Safeway, Whole Foods Not the Safest Routes to Riches

Thursday Safeway (NYSE: SWY) --  operator of supermarket brands like Vons, Randalls, Tom Thumb, Genuardi's and Carrs -- reported a rise in earnings but expects weak results due to the moribund U.S. economy. This suggests that if you're shopping for supermarket equities, you might be better off buying in the premium aisle where the well-off shop. Does that mean you should invest in Whole Foods (NASDAQ: WFM) instead?

Despite the gloomy outlook, Safeway beat expectations. Safeway reported $130.2 million in net income, up 6% from the year before while its 38 cents a share EPS beat expectations by three cents. And Safeway revenues climbed 7.1% to $10.06 billion, 2% higher than analysts polled by Thomson Reuters had forecast.

Safeway CEO Steve Burd told Dow Jones Newswires that high income consumers are spending as much as ever but most shoppers remain very price conscious -- a trend that Burd expects will continue for the next year. Nevertheless, Burd noted that Safeway's same-store-sales rose 2% during the most recent six weeks.

Whole Foods is doing way better than Safeway. When it last reported earnings for its second quarter in July, Whole Foods reported a 35% jump in earnings and raised its forecast for the rest of 2011. Its $88.5 million in second quarter earnings were up 35%; its revenues climbed 11% to $2.4 billion and its EPS of 50 cents per share were three cents better than expected.

What's behind the better than industry average performance at Whole Foods? It has revamped its product line so people perceive its prices as being lower. While that move may have drawn consumer back to its stores, Whole Foods' affluent customers appear willing to pay the higher prices its is charging to hold its profit margins as its cost of goods sold goes up. Demand is so high that Whole Foods is adding to its 309 stores in the U.S., U.K. and Canada.

So does this mean you should shun Safeway stock and invest in Whole Foods? I'd avoid them both. Here's why:

• Whole Foods: fast growing, decently profitable company; expensive stock. Whole Foods revenues increased 12.1% to $9.9 billion in the last year while its net income soared 102% to $325 million yielding a slim 3.3% net profit margin. But its Price-earnings-to-growth ratio (PEG) -- 1.0 is fair value -- is a pricey 2.17 with a P/E of 36.8 on earnings forecast to grow 17% to $2.25 in fiscal 2012.
• Safeway : barely growing, thinly profitable company, pricey stock. Safeway revenues are up 0.5% in the last year to $42.8 billion and its net income soared 154% to $531 million while it earned a slimmer 1.2% net profit margin. And its PEG is an over-valued 1.35 on a P/E of 12.6 with earnings forecast to grow 9.3% to $1.85 in 2012.

Even if Whole Foods maintained a 35% earnings growth rate, it would still not be a bargain at its current P/E. And Safeway's slim margins and slow growth make it hard to like --even with single-digit P/E.