
comparable models. We will use each to derive an estimated price which shall help to
determine the nature of value of the firm. Generally the estimates are stated as the
firm being undervalued or overvalued by comparable model. Typically these models are
referred as the “the quick and easy method” to valuation. They are not derived from
any real financial theory and are better utilized for determining industry averages than
as a sound pricing model. The later models used are generally referred to as intrinsic
valuation. These use much more complex financial theory and analysis and have been
developed using value drivers of a company to derive realistic prices. These will also be
weighted much more heavily on there said outcomes.
Method of Comparables
As stated before the comparable methods to valuation are highly simplistic forms
of valuation to gain quick and easy comparison to the industry as a whole. It is not
recommended they be given much more value than basic insight into industry averages.
The output prices produced should be used as a general point of reference which can
then be used as possible determination of the company being over or under-valued.
Safeway had a closing price of $31.87 on May 30, 2008. This was the price determined
to be used as the June 1, 2008 price since that day fell on a weekend. We will be using
a 20% margin to determine fair value based on model output. All comparable model
output will be stated as over/under-valued within these limits.
20% 20% $ 25.50 <============== $ 31.87 ============> $ 38.24
Determined: Over-Valued
Determined: Slightly Over-Valued (Watch
Area) Determined: Fairly Value Determined:
Under-Valued
157
P/E (Trailing) Multiple
PRICE TO EARNINGS (TRAILING)
PPS EPS P / E VALUATION PRICE
Safeway 31.870 2.013 15.832
$28.63
Safeway (Restated) 31.870 1.970 16.178
Kroger 27.640 1.746 15.830
$28.01
SuperVALU 35.070 2.781 12.611
Whole Foods 29.000 11.560 2.509 INDUSTRY AVERAGE
Wal-Mart 57.740 0.331 174.441 14.221
The Price to Earnings (Trailing) multiple uses price per share and earnings per
share as the basis for its industry average. The price is the closing price listed on the
valuation date and id divided by the current period. Each stores P/E is figured and then
averaged. Any company whose numbers fall extremely out of line are ruled an outlier
and not averaged. In this multiple Whole Foods and Wal-Mart are both regarded as
outliers. Using Kroger and SuperVALU an industry average of 14.221 was determined.
This was then multiplied by Safeway’s Earnings per Share on both an as stated and
restated basis. Value price for Safeway was $28.63 and $28.01. The as stated will
always be the uppermost value as the restated will always consist of the lower value.
Both are considered fairly valued. P/E is a multiple commonly used to show investor
willingness to purchase the stock. The higher the P/E multiple the more the investor is
willing to pay per dollar of stock.
158
P/E (Forward) Multiple
PRICE TO EARNINGS (FORWARD)
PPS EPS P / E VALUATION PRICE
Safeway 31.870 1.913 16.660
$33.96
Safeway (Restated) 31.800 2.028 15.680
Kroger 27.640 1.930 14.321
$36.00
SuperVALU 35.070 3.090 11.350
Whole Foods 29.000 1.180 24.576 VALUATION PRICE
Wal-Mart 57.740 2.781 20.762 17.752
This multiple is very similar to the trailing P/E multiple except the inputs are
different. This multiple still uses current price per share, however it uses earnings per
share that are the forecasted EPS for one year out. We shall use the same P/E
technique by dividing price per share by earnings per share. And upon doing this we
have $17.752 industry average. This average was once again taken and multiplied by
Safeway’s earnings per share to produce the estimated valuation price. Both the stated
(top) and restated (bottom) price this firm as fairly valued.
159
P/B Multiple
PRICE TO BOOK
BVE PPS BPS P / B VALUATION PRICE
Safeway 6701.800 31.870 15.186 2.099
$37.57
Safeway (Restated) 6682.610 31.870 15.143 2.105
Kroger 4914.000 27.640 7.656 3.610
$37.46
SuperVALU 5953.000 35.070 31.067 1.129
Whole Foods 1458.800 29.000 11.998 2.417 INDUSTRY AVERAGE
Wal-Mart 64608.000 57.740 16.580 3.483 2.474
The Price to Book multiple is to judge whether a firm’s share price is relative to
their book value of equity. The first step is took find the recorded book value of equity
within the 10K. Next you divide the BVE by the number of outstanding shares to get
the current BPS. After this you divide the current price per share by the calculated
book value per share to find the companies P/B. An industry average can now be
calculated and multiplied by Safeway’s Price per Share to estimate value. Both as
stated and restated prices are considered fairly valued.
D/P Multiple
DIVIDEND TO PRICE
DPS PPS D / P VALUATION PRICE
Safeway 0.288 31.870 0.009 $24.22
Kroger 0.270 27.640 0.010
SuperVALU 0.150 35.070 0.004
Whole Foods 0.460 29.000 0.016 INDUSTRY AVERAGE
Wal-Mart 0.580 57.740 0.010 0.012
160
The dividend to share multiple begins with dividend per share and dividing by
the current price per share. This will produce the D/P benchmark ratio to use and find
the industry average. SuperVALU was not used to such low D/Pratio. We then take our
dividend per share and divide by our industry average to get the relative estimate. This
produces a value below our 20% margin which suggests the firm to be over-valued.
P.E.G. Multiple
PRICE TO EARNINGS TO GROWTH
PPS EPS P / E P.E.G. VALUATION PRICE
Safeway 31.870 2.013 15.832 1.230 $12.07
Kroger 27.640 1.746 15.830 1.320
SuperVALU 35.070 2.781 12.611 1.360
Whole Foods 29.000 11.560 2.509 1.190 INDUSTRY AVERAGE
Wal-Mart 57.740 0.331 174.441 1.420 1.304
Using the P.E.G. multiple can be a little tricky. First you must get your P/E ratio
PPS divided by EPS. Then you will take the P/E multiple and divide it by your
forecasted 5 year growth rate to get the actual P.E.G. ratio. Now you find the industry
average and multiply this back out by the firm’s earnings per share and also by the
growth rate. The P.E.G. calculation produced an estimated share price of $12.07. This
is well below 20% margin stating a highly over-valued stock. This multiple seriously is
affected by the growth rate chosen to forecast. Our conservative growth estimates of
only 4.6% were the reason for such a low valuation. Not much weight can be put into
this model for us seeing as we already knew this was going to seem overvalued. This
is a good example of how estimates can be skewed by the accounting strategies chosen
by managers or in this case the analysts.
161
P/EBITDA
PRICE TO EBITDA
MC P / EBITDA AVG * EBITDA VALUATION PRICE
Safeway 12900.000 4.537 9105.668
$20.63
Safeway (Restated) 12900.000 4.199 9838.400
Kroger 17740.000 3.680 4820.652
$22.29
SuperVALU 6720.000 2.725 2466.055
Whole Foods 3700.000 0.510 7254.902 INDUSTRY AVERAGE
Wal-Mart 225000.000 29.100 7731.959 3.203
EBITDA (S) EBITDA (Res)
Operating Income BB
Operating Income BB
$1,772.10
$1,772.10
Add Depreciation
Add Depreciation
$2,843.30
$1,071.20
$3,072.10
$1,300.00
Add Amortization Add Amortization
$0.00
$0.00
Price to EBITDA is number similar to Cash flow from operations but only in the
aspect that it adds back certain financial activities. First we need to understand EBITDA
it is a recreated number the starts with operating income. This is the BIT part. The
acronym stands for earnings before interest, taxes, depreciation, and amortization. The
easiest way is to use operating income and then add back depreciation and
amortization. We will use market cap as share price and divide the market cap by
EDITBA. Now we have a P/EDITBA we can find our industry average. The P/EBITDA
provided by both Wal-Mart and Whole Foods proved to be outliers as both numbers
162
would severely skew the numbers. So using the other two we can come up with an
average of 3.203. We can take this and multiply it back by the EBITDA found and then
divide that number by shares outstanding to get a per share price. When we do this
both the stated and restated prices are well below margin. This puts the estimation
into the over-valued category for both. EBITDA is generally considered a true
representation of cash flow and real representation of a firms financial position.
P/FCF
PRICE TO FREE CASH FLOW
PPS SHARES OUTSTAND FCF P / FCF VALUATION PRICE
Safeway 31.870 0.438 4.863 6.55 $75.34
Kroger 27.640 0.642 2.580 10.713
SuperVALU 35.070 0.192 1.730 20.272
Whole Foods 29.000 0.127 0.376 77.128 INDUSTRY AVERAGE
Wal-Mart 57.740 3.900 22.210 2.600 15.492
Free Cash Flow
$504.10
CFFO BB
$2,190.50
- CFFI
($1,686.40)
= Total Free Cash Flow
$504.10
The price to free cash flow method is somewhat similar to the EBITDA multiple.
Free cash flow is the true cash from operations generated in a given year. It take into
163
account all the non-operating activities in the number. To find this multiple we begin
with current share price of market capitalization divided by number of outstanding
shares. Then also the first thing is to find actual free cash flow. This is found by taking
cash flow from operations and subtracting cash flow from investing. This is your total
free cash flow. You then take this and divide the current price per share by the free
cash flow. We can now take an industry average an multiply by the firms free cash
flow to find our estimated value. Safeway was found to be significantly undervalued
using this method. Both Wal-Mart and Whole Foods could be used and were tossed as
outliers.
