Safeway Entices as Whole Foods Sours

 | Apr 01, 2013 | 6:30 AM EDT
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Go long Safeway (SWY) and short Whole Foods (WFM)? Believe me, when I look at how the two are doing, it is tempting -- and I like Whole Foods, the company, very much.

If you think the first quarter's momentum is set to build in these names, though, this is the trade for you. Consider that Safeway, up 45% so far this year, is one of the quarter's top 10 performers. Whole Foods, on the other hand, can't get out if its own way, having fallen almost 5% for 2013.

Is this the revenge of the plain-vanilla supermarket against the higher-priced organic entry? Not really. It is true that people disliked that last Whole Foods quarter for the lack of a guide-up, although the tantalizing prospect of a tripled store count is never far away when the stock drops into the low $80s.

What really got the disparity going was Safeway's decision to sell $200 million worth of stock from its Blackhawk Network subsidiary -- a private maker of private-brand gift cards, with prepaid cash machines that have been buried within Safeway for years. The business is now growing like a weed, at a 20% a clip of late, and Goldman Sachs (GS) is set to bring it public sometime this spring. I think this will immediately highlight lots of hidden value in the supermarket chain.

Safeway itself is only selling at 11x earnings -- typical for a slow-growing supermarket -- but the company itself has been a fiend at returning cash to shareholders. It's got a 2.67% dividend yield, and has bought back 57 million shares for $1.24 billion, or 20% of the market capitalization.

Whole Foods, by contrast, is anything but cheap, even after the big languishing. It's selling at 30x 2013 figures, and with what looks to be a decelerating growth rate, according to the last conference call. Plus, when you read analysts' reports nowadays -- like last week's downgrade to Neutral by Piper Jaffray -- you now read about competition from the likes of Safeway's organic entry; Kroger's (KR) emphasis on organics; and Costco's (COST) initiatives. Perhaps most important, you hear about the influence of Trader Joe's, the private German company that's making a name for itself all over the country and doesn't have to worry about quarterly reports.

I never want to bet against Whole Foods' ability to surprise to the upside, though I see many others disagreeing with me. But one thing that I think is easy to agree with: Safeway, despite the humongous run in the first quarter, is still undervalued.



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