BMO Capital Markets analysts David J. Chiaverini and Richard Fellinger take a look at Safeway’s unexpected exit from Blackhawk Holdings. Though a surprise, they ultimately stick to their guns regarding Blackhawk, maintaining a Market Perform rating.

Safeway’s exit from blackhawk

Blackhawk Network Holdings Inc (NASDAQ:HAWK) reported modestly disappointing earnings, but the more important event is that Safeway Inc. (NYSE:SWY) unexpectedly announced it will distribute its 38 million HAWK shares (72% of outstanding HAWK shares) to Safeway Inc. (NYSE:SWY) stockholders. We believe this makes sense from Safeway’s perspective, but it is clearly negative for Blackhawk shareholders in the near term given the anticipated technical pressure on Blackhawk Network Holdings Inc (NASDAQ:HAWK)’s stock price – we expect the shareholder base to turn over following the distribution. Importantly, we believe Safeway Inc. (NYSE:SWY)’s planned exit has more to do with it wanting to dispose of a noncore asset as it explores a potential sale rather than there being any significant operational concerns with HAWK. We had previously assumed Safeway would exit in a measured, orderly fashion over time rather than in one fell swoop.

Impact & Analysis

Blackhawk Network Holdings Inc (NASDAQ:HAWK) reported 4Q13 adjusted EPS of $0.81 (BMO $0.82, cons. $0.84). We view HAWK’s results as modestly disappointing. Key takeaways from the quarter include: 1) total load value of $4.7B was up 17% y/y, which was below our estimate of +19.5% and below recent trends; management noted demand was affected by soft fourth-quarter sales at many US retailers; 2) adjusted net income was roughly in line with our estimate, though it resulted from lower-than-expected commissions and fees revenue being offset from lower distributions to partner commissions; and 3) Blackhawk Network Holdings Inc (NASDAQ:HAWK) will provide its 2014 financial outlook during its earnings call and investor conference tomorrow beginning at 8 a.m. ET; (877) 280-4962(877) 280-4962, passcode 82919903.

Valuation & Recommendation

There is no change to our 2014/2015 adjusted EPS estimates of $1.35/$1.60. Blackhawk Network Holdings Inc (NASDAQ:HAWK) is trading at 20.8x our 2014 adjusted EPS estimate compared with peers at 16.5x. Our $24 price target is based on HAWK’s trading at 18x our 2014 estimate. We rate shares Market Perform.