EV / EBITDA
Enterprise Value
EV / EBITDA
$21.53
- Book Value of Liabilities
$10.95
$10.58
+ Cash $ Fin Ins
$11.15
164
ENTERPRISE VALUE / EBITDA
PPS SHARES OUTSTAND EV EBITDA EV/EBITDA VALUATION PRICE
Safeway 31.870 438.000 25.360 2.84 8.920 $11.15
Kroger 27.640 641.823 15.450 3.68 4.198
SuperVALU 35.070 191.617 25.360 2.73 9.306
Whole Foods 29.000 127.586 4.490 0.51 8.804 INDUSTRY AVERAGE
Wal-Mart 57.740 3896.779 268.000 29.10 9.210 7.571
This multiple is very unique because it is the only one that takes debt into
account. It basically looks at a company as if it were being purchased which is a main
reason this multiple is used. We begin by finding the actual enterprise value. First we
take the market cap then add back the book value of liabilities and then subtract cash
and short term investments. We then divide by our EBITDA that we have already
calculated. We can now find our industry average and multiply this by our EBITA to
find our estimated share value. This model has priced Safeway at $11.15 again well
below margin of fair value estimating the stock to be over-priced.
Conclusion
No true conclusion can be derived from the use of multiples. There was an equal
amount over/under valuations from the pricing models. Since these are typically
thought to be the quick and easy way to value a firm it is not too surprising. These
multiples are based on many assumption values that can easily be manipulated. The
intrinsic models will give a much clearer valuation in the next section.
165
Multiple Valuation Models
P/E (T) P/E (F) P/B D/P P.E.G. P/EBITDA P/FCF EV/EBIT
DA
As State
d 28.6259
0815 33.9602
1924 37.5657
8121 24.2182
6718 12.0747792
20.63373725
75.33988617
11.1546926
Restated
28.01442576
36.00173791
37.45821498
22.29413154
Priced Fairly Under Under Over Over Over Under Over
Intrinsic Valuation Models
Intrinsic valuations provide the most accurate picture of the company as they
use financial theories along with value drivers to price firms based on scenarios rather
than individual tools. The models include the Discount Dividend model, Residual
Income, Long Run Residual Income, Discounted Free Cash Flows and Abnormal
Earnings Growth Model.
Discount Dividend Model
g 0.01 0.02 0.03 0.04 0.043 0.1143 4.25 4.5 4.81 5.2 4.96 0.1 5 5.38 6.76 6.52 6.76 0.08 6.6 7.35 10.59 9.95 10.59 Ke 0.06 9.51 11.32 23.52 20.34 23.52 0.04 16.38 23.33 - - - 0.02 51.01 - - - - 0.01 - - - - - Over Valued 20% 20%
$25.50 <===== $
31.87 =====>
$38.24
The discount dividend growth model takes all projected cash flows for a company and
estimates a model price by discounting all the cash flows back to the present day. It
then derives a price for the perpetuity amount. Or the dividend that is to be paid out
with no end date. The main problem with this model rests on the weight that is put on
the value of the perpetuity. Our estimate for cost of equity was used as the discount
166
factor in determining present value of all the dividends. Our dividend cash stream is
fairly young seeing that Safeway just started paying dividends 3 years ago. So we have
grown out dividends fairly conservatively for the next ten years. We gave them an 8%
dividend growth rate. The dividends are then discounted back and added up to find the
year by year sum of all dividends. The present value of all dividends is $3.15. 2018 is
the terminal value of our perpetuity. It was also discounted back by first finding the
present value of an annuity using the formula D(perp)/ divided by k-g. This gives us
the time value of the perpetuity at 2017. We then need to bring this back to present
day by multiplying it by the 2017 present value factor. Then you take the year by year
present value of the dividends and add that to present value of the perpetuity. This is
now our time consistent price. However we still have to bring the time consistent price
forward 5 months. So we multiply it by 1+ the discount rate raised to the 5/12. Our
pricing model like all discount dividend growth models is extremely sensitive to growth
rates. This leaves little room for error when estimating the cost of capital of growth
rates. When we entered our estimated cost of equity along with our continued growth
rate the model produced a time consistent price of $4.96 which states that Safeway is
significantly over-priced. When adjusting for sensitivity when we plugged in a cost of
equity of .02 and a growth rate of .01 there was the only positive time consistent price
of $51.01. This was not a good model in estimating the cost of equity.
167
Residual Income Model
$ 25.50 <===== $ 31.87 =====> $ 38.24
g 0 -0.1 -0.2 -0.3 -0.4 -0.5
0.15 8.52 9.65 10.18 10.46 10.64 10.76
0.1195 11.67 12.81 13.23 13.45 13.59 13.68
0.05 35.37 27.65 26.11 25.44 25.08 24.84
0.03 64.06 36.21 32.57 31.14 30.38 29.90
0.02 100.52 41.90 36.57 34.57 33.53 32.88
0.01 210.90 48.93 41.21 38.48 37.07 36.22
0 - 57.72 46.63 42.93 41.08 39.97
Over Valued
20% 20%
$ 25.50 <===== $ 31.87 =====> $ 38.24
Unlike the dividend growth model, the residual income model has far less
sensitivity from changes in growth. This is a much more reliable model since it does
not rely so heavily on the perpetuity reaction to changes in rates. Negative growth
rates are used in this model in the AEG because unlike the other models they will revert
back to normal levels. The model begins with the beginning balance of book value of
equity and then adds net income of the current year. All forecasted earnings and
dividends are entered into the model along with the book value of equity. Benchmark
(Normal) earnings must then be calculated. This is the previous year book value of
equity times the cost of equity done year by year for all forecasted years. Next
Residual income is calculated. This is done by subtracting normal earnings from net
income. These values are then discounted back to reflect the present value price of
residual income. The total year by year present value of residual income is added up.
The last stated year of the book value of equity is brought down used as the starting
point to come to a model price. The perpetuity which begins in 2018 has to be
discounted back to present value dollars. Next the total value of the year by year
residual income and the total value of the present value of the perpetuity are
subtracted from the book value of equity and we are given our total market value of
168
equity. This now needs to be restated in a per share basis so we divide by the total
number of outstanding shares. We now come up with an initial estimate using our cost
of equity and a 0 growth rate. We enter these values and come with a per share price
of 15.60. Even though the initial estimate was overvalued the sensitivity adjustment
put the price fairly valued as the growth and cost of equity increase.
Long Run Residual Income Model
20% 20%
$ 25.50 <===== $ 31.87 =====> $ 38.24
Ke Kept Constant at 11.95%
g ROE 0.1019 0.2 0.25 0.3 0.35 0.4
0.01 - 11.70 18.97 26.24 33.51 40.78
0.02 - 12.88 20.88 28.88 36.88 44.87
0.03 - 14.32 23.21 32.10 41.00 49.89
0.043 - 16.75 27.15 37.56 46.15 56.16
0.05 - 18.44 29.89 41.34 52.79 64.24
0.06 - 21.54 34.91 48.29 61.66 75.04
0.07 - 25.89 41.97 58.14 74.12 90.20
20% 20%
$ 25.50 <===== $ 31.87 =====> $ 38.24
ROE Kept Constant at 10.19%
Ke g 0.01 0.02 0.03 0.043 0.05 0.06
0.0200 125.41 250.82 - - - -
0.0400 31.85 38.22 95.55 191.11 - -
0.0500 20.11 22.52 40.22 53.62 114.91 -
0.0550 16.18 17.81 29.13 36.42 60.69 145.66
0.0575 14.53 16.24 25.10 30.67 38.35 65.20
0.0600 13.04 14.49 21.73 26.08 38.35 65.20
0.1195 - - - - - -
169
20% 20%
$ 25.50 <===== $ 31.87 =====> $ 38.24
g Kept Constant at .043%
Ke ROE 0.11 0.13 0.157 0.17 0.18 0.19
0.0200 - - - - - -
0.0400 - - - - - -
0.0500 132.84 177.12 236.90 265.69 287.83 309.97
0.0550 71.18 97.06 132.00 148.82 161.76 174.70
0.0575 56.28 77.72 106.67 120.60 131.32 142.04
0.0600 45.76 64.07 88.78 100.68 109.83 118.99
0.1195 - 2.18 7.80 10.51 12.59 -
For the long run residual income model we will use the book value of equity
along with a forecasted return on equity. The long run forecasted growth rate is also
used. We estimated this to be 4.3% since that is what we grew sales out with. Cost of
Equity wil also be used and as we do our sensitivity analysis one o these variables will
always be kept constant. Upon entering our initial estimates of ROE = 15.70% using
the estimated growth and an 11.95 cost of equity the model produced a time consistent
price of $7.80. As we adjust for sensitivity the higher the ROE goes and the lower the
Ke goes the more sensitive the price gets.
