Pat McKeough responds to many requests from members of his Inner Circle for specific advice about buying stocks as well as questions on investment strategy and the economy. Every week, his comments and recommendations on the most intriguing questions of the past week go out to all Inner Circle members. And each week, we offer you one of the highlights from these Q&A sessions. While we reserve our buy-hold-sell advice for Inner Circle members, these excerpts provide a great deal of information and analysis on stocks we’ve covered for members of Pat’s Inner Circle.

This week we had a question from an Inner Circle member about one of Canada’s three big grocery chains. Already the owner of Sobeys, Empire made a major acquisition late last year when it added the Canadian stores of U.S. chain Safeway. The deal gave the company a much larger presence in Western Canada to offset its concentration of Sobeys stores in eastern Canada. Pat examines the company’s business with Safeway on board and assesses the rewards and potential hidden risks of this big acquisition.

Q: Hi Pat: I know Empire Company isn’t one you follow regularly in your newsletters, but what do you think of the stock?

A: Empire Company Ltd. (symbol EMP.A on Toronto; www.empireco.ca), is a diversified Canadian firm based in Stellarton, Nova Scotia.

Empire sells and distributes food through national grocery retailer Sobeys. It also invests in real estate and various publicly traded companies.

In June 2007, Empire paid $58 per share (a total of $1.06 billion) for the 29.9% of Sobeys that it didn’t already own. (Sobeys was a recommendation of our Successful Investor newsletter. We first recommended the stock in April 2003 at $36, so the buyout left our subscribers with a 61% gain.)

Sobeys owns or franchises more than 1,500 stores across Canada. In addition to Sobeys, its banners include IGA, IGA Extra, Price Chopper, FreshCo and Safeway (see below).

The company’s real estate division includes commercial and residential property operations. It owns 41.6% of Crombie REIT (symbol CRR.UN on Toronto), which invests in retail, office and mixed-use properties. Empire handles its residential investments through a 40.7% interest in Genstar Development.

Empire also holds stocks that trade on Toronto and New York. Including its holdings in Crombie REIT and Genstar, Empire’s investment portfolio had a market value of $931.0 million, or $10.09 a share, on February 1, 2014.

Empire shares have dropped since Safeway acquisition

In November 2013, Empire completed its purchase of U.S. grocery store operator Safeway’s (symbol SWY on New York) Canadian operations. The deal included 213 grocery stores (200 which have in-store pharmacies), 62 gas stations, 10 liquor stores and four distribution centres.

Most of these stores are in Western Canada, which complements Empire’s Sobeys stores in Eastern Canada. A wider geographic presence should also help Sobeys compete with larger chains, like Loblaw, and non-traditional grocery sellers like Wal-Mart and Costco.

Empire paid $5.8 billion for the Safeway operations. To help fund the purchase, it sold $1.6 billion of non-voting class A shares. The company also sold 70 Safeway stores to Crombie REIT for $991.3 million. In addition, it raised $248 million by selling its Empire Theatres business, which included 46 cinemas with 397 screens across Canada.

Thanks to the Safeway acquisition, Empire’s sales jumped 40.4% in the three months ended February 1, 2014, to $6.0 billion from $4.3 billion a year earlier. Excluding Safeway, sales rose 2.7%.

Without one-time items, earnings gained 2.0%, to $77.3 million from $75.8 million. However, per-share earnings fell 24.3%, to $0.84 from $1.11, on more shares outstanding due to the Safeway acquisition.

In addition to selling assets and new shares, Empire borrowed $2.6 billion to finance the Safeway deal. As of February 1, 2014, its long-term debt was $3.5 billion, or a high 57% of its market cap.

The acquisition of Safeway should give Empire more bargaining power with suppliers. As well, Empire stands to benefit from Safeway’s steady cash flow.

Since it bought Safeway, Empire’s stock has dropped 17%. The shares yield 1.6%.

In the Inner Circle Q&A, Pat looks at the hidden risks that can come with a big purchase like that of Safeway. He considers whether Empire can realize the full benefits of its purchase in an increasingly competitive food retailing market that features expansion by big-box U.S. retailers like Wal-Mart and Costco. He concludes with his clear buy-hold-sell advice on this stock.

(Note: If you are a current member of the Inner Circle, please click here to view Pat’s recommendation. Be sure to log in first.)

COMMENTS PLEASE—Share your investment knowledge and opinions with fellow TSINetwork.ca members

When chains like Empire, Loblaw and Metro carve up a market between them, do you believe there is enough business to go around? Or do you think one, or more, will ultimately fall behind the competition? As an investor, how do you decide which stock in a competition like this will reward you with the greatest gains?