|Shares Out. (in M):||285||P/E||12.6x||16.5x|
|Market Cap (in $M):||9,400||P/FCF||14.0x||18.0x|
|Net Debt (in $M):||5,000||EBIT||1,250||1,050|
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Canadian Grocers – A repeat of the US Grocer decline in the face of competition from WMT and TGT
Loblaws ($34) – SHORT – Upside (+10%) / Downside (-40% to -70%)
The market is valuing Loblaws and peers like they are mature but stable companies.
Loblaws - $9.5B market cap, $16M DTV. 40% market share
Metro (MRU) – $5.5B market cap, $20M DTV. 11% market share
Empire (EMP/A) - $4B market cap, $4M DTV. 18% market share
Loblaws - Investment Thesis
The US Grocery Industry since 2002 – margins collapse in order to maintain market share. Stocks collapse too, trailing the market by 70%
There is a clear hollowing out of the middle, just as in the US but with a lag - Each customer shops at different places for different things; sometimes they seek value (WMT, dollar stores, discounters) and sometimes they seek indulgence (WFM, specialty, ethnic). That means there are two formulas for winning:
Conclusion – WMT is best in class Value grocer and WFM is a best in class Indulgence Grocer. TGT is a best in class convenience grocer. Loblaws is stuck in the middle
General drivers of success
Hollowing out of the middle – it’s a definite threat. Incumbents are signaling they expect increased competition. They are following the same playbook as US peers, which did not work
Loblaws – their traditional arm - Stuck in the middle
•Calls with independently sourced suppliers to perishables/bakery/branded goods, industry experts (Canadian Grocer Magazine). I’ve also shopped at all of these stores.
WMT – Strong management, low costs, gross merchandise and strong perishables generates traffic. Best overall position: strong in value, indulgence and convenience
TGT – moving aggressively. They will begin with smaller stores than in the US; they will win on convenience and branding. But the actual product will not include a great selection of perishables until 2014.
WFM – They dominate the indulgence shopping experience. While they often say they will grow heavily in Canada, they don’t deliver. they say this time will be different, but I don't factor that into my forecastsAt some point they will be a very large threat. Right now they have 7 stores. They often say they will focus on Canada but those plans get delayed. So I assume the delays continue.
Valuation and target price – upside is 10%, down side is 40% to 70%
Their private label brand, “president’s choice”, is the #3 brand in Canada and a big driver of traffic and margins. It is a great brand and the food is high quality. It’s success has masked the deterioration in the rest of the business. They have targets for profit margins on private label and sales as % of total. They are very close to reaching those long term targets. Given their disclosure you can accurately estimate what margins are in the rest of their business. You can see that all the growth in EBIT comes from private label. What you can see is that excluding private label, margins are down 50 bps and SSS barely rises, definitely less than inflation. The biz is already under a lot of pressure. total EBIT increased $430M over the last 4 years but private label EBIT increased $525M implying a nearly $100M EBIT decline in the rest of their business despite growing their store count. EBIT margins in the rest of their business is already down 50 bps. They had margin pressure in H2 2011 and I wouldn’t be surprised if this slowdown in the private label story is now exposing the deterioration in the rest of their business.
the quality of earnings is also deteriorating. lots of one time items etc that the sell side is ignoring but point to a continued deterioration in margins.
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