170
Abnormal Earnings Growth
Over Valued 20% 20%
$
25.50 <===== $
31.87 =====> $
38.24 0 -0.1 -0.2 -0.3 -0.4 -0.5 0.06 9.82 10.44 10.58 10.64 10.68 10.70 0.08 7.29 8.71 9.04 9.20 9.30 9.36 0.1 5.91 7.41 7.83 8.04 8.16 8.25 0.1195 5.26 6.44 6.88 7.11 7.25 7.35 0.14 4.36 5.65 6.07 6.31 6.45 6.56 0.16 4.13 5.04 5.44 5.66 5.81 5.91 0.18 3.77 4.55 4.92 5.13 5.27 5.37
Analyst Recommendation
We have done an extremely in depth equity valuation of Safeway Inc. The first
the first thing we analyzed was the retail grocery industry. After analyzing the industry
171
as a whole, we were able to carry out an accounting analysis, forecast Safeway’s future
financials, estimate their cost of capital, and finally give an equity valuation. Once we
had gathered this extensive information, we were able to state that through our
analysis Safeway’s share price is overvalued and should not be invested in.
We found that the retail grocery industry is a highly competitive industry. A few
of Safeway’s major competitors are Kroger, Wal-Mart, Supervalu, and Whole Foods.
Safeway and these other four firms hold a large portion of the retail grocery industry
market share. We also found that it is very difficult for new firms to enter this industry.
The large established firms hold the majority of the market share, have efficient
distribution systems, and are therefore able to offer a lower price than a new entrant.
Our accounting analysis displayed to us that there are two main areas of concern
in terms of accounting flexibility. They are pension plan choices (in terms of the chosen
discount rate) and leasing options. Safeway had a red flag by using operating leases
instead of capital leases. Safeway is keeping a large portion of liabilities off of the
balance sheet by using these operating leases. In order to account for this, we restated
Safeway’s income statement and balance sheet. We also carefully looked at Safeway’s
expense and sales manipulation diagnostic ratios to see if they had overstated or
understated net income. We analyzed the ratios meticulously and decided that these
ratios showed no signs of concern to potential investors.
We then forecasted Safeway’s financials and estimated their cost of capital. We
analyzed liquidity, profitability, and capital structure ratios for Safeway and the industry.
In terms of most of these ratios, Safeway is meeting the benchmark in the retail
grocery industry. We used the industry trends we found and Safeway’s past five years
financial data to forecast our assumptions of Safeway’s future financials. We used a
mildly conservative approach to our forecasting and displayed Safeway steadily
increasing their sales, assets, and free cash flows over the next ten years. We then
used regression analysis and the back door method to estimate Safeway’s cost of
capital.
Finally we were able to value Safeway’s share price by using the method of
comparables and intrinsic valuation models. We counted on the intrinsic valuation
172
models for our valuation of Safeway’s share price because they are more accurate than
the method of comparables. We relied most heavily on the residual income model and
the abnormal earnings growth model because they are the most accurate of all the
models. Our results indicated that Safeway’s share price as of 6/1/2008 is overvalued.
Therefore, we do not recommend buying Safeway’s stock. If it is currently owned, it
should be sold.
173
Appendix
Liquidity Ratios
2002.0 2003.0 2004.0 2005.0 2006.0 2007.0 2003.0 2004.0 2005.0 2006.0 2007.0
Saf ew ay 0.9 1.0 0.9 0.9 0.8 0.8 Saf ew ay 38.6 39.7 37.0 33.7 33.9
Kr oger 1.0 1.0 1.0 1.0 0.9 0.8 Kr oger 38.4 37.7 35.9 33.6 33.0
Super VALU 1.1 1.1 1.3 1.4 0.9 0.9 Super VALU 22.7 22.6 20.5 34.3 29.9
Whol e Foods 1.0 1.5 1.5 1.6 1.2 0.9 Whol e Foods 21.8 22.1 20.9 20.4 24.5
Wal -Mar t 0.9 0.9 0.9 0.9 0.9 0.8 Wal -Mar t 48.9 50.1 49.0 46.5 44.8
2002.0 2003.0 2004.0 2005.0 2006.0 2007.0 2003.0 2004.0 2005.0 2006.0 2007.0
Saf ew ay 0.1 0.2 0.2 0.2 0.1 0.2 Saf ew ay 42.5 43.1 40.3 37.9 38.9
Kr oger 0.1 0.1 0.2 0.1 0.1 0.1 Kr oger 43.4 43.1 40.1 37.9 37.0
Super VALU 0.3 0.4 0.6 0.8 0.3 0.3 Super VALU 30.7 31.3 28.6 43.6 37.7
Whol e Foods 0.3 0.6 0.9 0.8 0.9 0.3 Whol e Foods 27.2 28.2 26.1 26.1 39.4
Wal -Mar t 0.1 0.2 0.2 0.2 0.2 0.2 Wal -Mar t 50.6 52.3 52.0 49.5 48.3
2002.0 2003.0 2004.0 2005.0 2006.0 2007.0 2003.0 2004.0 2005.0 2006.0 2007.0
Saf ew ay 80.9 93.2 105.7 109.6 87.1 73.2 Saf ew ay 823.2 -184.3 -68.4 -38.8 -37.5
Kr oger 76.5 72.7 68.2 88.3 85.0 89.4 Kr oger 794.8 -243.2 -80.0 -44.6
Super VALU 40.1 45.1 42.1 45.2 39.1 46.3 Super VALU 89.6 39.5 30.1 -152.7 -95.8
Whol e Foods 87.1 68.5 59.5 70.5 64.2 24.4 Whol e Foods 26.0 25.6 18.5 49.1 -56.6
Wal -Mar t 147.6 206.3 165.8 121.2 122.8 103.7 Wal -Mar t -75.7 -65.7 -62.4 -67.5 -34.9
2002.0 2003.0 2004.0 2005.0 2006.0 2007.0 2003.0 2004.0 2005.0 2006.0 2007.0
Saf ew ay 4.5 3.9 3.5 3.3 4.2 5.0 Saf ew ay 0.4 -2.0 -5.3 -9.4 -9.7
Kr oger 4.8 5.0 5.4 4.1 4.3 4.1 Kr oger 0.1 0.5 -1.5 -4.6 -8.2
Super VALU 9.1 8.1 8.7 8.1 9.3 7.9 Super VALU 4.1 9.2 12.1 -2.4 -3.8
Whol e Foods 4.2 5.3 6.1 5.2 5.7 15.0 Whol e Foods 14.1 14.3 19.7 7.4 -6.5
Wal -Mar t 2.5 1.8 2.2 3.0 3.0 3.5 Wal -Mar t -4.8 -5.6 -5.8 -5.4 -10.5
2002.0 2003.0 2004.0 2005.0 2006.0 2007.0
Saf ew ay 8.8 9.5 9.2 9.9 10.8 10.8
Kr oger 9.1 9.5 9.7 10.2 10.9 11.1
Super VALU 15.8 16.1 16.2 17.8 10.6 12.2
Whol e Foods 16.3 16.7 16.5 17.5 17.9 14.9
Wal -Mar t 7.3 7.5 7.3 7.4 7.8 8.1
DAYS SUPPLY I NVENTORYCURRENT RATI O
DAYS SUPPLY RECEI VABLES
QUI CK ASSET RATI O
ACCOUNTS RECEI VABLES TURNOVER
I NVENTORY TURNOVER
CASH TO CASH CYCLE
WORKI NG CAPI TAL TURNOVER
DAYS SUPPLY WORKI NG CAPI TAL
174
Profitability Ratios
2002 2003 2004 2005 2006 2007 2002 2003 2004 2005 2006 2007
Saf ew ay 0.31 0.30 0.30 0.29 0.29 0.29 Saf ew ay 0.03 0.02 0.03 0.03 0.04 0.04
Kr oger 0.27 0.26 0.25 0.25 0.24 0.23 Kr oger 0.05 0.02 0.01 0.03 0.03 0.03
Super VALU 0.14 0.14 0.15 0.15 0.22 0.23 Super VALU 0.03 0.03 0.04 0.02 0.03 0.04
Whole Foods 0.35 0.34 0.35 0.35 0.35 0.35 Whole Foods 0.05 0.05 0.06 0.05 0.06 0.05
Wal -Mar t 0.22 0.22 0.23 0.23 0.23 0.23 Wal -Mar t 0.06 0.06 0.06 0.06 0.06 0.06
Safeway (Res 0.03 0.02 0.04 0.04 0.05 0.05
2002 2003 2004 2005 2006 2007 2003 2004 2005 2006 2007
Saf ew ay -0.02 0.00 0.02 0.01 0.02 0.02 Saf ew ay 2.23 2.37 2.50 2.55 2.60
Kr oger 0.02 0.01 0.00 0.02 0.02 0.02 Kr oger 2.65 2.72 2.96 3.23 3.31
Super VALU 0.01 0.01 0.02 0.01 0.01 0.01 Super VALU 3.43 3.17 3.17 6.08 2.03
Whole Foods 0.03 0.03 0.03 0.03 0.04 0.03 Whole Foods 3.34 3.14 3.09 2.97 3.23
Wal -Mar t 0.03 0.04 0.04 0.03 0.03 0.03 Wal -Mar t 2.73 2.70 2.60 2.52 2.50
Safeway (Res -0.02 -0.01 0.01 0.01 0.02 0.02 Safeway (Res 1.97 2.04 2.16 2.22 2.27
2003 2004 2005 2006 2007 2003 2004 2005 2006 2007
Saf ew ay -1.058% 3.711% 3.649% 5.525% 5.459% Saf ew ay -0.05 0.15 0.13 0.18 0.16
Kr oger 1.403% -0.501% 4.675% 5.444% 5.567% Kr oger 0.07 -0.03 0.26 0.25 0.24
Super VALU 4.751% 6.262% 3.286% 7.346% 2.732% Super VALU 0.14 0.17 0.08 0.17 0.11
Whole Foods 10.488% 10.534% 8.964% 10.789% 8.945% Whole Foods 0.17 0.17 0.14 0.15 0.13
Wal -Mar t 9.550% 9.741% 9.347% 8.166% 8.398% Wal -Mar t 0.23 0.24 0.23 0.21 0.21
Safeway (Res) -0.937% 3.197% 3.159% 4.802% 4.760% Safeway (Res -0.06 0.15 0.12 0.17 0.15
ASSET TURNOVER
OPERATI NG PROFI T MARGI NGROSS PROFI T MARGI N
NET PROFI T MARGI N
RETURN ON ASSETS RETURN ON EQUI TY
175
Capital Structure Ratios
2002 2003 2004 2005 2006 2007 2002 2003 2004 2005 2006 2007
Saf ew ay 3.42 3.14 2.57 2.20 1.87 1.63 Saf ew ay 2.20 1.30 2.85 3.02 4.04 4.56
Kr oger 4.31 4.10 4.66 3.67 3.31 3.54 Kr oger 4.15 2.22 1.51 3.99 4.58 4.85
Super VALU 1.93 1.79 1.50 1.35 3.09 2.54 Super VALU 3.52 4.10 6.23 4.10 2.34 2.38
Whole Foods 0.60 0.62 0.60 0.38 0.45 1.20 Whole Foods 13.92 20.64 29.88 103.48 10633.67 70.65
Wal -Mar t 1.40 1.42 1.43 1.60 1.46 1.53 Wal -Mar t 14.34 18.06 17.65 15.89 13.41 12.23
Safeway (Res 4.05 3.86 3.16 2.72 2.31 2.05 Safeway (Res 2.59 1.74 3.36 3.58 4.61 5.13
