* Q1 EPS excluding items $0.29 vs Street view $0.28
* Sales $9.77 billion vs Street view $9.45 billion
* Sees identical-store sales improving in Q2
* Shares fall as much as 4 pct (Adds analyst and executive comments, details on fuel sales, updates share activity)
By Lisa Baertlein
LOS ANGELES, April 28 (Reuters) - High fuel prices reduced quarterly gross profit at Safeway Inc SWY.N, the second-biggest U.S. supermarket operator, sending its shares down even though its earnings beat estimates.
Shares of Safeway were down 2.3 percent in afternoon trading after falling as much as 4 percent earlier, and shares of larger rival Kroger Co (KR.N) were also down 1.9 percent.
Wal-Mart Stores Inc (WMT.N), which sells more groceries than any other retailer, saw its shares rise 0.4 percent.
High gasoline prices squeezed Safeway's profit and fuel sales dragged down the company's gross margin by 87 basis points in the first quarter. The company sells a lot of gasoline at its grocery stores, and those gasoline sales -- while hurting margins -- contributed to Safeway's overall sales during the quarter.
Chief Executive Steve Burd said he does not think fuel prices will remain at current levels.
During a conference call with analysts, the CEO said gas prices could again hit margins in the second quarter if prices remain high. He also advised analysts to reduce estimates for the current quarter and raise them later in the year -- when lower gas prices could boost profits.
"That type of back-end loading is typically viewed skeptically by investors," BB&T Capital Markets analyst Andrew Wolf said.
The operator of grocery stores such as Safeway, Vons and Dominick's said first-quarter net income fell 74 percent to $25.1 million.
Excluding a tax charge related to repatriating $1.1 billion from Safeway's wholly owned Canadian subsidiary, it reported a profit of 29 cents per share -- a penny better than analysts' average estimate, according to Thomson Reuters I/B/E/S.
Sales rose a bigger-than-expected 4.8 percent to $9.77 billion.
Safeway attributed the sales rise to higher fuel sales, a 0.4 increase in identical-store sales, excluding fuel, and a higher Canadian exchange rate, partly offset by reduced sales due to store closures.
Identical-store sales are a key gauge of performance for grocery stores and at Safeway include established supermarkets that have not been significantly renovated or replaced.
Burd said Safeway lost some market share during the first quarter, but that such declines would end when identical-store sales rise about 1 percent.
"We think we could be close to a 1 percent" identical-store sales increase in the second quarter, Burd said.
"That's what he is hoping to get to, but that's not where they are," said Susquehanna Financial Group analyst Robert Summers, who noted that Burd declined to talk about quarter-to-date trends.
U.S. grocers have had success passing through higher costs for key staples like beef, dairy products and produce. But if prices for those items rise too much, shoppers could change stores or trade down to lower-cost alternatives.
Pleasanton, California-based Safeway repeated its forecast for full-year earnings of $1.45 to $1.65 per share, including an estimated hit of 15 cents per share from the Canadian dividend. That assumes identical-store sales growth, excluding fuel, of 1 percent to 1.5 percent.
"We still see significant risk to the full year outlook," Hapoalim Securities analyst Ajay Jain said in a client note.
He said Safeway faces higher hurdles ahead because it had real estate gains, tax credits and vendor income in the second half of 2010.
Union workers at Safeway's Vons chain -- as well as those at Kroger's Ralphs and Supervalu's (SVU.N) Albertsons markets, last week authorized union leaders to call a strike if contract talks fail.
"I don't think you should interpret that in any way that we are near a strike. It is very, very common for them to get a strike vote and be back at the table," Burd said. (Reporting by Lisa Baertlein, editing by Gerald E. McCormick, Dave Zimmerman and Matthew Lewis)