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A rating downgrade by Credit Suisse caused Safeway Inc. (NYSE:SWY) stock to fall on Monday, but shareholders are shrugging off the news today as the stock has recovered roughly 1%. Analyst Edward Kelly said the grocery chain’s pension plans could have more underfunded liability than expected, which could eventually increase its costs.
Kelly said that in analyzing Safeway’s multi-employer pension plans, his firm discovered a $7 billion pre-tax underfunded liability. Although this shouldn’t immediately affect the company’s cash flow, it could potentially cause labor costs to rise over time, Kelly said, making Safeway’s shares pricier than they appear.
The analyst also noted that Safeway’s sales volume has seen no growth since 2006, and there is no indication that the company can make a significant recovery in the near future. Safeway is dealing with fierce competition and has the majority of its business in California, where the economy is particularly bad. Kelly lowered Safeway to Neutral from Outperform and cut his target price on its shares to $20 from $26.
Safeway has a huge financial responsibility in its multi-employer pension plans, which are funded by several employers and typically provided to union workers. Until a recent rule change by regulators, it had been impossible for investors to determine a single company’s full stake or risk in these plans due to lack of information. Regulators now require that companies disclose more details about their plans.
Safeway is the first grocery chain to disclose the additional information. Credit Suisse estimates the grocery store operator’s obligation is $7 billion pre-tax and $4.5 billion after tax, which Kelly says is too much exposure for a company of its size. Although factors such as improving financial markets, a rise in interest rates, shrinkage of employee benefits or an increase in companies’ contributions to the pension could cause Safeway’s exposure to improve, Kelly said it is wise to view the underfunding is a serious liability for the chain.
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