2003 2004 2005 2006 2007
Saf ew ay 1.96 2.97 2.94 2.89 2.63
Kr oger 6.29 9.40 30.87 4.24 2.85
Super VALU 13.75 2.62 6.99 7.15 6.06
Whole Foods 49.06 56.86 68.81 76.33 7972.00
Wal -Mar t 2.76 2.36 2.34 2.31 2.46
DEBT TO EQUI TY RATI O TI MES I NTEREST EARNED
DEBT SERVI CE MARGI N
Growth Rate Ratios
2003 2004 2005 2006 2007 2003 2004 2005 2006 2007
Saf ew ay -4.68% 15.37% 11.99% 15.74% 13.71% Saf ew ay -1.06% 3.71% 3.36% 4.92% 4.77%
Kr oger 7.45% -2.56% 26.47% 25.39% 23.98% Kr oger 1.40% -0.50% 4.68% 5.44% 5.56%
Super VALU 13.91% 17.43% 8.19% 17.23% 11.16% Super VALU 4.74% 6.25% 3.28% 7.34% 2.73%
Whole Foods 16.79% 16.98% 14.31% 14.73% 12.96% Whole Foods 10.49% 10.51% 8.93% 10.65% 8.91%
Wal -Mar t 22.94% 23.53% 22.74% 21.22% 20.67% Wal -Mar t 9.55% 9.74% 9.35% 8.17% 8.40%
Safeway (Res) -4.14% 13.25% 11.27% 15.38% 13.66% Safeway (Res -0.94% 3.20% 3.16% 4.80% 4.76%
I n t er nal Gr ow t h Rat eSUSTAI NED GROWTH RATE
176
3 Month Regression
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.417663889R Square 0.174443124Adjusted R Square 0.162649454Standard Error 0.071277592Observations 72 months
ANOVAdf SS MS F Significance F
Regression 1 0.075146877 0.075146877 14.79125065 0.000261915Residual 70 0.35563466 0.005080495Total 71 0.430781537
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept -0.001849017 0.008415338 -0.21971992 0.82672877 -0.01863288 0.014934845 -0.01863288 0.014934845X Variable 1 0.940179744 0.244460357 3.845939502 0.000261915 0.452618942 1.427740547 0.452618942 1.427740547
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.34478977R Square 0.118879985Adjusted R Square 0.103688261Standard Error 0.062127696Observations 60 months
ANOVAdf SS MS F Significance F
Regression 1 0.030204535 0.030204535 7.825312132 0.006979547Residual 58 0.223871332 0.003859851Total 59 0.254075868
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007640143 0.008127793 0.940002171 0.35111494 -0.008629402 0.023909687 -0.008629402 0.023909687X Variable 1 0.919010419 0.32852589 2.797375937 0.006979547 0.261394407 1.576626432 0.261394407 1.576626432
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.422555857R Square 0.178553453Adjusted R Square 0.160695919Standard Error 0.058134881Observations 48 months
ANOVAdf SS MS F Significance F
Regression 1 0.033792503 0.033792503 9.998774539 0.002772459Residual 46 0.155464564 0.003379664Total 47 0.189257067
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007577616 0.008418069 0.900160908 0.372723152 -0.009367077 0.02452231 -0.009367077 0.02452231X Variable 1 1.07717252 0.340652733 3.162083892 0.002772459 0.391474144 1.762870897 0.391474144 1.762870897
177
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.479711704R Square 0.230123319Adjusted R Square 0.207479887Standard Error 0.049589418Observations 36 months
ANOVAdf SS MS F Significance F
Regression 1 0.024991735 0.024991735 10.16291705 0.003070818Residual 34 0.083609754 0.00245911Total 35 0.108601489
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.011011338 0.008278414 1.330126502 0.192330646 -0.005812423 0.027835099 -0.005812423 0.027835099X Variable 1 1.055449001 0.331076277 3.187933037 0.003070818 0.382621059 1.728276942 0.382621059 1.728276942
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.448542997R Square 0.20119082Adjusted R Square 0.164881312Standard Error 0.053882146Observations 24 months
ANOVAdf SS MS F Significance F
Regression 1 0.016087093 0.016087093 5.540995472 0.027919743Residual 22 0.063872285 0.002903286Total 23 0.079959377
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.01396192 0.01100681 1.268480072 0.217885365 -0.008864808 0.036788647 -0.008864808 0.036788647X Variable 1 0.949264335 0.403267541 2.353931917 0.027919743 0.112938647 1.785590023 0.112938647 1.785590023
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.814139326R Square 0.662822842Adjusted R Square 0.629105127Standard Error 0.030803099Observations 12 months
ANOVAdf SS MS F Significance F
Regression 1 0.018652117 0.018652117 19.65799959 0.001266756Residual 10 0.009488309 0.000948831Total 11 0.028140426
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007251583 0.009287258 0.780809866 0.453001466 -0.013441717 0.027944882 -0.013441717 0.027944882X Variable 1 1.24950261 0.281817207 4.433734272 0.001266756 0.621574744 1.877430476 0.621574744 1.877430476
178
6 Month RegressionSUMMARY OUTPUT
Regression StatisticsMultiple R 0.417247581R Square 0.174095544Adjusted R Square 0.162296909Standard Error 0.071292595Observations 72 months
ANOVAdf SS MS F Significance F
Regression 1 0.074997146 0.074997146 14.75556645 0.000266035Residual 70 0.355784391 0.005082634Total 71 0.430781537
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept -0.001731268 0.008415353 -0.20572728 0.83760108 -0.018515159 0.015052624 -0.018515159 0.015052624X Variable 1 0.939335166 0.244535907 3.841297495 0.000266035 0.451623685 1.427046647 0.451623685 1.427046647
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.344640285R Square 0.118776926Adjusted R Square 0.103583425Standard Error 0.062131329Observations 60 months
ANOVAdf SS MS F Significance F
Regression 1 0.030178351 0.030178351 7.81761387 0.007005734Residual 58 0.223897517 0.003860302Total 59 0.254075868
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007774368 0.008120726 0.957348909 0.342364831 -0.008481031 0.024029768 -0.008481031 0.024029768X Variable 1 0.918593981 0.328538665 2.795999619 0.007005734 0.260952397 1.576235565 0.260952397 1.576235565
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.422368125R Square 0.178394833Adjusted R Square 0.160533851Standard Error 0.058140494Observations 48 months
ANOVAdf SS MS F Significance F
Regression 1 0.033762483 0.033762483 9.9879634 0.00278583Residual 46 0.155494584 0.003380317Total 47 0.189257067
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007751126 0.008414686 0.9211426 0.361781921 -0.009186759 0.02468901 -0.009186759 0.02468901X Variable 1 1.076986046 0.340778044 3.160373934 0.00278583 0.391035433 1.76293666 0.391035433 1.76293666
179
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.47930232R Square 0.229730713Adjusted R Square 0.207075734Standard Error 0.049602061Observations 36 months
ANOVAdf SS MS F Significance F
Regression 1 0.024949098 0.024949098 10.14040725 0.003099734Residual 34 0.083652392 0.002460364Total 35 0.108601489
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.011155727 0.00827808 1.347622592 0.186691736 -0.005667355 0.027978809 -0.005667355 0.027978809X Variable 1 1.055072158 0.331325196 3.184400611 0.003099734 0.38173835 1.728405965 0.38173835 1.728405965
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.447729998R Square 0.200462151Adjusted R Square 0.164119522Standard Error 0.053906716Observations 24 months
ANOVAdf SS MS F Significance F
Regression 1 0.016028829 0.016028829 5.515895639 0.028239427Residual 22 0.063930548 0.002905934Total 23 0.079959377
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.014064863 0.011010255 1.277432949 0.214766304 -0.008769009 0.036898735 -0.008769009 0.036898735X Variable 1 0.948103891 0.403689923 2.348594397 0.028239427 0.110902236 1.785305547 0.110902236 1.785305547
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.813242361R Square 0.661363138Adjusted R Square 0.627499452Standard Error 0.030869703Observations 12 months
ANOVAdf SS MS F Significance F
Regression 1 0.01861104 0.01861104 19.53015788 0.001295535Residual 10 0.009529386 0.000952939Total 11 0.028140426
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007424373 0.009319565 0.796643674 0.444159884 -0.013340913 0.028189658 -0.013340913 0.028189658X Variable 1 1.249964418 0.282842569 4.419293821 0.001295535 0.619751904 1.880176933 0.619751904 1.880176933
180
2 Year RegressionSUMMARY OUTPUT
Regression StatisticsMultiple R 0.418734614R Square 0.175338677Adjusted R Square 0.163557801Standard Error 0.071238921Observations 72 months
