METRO INC. $37 (Toronto symbol MRU.A; Aggressive Growth Portfolio, Consumer sector; Shares outstanding: 108.5 million; Market cap: $4.0 billion; Price-to-sales ratio: 0.4; Dividend yield: 1.5%; SI Rating: Average) is Canada’s third-largest supermarket operator, after Loblaw and Sobeys. Metro operates roughly 660 grocery stores in Quebec and Ontario. Its major banners include Metro, Super C and Food Basics. The company also operates or supplies around 270 drug stores. Eighty-one of these are located inside its supermarkets.

Aside from its grocery business, Metro owns roughly 23% of Alimentation Couche-Tard Inc. (Toronto symbol ATD.B). Couche-Tard has more than 3,500 convenience stores in the U.S., and is the largest convenience-store operator in Canada, with over 2,000 outlets. The Canadian stores operate under the Couche-Tard and Mac’s banners, while the U.S. stores mainly use the Circle K brand.

Based on Alimentation Couche-Tard’s current stock price, this investment accounts for 23% of Metro’s market cap. Couche-Tard is a recommendation of Stock Pickers Digest, our publication for aggressive investors.

Big acquisition has paid off

In 2005, Metro bought A&P Canada for $1.7 billion. A&P operated over 240 food stores in Ontario, mostly under the A&P and Dominion names. The purchase helped lower Metro’s reliance on Quebec.

Adding A&P pushed up Metro’s sales from $6.6 billion in 2005 to $11.2 billion in 2009 (Metro’s fiscal year ends September 30). If you exclude the costs of integrating these new stores, Metro’s earnings rose from $1.92 a share (or a total of $190.4 million) in 2005 to $2.53 a share (or $295.0 million) in 2007.

Metro’s 2008 earnings fell to $2.48 a share (or $281.3 million), mostly because of rising price competition in Ontario. However, its 2009 earnings rebounded to a record $3.23 a share (or $359.0 million). That’s partly because Couche-Tard contributed $37.4 million to Metro’s 2009 earnings, compared to $17.6 million in the prior year.

Single banner lowers advertising costs

Metro is lowering its marketing costs by converting its Dominion, A&P, Loeb, The Barn and Ultra supermarkets in Ontario to the single Metro banner. The conversion, which should be completed by the end of 2009, will cost Metro $200 million.

Similarly, Metro has consolidated its various private labels into two main brands: “Irresistibles” for higher-quality products, and “Selection” for more common items. This gives it more purchasing power and negotiating clout with its suppliers.

Metro is also starting to see better productivity as a result of its investments in computerized cash registers and inventory systems. This equipment will also help Metro with a joint venture it recently formed with marketing firm dunnhumby, which collects and analyzes customer data, including buying habits and other trends.

dunnhumby will help Metro improve the effectiveness of its advertising and create new customer-loyalty programs.

Discount chain helps Metro compete

Because of the weak economy, many shoppers are going to discount supermarkets to cut their grocery bills.

In response, Metro is expanding its Food Basics discount chain in Ontario. Last year, the company bought back 36 of these stores from franchisees for $16.4 million. Metro now owns the entire chain. This makes it easier to renovate the stores, and adjust their inventory to suit local tastes. These moves should help Food Basics compete with bigger discount retailers, such as Wal-Mart and Costco.

The company is also expanding in Quebec. In September 2009, it paid an undisclosed sum for Les Supermarchés GP (Groupe GP), which operates 15 supermarkets in eastern Quebec.

The two companies have a long-standing partnership, and eight of Groupe GP’s stores operate under the Metro and Metro Plus banners. The new stores should add $300 million to Metro’s annual revenue.

Metro’s $1-billion long-term debt is just 25% of its market cap. It holds cash of $241.4 million, or $2.22 a share. These factors give Metro plenty of flexibility to expand or make acquisitions. The company is also an aggressive buyer of its own shares: In fiscal 2009, it spent $142.5 million on share repurchases.

P/e ratio still low despite big gain

The stock has gained over 70% since March 2008, but still trades at just 10.9 times the $3.38 a share that Metro is likely to earn in 2010. The company also has a long history of raising its dividend. The current rate of $0.55 a share, which is up 10% from a year ago, yields 1.5%.

Metro is a buy.