Loblaw Managing Through Increasingly Promotional Food Retail Environment

We don’t expect a material change to our CAD 97 fair value estimate for no-moat Loblaw L, and we see the shares overvalued. The company continues to leverage its data and scale capabilities to manage through an increasingly promotional environment.

2022 sales were up 6% versus our 5% estimate, aided by strong drug retail performance that was mitigated by intensifying competition for consumer wallet share in the food business. Drug same-store sales rose 6.9% (versus our 5.5% estimate), aided by continued beauty and cold and flu demand, while food same-store sales grew 4.7% (in line with our forecast). In the quarter, food inflation was 11.2%, with Loblaw’s same-store sales growth of 8.4% lagging once again after its third-quarter sales growth of 6.9% was behind inflation of 10.7%. The company said promotional activity has picked up and consumers continue to trade down, making it challenging to push significant price hikes, even though more than 1,000 of its suppliers are requesting them. As a result, food retail margins remain below mid-2021 peak levels, including a fourth-quarter retail gross margin of 30.6% that was down from 30.9% a year ago.

Given limited visibility on inflation and economic growth, Loblaw did not provide much guidance for 2023, but it did say it expects gross margin to remain around the 2022 level, in line with our forecast. Also, Loblaw targets 2023 adjusted EPS to grow by a low-double-digit percentage; we plan to maintain our 12% estimate. We maintain our long-term low-single-digit average revenue growth and mid-single-digit operating margin expectations. Although Loblaw operates in a competitive space that produces narrow margins, we view initiatives such as the conversion of select market stores to discount banners, pharmacist-staffed walk-in clinics, investment in private-label expansion, and newly announced future automation efforts as prudent in adding value to shoppers while maintaining industry-competitive margins.