ANOVAdf SS MS F Significance F
Regression 1 0.075532665 0.075532665 14.88333094 0.000251587Residual 70 0.355248872 0.005074984Total 71 0.430781537
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept -0.001516212 0.008405968 -0.18037328 0.857380711 -0.018281386 0.015248962 -0.018281386 0.015248962X Variable 1 0.942446228 0.244290462 3.857892034 0.000251587 0.45522427 1.429668185 0.45522427 1.429668185
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.34534035R Square 0.119259957Adjusted R Square 0.104074784Standard Error 0.062114298Observations 60 months
ANOVAdf SS MS F Significance F
Regression 1 0.030301077 0.030301077 7.853710731 0.006883836Residual 58 0.223774791 0.003858186Total 59 0.254075868
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007936429 0.008109289 0.978683689 0.33180096 -0.008296076 0.024168934 -0.008296076 0.024168934X Variable 1 0.922446787 0.329157589 2.802447275 0.006883836 0.263566292 1.581327282 0.263566292 1.581327282
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.423240931R Square 0.179132886Adjusted R Square 0.161287948Standard Error 0.058114374Observations 48 months
ANOVAdf SS MS F Significance F
Regression 1 0.033902164 0.033902164 10.0383029 0.002724144Residual 46 0.155354902 0.00337728Total 47 0.189257067
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007835258 0.008408903 0.931781295 0.356314445 -0.009090985 0.024761502 -0.009090985 0.024761502X Variable 1 1.080008126 0.340876353 3.168328092 0.002724144 0.393859625 1.766156626 0.393859625 1.766156626
181
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.479127652R Square 0.229563307Adjusted R Square 0.206903405Standard Error 0.049607451Observations 36 months
ANOVAdf SS MS F Significance F
Regression 1 0.024930917 0.024930917 10.1308161 0.003112143Residual 34 0.083670572 0.002460899Total 35 0.108601489
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.01108373 0.008280188 1.338584359 0.189588588 -0.005743636 0.027911096 -0.005743636 0.027911096X Variable 1 1.055753805 0.331696157 3.182894296 0.003112143 0.381666116 1.729841495 0.381666116 1.729841495
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.447454498R Square 0.200215528Adjusted R Square 0.163861688Standard Error 0.053915029Observations 24 months
ANOVAdf SS MS F Significance F
Regression 1 0.016009109 0.016009109 5.507410768 0.02834842Residual 22 0.063950268 0.00290683Total 23 0.079959377
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.013925565 0.011014176 1.264331048 0.219342584 -0.008916438 0.036767568 -0.008916438 0.036767568X Variable 1 0.948447266 0.404147088 2.346787329 0.02834842 0.110297508 1.786597024 0.110297508 1.786597024
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.812804635R Square 0.660651375Adjusted R Square 0.626716513Standard Error 0.030902127Observations 12 months
ANOVAdf SS MS F Significance F
Regression 1 0.018591011 0.018591011 19.46822021 0.001309761Residual 10 0.009549415 0.000954941Total 11 0.028140426
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007416075 0.009329234 0.794928545 0.445112085 -0.013370755 0.028202904 -0.013370755 0.028202904X Variable 1 1.254432729 0.284304839 4.412280613 0.001309761 0.620962074 1.887903384 0.620962074 1.887903384
182
5 Year RegressionSUMMARY OUTPUT
Regression StatisticsMultiple R 0.425994616R Square 0.181471413Adjusted R Square 0.169778147Standard Error 0.070973537Observations 72 months
ANOVAdf SS MS F Significance F
Regression 1 0.078174534 0.078174534 15.51931002 0.00019084Residual 70 0.352607003 0.005037243Total 71 0.430781537
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept -0.001759682 0.00837755 -0.21004733 0.834240904 -0.018468178 0.014948814 -0.018468178 0.014948814X Variable 1 0.956570145 0.242817855 3.939455549 0.00019084 0.47228521 1.440855079 0.47228521 1.440855079
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.351838913R Square 0.123790621Adjusted R Square 0.108683563Standard Error 0.061954329Observations 60 months
ANOVAdf SS MS F Significance F
Regression 1 0.031452209 0.031452209 8.194224112 0.00583796Residual 58 0.222623658 0.003838339Total 59 0.254075868
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007385468 0.008115493 0.910045449 0.366565051 -0.008859457 0.023630392 -0.008859457 0.023630392X Variable 1 0.941405928 0.328869055 2.862555521 0.00583796 0.283102997 1.59970886 0.283102997 1.59970886
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.429259577R Square 0.184263784Adjusted R Square 0.166530388Standard Error 0.057932465Observations 48 months
ANOVAdf SS MS F Significance F
Regression 1 0.034873223 0.034873223 10.39077817 0.002330637Residual 46 0.154383843 0.003356171Total 47 0.189257067
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.006730874 0.008412705 0.80008437 0.427774614 -0.010203023 0.023664772 -0.010203023 0.023664772X Variable 1 1.0896829 0.338046232 3.223472999 0.002330637 0.409231139 1.770134661 0.409231139 1.770134661
183
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.479719273R Square 0.230130581Adjusted R Square 0.207487363Standard Error 0.049589185Observations 36 months
ANOVAdf SS MS F Significance F
Regression 1 0.024992524 0.024992524 10.16333362 0.003070286Residual 34 0.083608965 0.002459087Total 35 0.108601489
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.009608594 0.008315114 1.155557586 0.25591842 -0.007289752 0.026506939 -0.007289752 0.026506939X Variable 1 1.048188002 0.328791888 3.187998371 0.003070286 0.380002498 1.716373507 0.380002498 1.716373507
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.450314221R Square 0.202782897Adjusted R Square 0.166545756Standard Error 0.053828424Observations 24 months
ANOVAdf SS MS F Significance F
Regression 1 0.016214394 0.016214394 5.595996027 0.027233306Residual 22 0.063744983 0.002897499Total 23 0.079959377
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.012551655 0.01103473 1.137468197 0.267579849 -0.010332975 0.035436285 -0.010332975 0.035436285X Variable 1 0.943407057 0.398804841 2.365585768 0.027233306 0.116336441 1.770477673 0.116336441 1.770477673
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.810715823R Square 0.657260146Adjusted R Square 0.622986161Standard Error 0.031056151Observations 12 months
ANOVAdf SS MS F Significance F
Regression 1 0.01849558 0.01849558 19.17664779 0.001379306Residual 10 0.009644845 0.000964485Total 11 0.028140426
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.006596565 0.009324618 0.707435446 0.495451953 -0.014179979 0.02737311 -0.014179979 0.02737311X Variable 1 1.251642108 0.285820793 4.379114955 0.001379306 0.614793698 1.888490518 0.614793698 1.888490518
184
10 Year RegressionSUMMARY OUTPUT
Regression StatisticsMultiple R 0.423185593R Square 0.179086046Adjusted R Square 0.167358704Standard Error 0.071076877Observations 72 months
ANOVAdf SS MS F Significance F
Regression 1 0.077146962 0.077146962 15.27081269 0.000212534Residual 70 0.353634575 0.005051922Total 71 0.430781537
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept -0.000632518 0.008378559 -0.07549244 0.94003825 -0.017343026 0.01607799 -0.017343026 0.01607799X Variable 1 0.951955458 0.243604638 3.907788721 0.000212534 0.466101333 1.437809583 0.466101333 1.437809583
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.348410137R Square 0.121389624Adjusted R Square 0.106241169Standard Error 0.062039155Observations 60 months
ANOVAdf SS MS F Significance F
Regression 1 0.030842174 0.030842174 8.013333731 0.006370953Residual 58 0.223233694 0.003848857Total 59 0.254075868
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.008627072 0.008065506 1.069625697 0.289219151 -0.007517792 0.024771936 -0.007517792 0.024771936X Variable 1 0.93168079 0.329124738 2.830783236 0.006370953 0.272866054 1.590495526 0.272866054 1.590495526
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.426737737R Square 0.182105096Adjusted R Square 0.164324772Standard Error 0.058009068Observations 48 months
ANOVAdf SS MS F Significance F
