The nation’s second-largest grocer, Safeway (SWY), is for sale.
The California-based parent of the Vons, Tom Thumb, and Randalls chains is talking with at least three private equity firms about a potential buyout, Bloomberg News reported late Thursday, citing people with knowledge of the matter. “Although the discussions are ongoing, the company has not reached an agreement on a transaction, and there can be no assurance that these discussions will lead to an agreement or a completed transaction,” Safeway said in a statement. The company also announced a quarterly profit that topped Wall Street forecasts on sales that fell short.
If there is a deal, it would be the latest—and largest—move yet for a grocer that has aggressively sold off many of its most valuable assets in a furious period of financial engineering, leaving the Canadian and Chicago markets entirely last year. Together, those sold-off businesses accounted for more than a third of Safeway’s sales, and the company is also looking to shed its 49 percent stake in a Mexican grocery chain, Casa Ley.
While the supermarket business is hardly sexy, with meager profit margins that largely resist managerial skill, a private equity buyer might appreciate the steady cash most grocers produce. And recent years have brought several such buyouts. Cerberus Capital Management, one of the firms reportedly discussing a deal for Safeway, acquired 877 Supervalu (SVU) grocery stores last year for $3.3 billion. In 2011, meanwhile, the other two firms reportedly interested in Safeway—Leonard Green & Partners and CVC Capital Partners—teamed up to acquire BJ’s Wholesale Club. Leonard Green has also invested in Whole Foods Market (WFM) in the past, once owning 17 percent of that company.
“If you take on some debt to do an LBO [leveraged buyout], you could take some comfort in the steady quality of the free cash flow in terms of servicing the debt,” says Joe Feldman, an analyst with Telsey Advisory Group, who today raised his target for the stock to $46. Safeway shares rose 5 percent today, to more than $36.
Safeway’s core stores tend to be in more affluent communities in the West, and the chain avoids discounting prices to match the grocery offerings at rivals Wal-Mart Stores (WMT) and Kroger (KR), the largest U.S. grocery chain. Some products at Safeway can be as much as 20 percent more expensive than at Wal-Mart, Feldman says. A private Safeway would likely undertake greater “price investments” to bolster market share and further chop structural costs, while divesting even more stores. That would leave the chain smaller but probably more profitable and could present a profitable exit strategy for a private equity owner.
Last year, Safeway had revenue of $36.1 billion, the same as in 2012. It has been working to increase sales, seeing some success with more organic and natural-food offerings.
Safeway’s profit margins and return on capital are higher in its core West Coast market than in other areas, Deutsche Bank (DB) analysts Karen Short and Shane Higgins noted last week, recommending that Safeway divest its properties in the Texas, Phoenix, and Denver markets. “Bottom line: Safeway has many options at hand to drive shareholder value,” they wrote.
And for a potential Safeway buyer, there’s another appealing part of the grocery trade: Everybody needs to eat. That tends to make for a nice, steady cash flow.