Loblaw Earnings: Pricing Can’t Quite Offset Inflation, Private Label and Drug Prowess Persist

No-moat Loblaw L commented that it didn’t fully pass along the 10.5% food inflation seen in its fiscal 2023 first quarter with just a 3.1% lift in food same-store sales, sending shares down a low-single-digit percentage after earnings were released. We suspect wallet-stretched consumers’ desire for value in an industry that is conducive to price competition has eroded operators’ ability keep pace with vendor price hikes and maintain segment gross margin, regardless of brand, underpinning the firm’s no-moat designation. Drug retail same-store sales popped 7.4%, serving as a partial offset, boosted by front store same-store sales of 10.3% as beauty and cough and cold sales rebounded from omicron-related travel restrictions, bringing Loblaw’s aggregate growth to 6% (trending near our 4% full-year estimate). This higher-margin fare helped lift retail gross margins to 31.3%, a 20-basis-point improvement despite the cost of food drag. As such, management reiterated calls for 2023 gross margin to remain around 2022 levels, with low-double-digit EPS growth, harmonizing with our forecast for stable margins (around 32%) and 12% EPS growth. Consequently, we don’t anticipate a material change to our $106 fair value estimate, leaving shares rich.

The state of the consumer remained top of mind at Loblaw this quarter, as management noted that consumers have continued to alter their shopping patterns by increasing trips and reducing basket sizes, favoring hard discount banners (Maxi), and purchasing private-label fare. In fact, the firm’s private-label brands (No Name and President’s Choice) grew at twice the pace of national brands, delivering double-digit sales growth. We attribute years of private-label investment, coupled with Loblaw’s PC Optimum discounting, to the segment’s strength and ability to gain share in the quarter.