Regression 1 0.034464676 0.034464676 10.24194475 0.002488935Residual 46 0.15479239 0.003365052Total 47 0.189257067
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.008344429 0.008383733 0.995311933 0.324791623 -0.008531149 0.025220008 -0.008531149 0.025220008X Variable 1 1.085294763 0.339122412 3.200303852 0.002488935 0.402676762 1.767912763 0.402676762 1.767912763
185
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.480195674R Square 0.230587885Adjusted R Square 0.207958117Standard Error 0.049574454Observations 36 months
ANOVAdf SS MS F Significance F
Regression 1 0.025042188 0.025042188 10.18958233 0.003036938Residual 34 0.083559302 0.002457627Total 35 0.108601489
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.011391455 0.008269949 1.377451639 0.177373316 -0.005415104 0.028198015 -0.005415104 0.028198015X Variable 1 1.053202707 0.329939092 3.192112518 0.003036938 0.382685802 1.723719611 0.382685802 1.723719611
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.449762418R Square 0.202286233Adjusted R Square 0.166026516Standard Error 0.053845189Observations 24 months
ANOVAdf SS MS F Significance F
Regression 1 0.016174681 0.016174681 5.578814489 0.027445689Residual 22 0.063784696 0.002899304Total 23 0.079959377
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.014281939 0.010994847 1.298966534 0.20740534 -0.008519979 0.037083856 -0.008519979 0.037083856X Variable 1 0.947920508 0.401329384 2.361951415 0.027445689 0.11561431 1.780226706 0.11561431 1.780226706
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.812398528R Square 0.659991368Adjusted R Square 0.625990505Standard Error 0.030932164Observations 12 months
ANOVAdf SS MS F Significance F
Regression 1 0.018572438 0.018572438 19.41101801 0.001323066Residual 10 0.009567988 0.000956799Total 11 0.028140426
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.008416949 0.009407732 0.894684186 0.391981259 -0.012544784 0.029378682 -0.012544784 0.029378682X Variable 1 1.254343395 0.284703162 4.405793687 0.001323066 0.619985221 1.88870157 0.619985221 1.88870157
186
Cost of Debt and WACC
Bank credit agreement, unsecured
Commercial paper 25 0.004952064 0.0556 0.000275335
Other bank borrowings, unsecured 99.7 0.019748831 0.0479 0.000945969
Mortgage notes payable, secured 20.1 0.003981459 0.0806 0.000320906
4.125% Senior Notes due 2008, unsecured 300 0.059424768 0.04125 0.002451272
4.45% Senior Notes due 2008, unsecured 301.1 0.059642659 0.0445 0.002654098
6.50% Senior Notes due 2008, unsecured 250 0.04952064 0.065 0.003218842
7.50% Senior Notes due 2009, unsecured 500 0.09904128 0.075 0.007428096
5.19% Floating Rate Notes due 2009, unsecured 250 0.04952064 0.0519 0.002570121
4.95% Senior Notes due 2010, unsecured 500 0.09904128 0.0495 0.004902543
6.50% Senior Notes due 2011, unsecured 500 0.09904128 0.065 0.006437683
5.80% Senior Notes due 2012, unsecured 800 0.158466049 0.058 0.009191031
5.625% Senior Notes due 2014, unsecured 250 0.04952064 0.05625 0.002785536
6.35% Senior Notes due 2017, unsecured 500 0.09904128 0.0635 0.006289121
7.45% Senior Debentures due 2027, unsecured 150 0.029712384 0.0745 0.002213573
7.25% Senior Debentures due 2031, unsecured 600 0.118849536 0.0725 0.008616591
9.875% Senior Subordinated Debentures 0 0.09875
due 2007, unsecured 0
Other notes payable, unsecured 2.5 0.000495206 0.0407 2.01549E-05
5048.4 0.060320872
Less current maturities -954.9
Long-term portion
6855.7 10949.2
Accounts Payable 2825.4 0.25804625 0.023 0.005935064 3MAANFCP
Accrued Expenses 1225.6 0.111935119 0.023 0.002574508 3MAANFCP
Notes Payable/Short Term Debt 0 0 0
Current Port. of LT Debt/Capital Leases 997.4 0.091093413 0.0497 0.004527343 10K
Other Current liabilities, Total 88 0.008037117 0.0806 0.000647792 Largest LT Rate
Long Term Debt 4093.5 0.373862931 0.060320872 0.022551738 10K
Capital Lease Obligations 564.2 0.051528879 0.0806 0.004153228 10K
Deferred Income Tax 254.7 0.023261973 0.0388 0.000902565 10 YR Riskless
Minority Interest - 0
Other Liabilities, Total 900.4 0.082234318 0.0806 0.006628086 Largest LT Rate
Total Liabilities 10949.2 11
Cost of Debt
4.792%
187
Bank credit agreement, unsecured
Commercial paper 25 0.004952064 0.0556 0.000275335
Other bank borrowings, unsecured 99.7 0.019748831 0.0479 0.000945969
Mortgage notes payable, secured 20.1 0.003981459 0.0806 0.000320906
4.125% Senior Notes due 2008, unsecured 300 0.059424768 0.04125 0.002451272
4.45% Senior Notes due 2008, unsecured 301.1 0.059642659 0.0445 0.002654098
6.50% Senior Notes due 2008, unsecured 250 0.04952064 0.065 0.003218842
7.50% Senior Notes due 2009, unsecured 500 0.09904128 0.075 0.007428096
5.19% Floating Rate Notes due 2009, unsecured 250 0.04952064 0.0519 0.002570121
4.95% Senior Notes due 2010, unsecured 500 0.09904128 0.0495 0.004902543
6.50% Senior Notes due 2011, unsecured 500 0.09904128 0.065 0.006437683
5.80% Senior Notes due 2012, unsecured 800 0.158466049 0.058 0.009191031
5.625% Senior Notes due 2014, unsecured 250 0.04952064 0.05625 0.002785536
6.35% Senior Notes due 2017, unsecured 500 0.09904128 0.0635 0.006289121
7.45% Senior Debentures due 2027, unsecured 150 0.029712384 0.0745 0.002213573
7.25% Senior Debentures due 2031, unsecured 600 0.118849536 0.0725 0.008616591
9.875% Senior Subordinated Debentures 0 0.09875
due 2007, unsecured 0
Other notes payable, unsecured 2.5 0.000495206 0.0407 2.01549E-05
5048.4
5048.4 0.060320872
Less current maturities -1054.9
Long-term portion 3993.5
Accounts Payable 2825.4 0.206049335 0.023 0.004739135 3MAANFCP
Accrued Expenses 1791.46 0.130646685 0.023 0.003004874 3MAANFCP
Notes Payable/Short Term Debt 0 0 0
Current Port. of LT Debt/Capital Leases 997.4 0.07273788 0.0497 0.003615073 10K
Other Current liabilities, Total 88 0.006417619 0.0806 0.00051726 Largest LT Rate
Long Term Debt 3993.5 0.291235939 0.060320872 0.017567606 10K
Capital Lease Obligations 2861.39 0.208673996 0.0806 0.016819124 10K
Deferred Income Tax 254.7 0.018574632 0.0388 0.000720696 10 YR Riskless
Minority Interest 0 0 0
Other Liabilities, Total 900.4 0.065663914 0.0806 0.005292511 Largest LT Rate
13712.25 0
Total Liabilities 13712.25 11
Cost of Debt (Restated)
5.228%
188
Market Value of Equity Book Value of Equity
(ROE - Ke)
Ke - g
ROE = 0.157 ROE + ( P/B - 1 ) gP = 31.87B = 6701.8
Shares = 441.3PPS = 15.1865
g = 0.046
MVE
Cost of Equity
12.145=P/B =
)
Ke
= BVE 1 +(
AT (Kd) * (1-T) + (Ke)=
AT (Kd) + (Ke)=
VeVf
Ve
WACC VdVf
VdWACCVf Vf
WACC AT As Stated WACC AT Restated WACC BT As Stated WACC BT RestatedVd = 10,949.20$ Vd = 13,712.25$ Vd = 10,949.20$ Vd = 13,712.25$ Kd = 0.05 Kd = 0.05 Kd = 0.05 Kd = 0.051-T = 0.65 1-T = 0.65 Ve = 14,064.20$ Ve = 14,064.23$ Ve = 14,064.20$ Ve = 14,064.23$ Ke = 0.12 Ke = 0.12Ke = 0.12 Ke = 0.12 Vf = 25,013.40$ Vf = 27,776.48$ Vf = 25,013.40$ Vf = 27,776.48$
7.59%8.42%
8.21%9.01%
Method of Comparables
Multiple Valuation Models P/E (T) P/E (F) P/B D/P P.E.G. P/EBITDA P/FCF EV/EBITDA
As Stated
28.62590815
33.96021924
37.56578121
24.21826718
12.0747792
20.63373725
75.33988617
11.1546926
Restated
28.01442576
36.00173791
37.45821498
22.29413154
Priced Fairly Under Under Over Over Over Under Over
189
Altman Z-Score
Computing Altman Score
Total Current Assets
Net Working Capital
X1 Liquidity
Total Current Liabilities
W = 1.2 Total Assets
Total Assets
Retained Earnings
Retained Earnings
X2 Profitability W = 1.4
Total Assets
Total Assets
Operating Income
EBIT
X3 ROA W = 1.4
Total Assets
Total Assets
Stock Price x
Market Value of Equity
X4 Leverage
# Outstanding Shares
W = 3.3 BV of Total Liabilities
Total Liabilities
Total Revenue
Sales
X5 Asset Potential W = 1
Total Assets
Total Assets
ALTMAN - Z SCORE 2003 2004 2005 2006 2007
Safeway 3.38 3.47 3.70 4.10 4.04Kroger 3.55 3.60 4.09 4.41 4.23
SuperVALU 4.80 4.98 5.03 2.73 4.02Whole Foods 13.84 16.01 15.46 9.03 4.87
Wal-Mart 5.64 5.21 4.54 4.51 4.26Safeway (Res) 2.88 2.93 3.03 3.23 3.56
190
Long Run Residual Income
20% 20%
BookEquity 6701.
