We report on a retailer that’s a leader in Canada’s grocery and prescription drugs markets. Loblaw is Canada’s largest supermarket operator with more than 1,130 stores across the country under different names. The company’s 2014 purchase of Shoppers Drug Mart has boosted Loblaw’s sales. The company has also adopted new inventory-management systems that have improved operations at its grocery stores. Continued strong sales, a share buyback plan and the company’s growing financial services business should help lift profits further next year. We view Loblaw as a dividend stock to buy for conservative investors.

Loblaw shares hovered between $30 and $40 between 2008 and 2012. That’s mainly because the company had trouble upgrading its inventory-management systems and streamlining its distribution networks. As a result, many of its stores frequently ran out of basic items.

The company has fixed these problems and is now enjoying the benefits of its new systems. In addition, its 2014 purchase of the Shoppers Drug Mart chain sets it up for years for growth.

LOBLAW COMPANIES LTD. (Toronto symbol L; www.loblaw.ca) opened its first self-serve, cash-and-carry grocery store in Toronto in 1919.

Today, the company is Canada’s largest supermarket operator, with over 1,130 stores. Its main banners include Loblaws, Provigo, Fortinos, Real Canadian Superstore, No Frills and T&T Supermarkets. Loblaw owns about half of these stores, while franchisees own the other half.

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In March 2014, Loblaw bought the 1,250-store Shoppers Drug Mart chain for $12.3 billion in cash and shares. Franchisees operate most of these locations.

Adding Shoppers lets Loblaw profit from an aging population, which will spur demand for prescription drugs. As well, most Shoppers stores are small and in urban areas, so there’s little overlap with Loblaw’s mainly suburban supermarkets.

The company’s retail stores supply 97% of its revenue and 80% of its earnings. It gets a further 2% of revenue and 4% of earnings from financial services, such as credit cards and insurance. The remaining 1% of revenue and 16% of earnings comes from its 83.0% stake in Choice Properties REIT (Toronto symbol CHP.UN), which owns 515 commercial properties, mainly Loblaw’s stores.

The Shoppers deal boosted Loblaw’s sales by 38.2%, from $30.8 billion in 2010 to $42.6 billion in 2014. Sales probably rose to $45.4 billion in 2015.

If you exclude costs to integrate Shoppers, Loblaw’s earnings rose to $3.22 a share (or $1.2 billion) in 2014 from $2.23 a share (or $627 million) in 2013.

The company feels it should save $235 million in 2015 by combining its marketing and distribution functions with those of Shoppers, up from its earlier target of $200 million.

By the end of 2016, Loblaw expects these annual savings to rise to $300 million.

The company recently announced that it would close 52 less-profitable stores in the next year, including supermarkets, gas bars and stand-alone Joe Fresh casual clothing outlets. The move will cut Loblaw’s yearly sales by $300 million, but it should add $35 million to $40 million to its annual gross profits.

Dividend stocks: Shoppers merger to save on costs

If you disregard unusual costs, Loblaw’s earnings rose 10.0% in the three months ended October 10, 2015, to $408 million, or $0.99 a share. A year earlier, it earned $371 million, or $0.90 a share. Sales rose 2.6%, to $13.9 billion from $13.6 billion. Excluding gasoline, same-store sales in- creased by 3.1% at Loblaw’s supermarkets. Shoppers’ same-store sales gained 4.9%, reflecting 3.5% higher prescription-drug sales and a 6.2% increase in sales of other merchandise.

The savings from the Shoppers purchase have helped Loblaw pay down the cash it borrowed to complete the deal.

As of October 10, 2015, the company’s adjusted debt (short- and long-term debt less certain items) was $9.2 billion, down 16.9% from $11.1 billion when it closed the Shoppers acquisition.

The company now plans to use more of its excess cash flow for share repurchases instead of debt repayments. In the first nine months of 2015, Loblaw spent $94 million on share buybacks, but it will probably repurchase $1 billion worth of its stock in each of 2016 and 2017.

In addition, the company probably spent $1.2 billion on capital projects in 2015, mainly to build 50 new stores and upgrade 100 others.

These outlays also include new investments in its e-commerce operations. For example, Loblaw recently launched a program in Toronto called Click & Collect, which lets shoppers order their groceries online and pick them up at their nearest store, where employees load them into customers’ cars.

At the same time, the company is enhancing its financial-services business. It recently launched a new premium President’s Choice MasterCard that offers users more rewards than its regular card. Loyalty programs like this help retailers increase customer visits. Moreover, Loblaw can analyze their shopping habits to create customized offers and encourage more spending per visit.

The company’s per-share earnings will probably rise from $3.48 in 2015 to $4.04 in 2016. The stock trades at a moderate 16.1 times the 2016 forecast. The $1.00 dividend yields 1.5%.

Recommendation in The Successful Investor: BUY  

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