80 AVG ROE 0.1019 $
25.50 <===
== $
31.87 ====
=> $
38.24
AVG g 0.043 Ke Kept Constant at 11.95%
Ke 0.050
0 g ROE 0.1019 0.2 0.25 0.3 0.35 0.4
ROE 0.180
0 Est MVE
12/31/07 124462
.00 0.01 - 11.7
0 18.97 26.2
4 33.51 40.78
g 0.043 Div by Shares 441.30 0.02 - 12.8
8 20.88 28.8
8 36.88 44.87
PPS 282.03 0.03 - 14.3
2 23.21 32.1
0 41.00 49.89
Time Adj 5/31/07 287.83 0.043 -
16.75 27.15
37.56 46.15
56.16
0.05 - 18.4
4 29.89 41.3
4 52.79 64.24
0.06 - 21.5
4 34.91 48.2
9 61.66 75.04
0.07 - 25.8
9 41.97 58.1
4 74.12 90.20
20% 20% 20% 20%
$
25.50 <====
= $
31.87 =====> $
38.24 $
25.50 <===
== $
31.87 ====
=> $
38.24
g Kept Constant at .043% ROE Kept Constant at 11% Ke ROE 0.11 0.13 0.157 0.17 0.18 0.19
Ke g 0.01 0.02 0.03
0.043 0.05
0.06
0.0200 - - - - - - 0.02 137.81 - - - - -
0.0400 - - - - - - 0.04 36.02 54.0
3 108.06 - - -
0.0500 132.84 177.1
2 236.90 265.69 287.83 309.97 0.06 15.56
19.45 25.93
45.76 77.80 -
0.0550 71.18 97.06 132.00 148.82 161.76 174.70 0.08 6.72 7.84 9.41
12.71 15.68
23.52
0.0575 56.28 77.72 106.67 120.60 131.32 142.04 0.10 1.76 1.98 2.26 2.77 3.16
3.95
0.0600 45.76 64.07 88.78 100.68 109.83 118.99 0.1195 - - - - - -
0.1195 - 2.18 7.80 10.51 12.59 - 0.14 - - - - - -
191
Discounted Dividends Approach
Perp
Relevant Valuation Item 0 1 2 3 4 5 6 7 8 9 10
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Dividends per Share 0.26 0.28 0.30 0.33 0.35 0.38 0.41 0.45 0.48 0.52 0.56
PV Factor 0.897 0.805 0.723 0.649 0.582 0.522 0.469 0.421 0.378 0.339
PV of Annual Dividend 0.25 0.24 0.24 0.23 0.22 0.22 0.21 0.20 0.20 0.19
PV YBY div 2.01 g
TV PERP 3.10 0.01 0.02 0.03 0.04 0.043 7.87
0.1143 4.25 4.5 4.81 5.2 4.96
12/31/1987 model price 0.1 5 5.38 6.76 6.52 6.76
Time Consistent Price 5.11 0.08 6.6 7.35 10.59 9.95 10.59
5 months bigger 5.34 Ke 0.06 9.51 11.32 23.52 20.34 23.52
0.04 16.38 23.33 - - -
Observed Share Price 6/1/1988 $31.87 0.02 51.01 - - - -
0.01 - - - - -
Initial Cost of Equity 0.1143 Over Valued
Perpetuity Growth Rate (g) 0.043 20% 20%
$25.50 <===== $ 31.87 =====> $38.24
192
Discounted Free Cash Flow
0 1 2 3 4 5 6 7 8 9 10
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
Cash Flow From Operations (Millions) 2205.21 2300.04 2398.94 2502.10 2609.69 2721.90 2838.94 2961.02 3088.34 3221.14 Cash Flow From Investing Activities -1764.17 -1840.03 -1919.15 -2001.68 -2087.75 -2177.52 -2271.15 -2368.81 -2470.67 -2576.91 FCF Firm 441.04 460.01 479.79 500.42 521.94 544.38 567.79 592.20 617.67 322.00 PV Factor 0.93 0.87 0.82 0.76 0.71 0.67 0.62 0.58 0.54 0.51 PV FCF each year 412.19 401.79 391.65 381.77 372.13 362.74 353.59 344.67 335.97 163.69 Total PV of YBY FCF 3520.19 11925.93 TV Perpetuity 6062.536002 MV Asssets 9582.73
Book Value Debt & Preferred Stock $2,290
Model Estimated Total Mve 12/31/87 $7,292.73 20% 20%
Divide by Shares 441.3 $ 25.50 <===== $ 31.87 =====> $ 38.24
Model Share Price 12/31/87 $16.53 g
0.01 0.02 0.03 0.043 0.05 0.06
Time consistent price 17.00 0.02 65.46 - - - - -
Observed Share Price $31.87 0.03 32.08 59.56 - - - -
0.04 20.82 29.17 54.23 - - -
WACC(BT) 0.07 WACC 0.05789 12.23 14.57 18.60 31.90 57.57 -
g 0.043 0.07 9.23 10.50 12.41 17.00 21.94 41.02
0.08 7.49 8.32 9.48 11.93 14.13 19.95
0.09 6.15 6.72 7.48 8.96 10.15 12.81
193
Residual Income Model
All Items in Millions of Dollars 0 1 2 3 4 5 6 7 8 9 10 Perp 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Net Income (Millions) 888.00 837.98 874.01 911.60 950.80 991.68 1034.32 1078.80 1125.19 1173.57 1224.03 Total Dividends (Millions) 111.50 118.75 126.47 134.69 143.44 152.76 162.69 173.27 184.53 196.53 209.30
Book Value Equity (Millions) 6701.80 7421.0
3 8168.5
8 8945.4
9 9752.85 10591.7
7 11463.39 12368.9
2 13309.58 14286.6
2 15301.3
5 Annual Normal Income (Becnhmark) 800.87 886.81 976.15 1068.99 1165.47 1265.72 1369.88 1478.09 1590.49 1707.25
Annual Residual Income 37.12 -12.80 -64.55 -118.19 -173.79 -231.39 -291.08 -352.90 -416.92 -483.22
-386.5
7 pv factor 0.89 0.80 0.71 0.64 0.57 0.51 0.45 0.41 0.36 0.32 YBY PV RI 33.15 -10.21 -46.01 -75.25 -98.83 -117.55 -132.08 -143.04 -150.95 -156.28
-1.34 4.04 0.83 0.47 0.33 0.26 0.21 0.18 0.16 0.57 ===
> 10 YR AVG
Book Value Equity (Millions) 6701.80 0.18 ===
> 3 YR AVG
Total PV of YBY RI
-740.759251
7
Terminal Value Perpetuity
-1046.22224
6 -
3234.93
MVE 12/31/07 4914.81850
2 $
25.50 <===== $
31.87 =====> $
38.24
divde by shares 441.3 g 0 -0.1 -0.2 -0.3 -0.4 -0.5
Model Price on 12/31/07 11.14 Ke 0.15 8.52 9.65 10.18 10.46 10.64 10.76
time consistent Price 11.67 0.1195 11.67 12.81 13.23 13.45 13.59 13.68
0.05 35.37 27.65 26.11 25.44 25.08 24.84 Observed Share Price (5/31/2007) $31.87 0.03 64.06 36.21 32.57 31.14 30.38 29.90
Initial Cost of Equity 0.1195 0.02 100.52 41.90 36.57 34.57 33.53 32.88
Perpetuity Growth Rate (g) 0 0.01 210.90 48.93 41.21 38.48 37.07 36.22
0 - 57.72 46.63 42.93 41.08 39.97
194
AEG All Items in Millions of Dollars 0 1 2 3 4 5 6 7 8 9 10 Perp 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2017 Net Income (Millions) 888.00 837.98 874.01 911.60 950.80 991.68 1034.32 1078.80 1125.19 1173.57 1224.03 Total Dividends (Millions) 111.50 118.75 126.47 134.69 143.44 152.76 162.69 173.27 184.53 196.53 209.30 Drip Income 14.19 15.11 16.10 17.14 18.26 19.44 20.71 22.05 23.48 Cumulative Dividend Income 888.21 926.71 966.89 1008.82 1052.58 1098.24 1145.89 1195.62 1247.52
Normal (Becnhmark) Income 938.12047
06 978.45965
1 1020.5334
2 1064.4163
5 1110.1862
6 1157.9242
6 1207.7150
1 1259.6467
5 1313.8115
6
Annual AEG -49.92 -51.75 -53.64 -55.59 -57.61 -59.68 -61.82 -64.03 -66.29 -
54.42 pv factor 0.893 0.798 0.713 0.637 0.569 0.508 0.454 0.405 0.362 PV AEG -44.59 -41.29 -38.23 -35.39 -32.76 -30.32 -28.05 -25.95 -24.00 Change In Residual Income -35.89 -37.17 -38.49 -39.85 -41.25 -42.69 -44.16 -45.68 -47.24
Core to the Perpetuity 837.98166
2 Total PV of AEG added to the core -276.59
AEG TV Perp -184.5905
-455.40953
7
Total Adjusted Earnings Perp 376.80127
9 Over Valued
Capitalization Rate (Ke) 0.17 20% 20%
Model MVE 12/31/87 2216.48 $
25.50 <===== $
31.87 =====> $
38.24 Divide by shares 441.30 Model Price at 12/31/87 5.02 0 -0.1 -0.2 -0.3 -0.4 -0.5 Time Consistent Price $5.26 0.06 9.82 10.44 10.58 10.64 10.68 10.70 0.08 7.29 8.71 9.04 9.20 9.30 9.36 0.1 5.91 7.41 7.83 8.04 8.16 8.25 0.1195 5.26 6.44 6.88 7.11 7.25 7.35 0.14 4.36 5.65 6.07 6.31 6.45 6.56 Observed Share Price (6/1/1988)
$ 31.87 0.16 4.13 5.04 5.44 5.66 5.81 5.91
195
Initial Cost of Equity (You Derive) 0.1195 0.18 3.77 4.55 4.92 5.13 5.27 5.37 Perpetuity Growth Rate (g) 0
0
10.00%2003 341.702004 332.702005 317.102006 299.40
Capital Operating 2007 279.50 ====> ====>leases leases PMT # 10% PVF 314.08 ÷ 8
2003.00 341.70 1 2003 0.9090909 341.70 310.642004.00 79.10 332.70 2 2004 0.8264463 332.70 274.962005.00 77.80 317.10 3 2005 0.7513148 317.10 238.242006.00 75.60 299.40 4 2006 0.6830135 299.40 204.492007.00 72.60 279.50 5 2007 0.6209213 279.50 173.55
Thereafte 749.20 2,542.70 1 6 2008 0.5644739 317.84 179.41Total min 2 7 2009 0.5131581 317.84 163.10Less amou 1,134.00 3 8 2010 0.4665074 317.84 148.27Present v 4 9 2011 0.4240976 317.84 134.79Less curr (596.5) 5 10 2012 0.3855433 317.84 122.54Long-term 6 11 2013 0.3504939 317.84 111.40
537.5 7 12 2014 0.3186308 317.84 101.27(25.2) 8 13 2015 0.2896644 317.84 92.07
512.3Target 4,113.10 <=====>
÷ 13
1 10.00%2 10.00%3 10.00%4 10.00%5 10.00%6 10.00%7 10.00%8 10.00%9 10.00%
10 10.00%11 10.00%12 10.00%13 10.00% $173,441,345.40
$2,254,737,490.25-$115,501,836$202,335,664
$4,113,100,000 $2,254,737,490
(a) Based on a 10% discount factor on the estimated present value of future operating lease payments.
4,113.10
<== AVG PMT
$4,113,100,000
-$89,234,274 $288,943,182$92,066,202 $0
$551,618,802 $55,161,880.17 $228,603,226 $173,441,345.40$101,272,823$317,837,500$288,943,182 $28,894,318.18 $317,837,500
2254.74Total PV of OL4,113.10
Beginning Balance PV of Oper Lease Effect
317.84
4,113.10
1,570.40 2,542.70
Converting Operating Leases to Capital Leases
PV of 2008 - 2012 Remaining Thereafter
$1,858,362,509.75
79.70
$2,254,737,490
Depreciation$173,441,345.40$173,441,345.40$173,441,345.40
$173,441,345.40
$173,441,345.40$173,441,345.40$173,441,345.40$173,441,345.40$173,441,345.40$173,441,345.40$173,441,345.40
$343,005,306$328,177,952
$317,837,500
$279,500,000$317,837,500$317,837,500
$311,867,863
$387,292,469$375,407,582
$299,400,000$352,999,491$363,894,205
$341,700,000
Depreciation Exp$173,441,345.40Capital Expense
$398,915,094Payment
$190,452,859.95$179,558,145.95$169,563,960.54
$317,837,500
Interest Exp$225,473,749.03$213,851,123.93$201,966,236.32
$57,215,094
$79,041,481.97
$293,926,764$274,191,556$252,482,827$317,837,500
$154,736,606.60$138,426,517.26$120,485,418.98$100,750,210.88
$64,494,205$173,547,510$179,410,983
$10,340,452
$54,592,469$58,307,582
$122,540,115
$163,100,893$148,273,539
-$23,910,736-$43,645,944
-$5,969,637
$274,958,678$238,241,923
$111,400,105 -$65,354,673
Ending Balance$2,138,511,239$2,019,662,363$1,904,528,600$1,795,581,459
$73,499,491$25,167,806
$1,007,502,109$790,414,820$551,618,802
$1,695,639,605$1,547,366,066$1,384,265,173$1,204,854,190
$134,794,127
$1,547,366,066
$2,254,737,490$2,138,511,239$2,019,662,363
$310,636,364
$204,494,229
$332,700,000$317,100,000
$317,837,500
$18,583,625,097
$790,414,820
$1,904,528,600$1,795,581,459$1,695,639,605
$1,384,265,173$1,204,854,190$1,007,502,109
0
8(a) Based on a 10% discount factor on the estimated present value of future operating lease payments.
10.00%2004 400.102005 394.60
200600% 379.202007 358.40 PV of 2008 - 2012
Capital Operating 2008 340.70 ====> 1873.00 ====> 2885.7leases leases PMT # 0.1 PVF 374.60 AVG PMT ÷ 8
2004.00 118 400.1 1 2004 0.9090909 400.10 363.73 360.71252005.00 104.60 394.60 2 2005 0.8264463 394.60 326.12
2006 97.70 379.20 3 2006 0.7513148 379.20 284.902007 94.2 4 2007 0.6830135 358.40 244.792008 90.90 340.70 5 2008 0.6209213 340.70 211.55
Thereafter 907 2,885.70 1 6 2009 0.5644739 360.71 203.61Total minim 4758.7 2 7 2010 0.5131581 360.71 185.10Less amoun 1412.4 3 8 2011 0.4665074 360.71 168.28e payments 4 9 2012 0.4240976 360.71 152.98t obligations -693.6 5 10 2013 0.3855433 360.71 139.07Long-term 6 11 2014 0.3504939 360.7125
718.8 7 12 2015 0.3186308 360.7125-50.5 8 13 2016 0.2896644 360.71
2625.9667668.3 Total PV of OL
1 10.00%2 10.00%3 10.00%4 10.00%5 10.00%6 10.00%7 10.00%8 10.00%9 10.00%
10 10.00%11 0.1 -69011204 62602995912 626029959 0.1 ###### 360712500 264600432 114934119 201997436 -96112068 32792045513 327920455 0.1 ###### 360712500 234789481 104485563 201997436 -1.26E+08 -3.22E-06
2.133E+10 ###### 4.759E+09 4.759E+09 2.626E+09
Beginning Balance÷
Target <=====>
126.43114.9341188
Interest Exp
Depreciation Exp
Payment$201,997,436
104.49
Converting Operating Leases to Capital Leases
Remaining Thereafter
$1,570,996,975$1,367,384,173$1,143,410,090$897,038,599
$2,197,780,633$2,059,158,697$1,924,374,566$1,756,099,523
$2,625,966,667$2,488,463,333$2,342,709,667
$1,143,410,090-$21,976,647-$1,615,367
$152,977,312$338,735,853$157,099,697.51$136,738,417.26
$1,924,374,566$1,756,099,523$1,570,996,975$1,367,384,173
$897,038,599-$44,374,055
Ending Balance$2,488,463,333$2,342,709,667$2,197,780,633$2,059,158,697
$67,213,306$33,722,393$16,894,888
$139,070,284
$185,102,548$168,275,043 $201,997,435.89
$201,997,435.89$201,997,435.89
$126,427,531
Effect$64,494,103$56,243,769$57,068,403$63,375,499
$211,547,895$203,612,802
Depreciation$201,997,435.89
$316,338,445$291,701,296
PV of Oper Lease$363,727,273$326,115,702$284,898,573$244,792,022
Capital Expense$464,594,103$450,843,769
$114,341,008.98$89,703,859.88
$219,778,063.32$205,915,869.65$192,437,456.62$175,609,952.28
$262,596,666.66$248,846,333.32$234,270,966.65
$360,712,500
$358,400,000$340,700,000$360,712,500$360,712,500$360,712,500
$394,600,000$379,200,000
$360,712,500$360,712,500
$400,100,000
$201,997,435.89$201,997,435.89$201,997,435.89
$436,268,403$421,775,499$407,913,306$394,434,893
$201,997,435.89$201,997,435.89
$2,625,966,667
$377,607,388$359,097,133
$201,997,435.89
$201,997,435.89
0
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0
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0
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37. Summer 2004 Exam
