Top Canadian Grocery Stocks

Canadian grocer results are solid, driven by discount formats and private labels as consumers seek value in food and daily necessities.

Ruth Saldanha 28 November, 2023 | 4:12AM
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Grocery store

Two of the largest grocers in Canada, Loblaw Companies (L) and Metro (MRU) posted a rise in profits during the third quarter of this year. Morningstar analyst Dan Su says the results are solid, driven by discount formats and private labels as consumers seek value in food and daily necessities. 

However, she warns that “2024 is shaping up to be a tougher year, given more planned price hikes from national brands. Grocers’ ability to pass through the higher prices will be limited.” Earlier in October, Minister François-Philippe Champagne announced that the grocers have presented initial plans to stabilize prices, which include discounts, price freezes and price-matching campaigns.

Investors should note that none of the three Canadian grocery stocks we cover are cheap at present. Plus, none of them have an economic moat or a competitive advantage. Both the American grocery chains that have a presence in Canada, on the other hand, do have a Wide economic moat.

“Walmart and Costco both have significant cost advantages given their massive scale, and Costco also has a unique membership-based model, that allows them to maintain competitive prices and retain shoppers. However, we don't think Metro and Loblaw have material cost advantages and economic profits are likely to be competed away via discounts and promotions in the commoditized food retail space,” Su says, adding that exposure to food retail at Walmart and Costco is under 50%.  

Here is the list of grocers in Canada:

Let’s look at the Canadian stocks in some detail.

1. Loblaw Companies (L)

  • Morningstar Fair Value Estimate: $117
  • Morningstar Star Rating: 3-Stars
  • Economic Moat: None

We don’t plan any material changes to our $117 fair value estimate after absorbing no-moat grocer Loblaw’s (L) solid third-quarter results, with sales and adjusted EPS up 5% and 12%, respectively, in line with our estimates. The earnings update reaffirms our view that Loblaw is poised to capture more consumer spending as shoppers, squeezed by financial strains, seek value through its discount formats and private-label offerings. We maintain our full-year 2023 estimates for sales and adjusted EPS to grow 5% and 12%, respectively, and our 10-year forecasts for a 3% sales CAGR and operating margins averaging around 5% remain in place. Shares look fairly valued.

In food retail (70% of sales), shoppers remained in a cautious, value-seeking mode as the 5% grocery sales growth was mainly driven by higher foot traffic and transaction volumes while average basket size shrank. Discount formats and private-label products continued to gain volume and sales share in the overall Loblaw network, prompting conversion of some full-price stores into value formats and higher allocation of shelf space to its in-house brands versus national or global peers.

Drugstore sales grew at a similar pace (5%) despite tough comparison (10%), as the Shoppers Drug Mart chain’s comprehensive health and wellness offerings continued to resonate with Canadian shoppers. Beauty demand remained a key driver in front-store sales (50% of total drugstore revenue), though management flagged a shift from prestige to mass brands, which suggests some margin erosion down the road.

For the quarter, management squeezed a 20-basis-point savings in operational expenses, which more than offset a 10-basis-point contraction on the gross margin line due to persistent shrinking at drugstores, sending operating margins higher to 5.8%. Given tight labor supply and planned price hikes from national brands in 2024, we think Loblaw will struggle to preserve margins without compromising its value proposition to consumers.

2.Metro Inc (MRU)

  • Morningstar Fair Value Estimate: $69
  • Morningstar Star Rating: 3-Stars
  • Economic Moat: None

We plan to maintain our CAD 69 fair value estimate for no-moat Metro, as we balance solid results from the fourth quarter of fiscal 2023 (sales up 14% and adjusted EPS, excluding the strike impact, up 20%) against a cautious 2024 outlook. Management expects the underutilization of its newly expanded distribution capacity will drive up costs and cause a 1% contraction in adjusted EPS in the year ahead. We plan to reduce our fiscal 2024 earnings estimate to align with guidance but believe the capacity underutilization is temporary given strong ecommerce trends. We see no need to change our 10-year projections calling for low-single-digit top-line growth and operating margins averaging 6.5%. Shares strike us as fairly valued.

Consistent with trends at larger peer no-moat Loblaw, discount banners and pharmacies drove the bulk of sales and profit growth, as value-oriented shoppers look for savings in food and daily necessities while continuing to spend on health and beauty products for a better quality of life. With Metro’s internally measured food basket inflation at 5.5%, about 200 basis points below published food CPI, we are not surprised to see that food samestore sales rose 7% in the quarter, on top of a tough comparison (8%). In pharmacy, despite normalizing sales of masks and cold medicines from pandemic peaks, same-store sales rose 6% on strength in both prescription drug and front-store sales. E-commerce sales surged 116% thanks to strong merchandising and targeted promotions based on data from the Moi loyalty program, though most orders were fulfilled through third-party partners. As Metro migrates order picking and fulfilment to its own automated distribution centers in the coming years, we expect capacity utilization to pick up steadily, driving faster deliveries and lower fulfillment costs. Therefore, we model gross margins to revert to 20% in 2025 and onward, after a dip to 19.6% in 2024.

3.George Weston (WN)

  • Morningstar Fair Value Estimate: $168
  • Morningstar Star Rating: 3-Stars
  • Economic Moat: None

As the majority shareholder of Canada’s largest retailer Loblaw and leading real estate investment trust Choice Properties, George Weston (WN) capitalizes on resilient consumer demand for groceries and pharmacy services, and benefits from synergies between the two operating subsidiaries. We view its financial performance as anchored by steady dividends from the retail and property arms, but we don’t think the firm has a durable competitive edge based on our no-moat rating on Loblaw, which makes up the bulk of revenue and profits for the holding company.

George Weston has gained more financial flexibility to invest following the 2022 disposal of the low-margin bakery business Weston Foods, though we expect the firm to remain steadfast in its core competencies of retail and real estate. Specifically, we expect the firm to continue using Loblaw as an anchor to execute strategic initiatives in digital engagement, private label, and e-commerce, ensuring its grocery and drugstore banners stay relevant amid evolving consumer trends. While discount formats and no-frills in-house brands will remain an investment priority to serve value shoppers, we expect Loblaw to also invest heavily in product innovation and responsible sourcing to deliver on its quality commitment. This endeavor should benefit from the perspective and experience of incoming Loblaw CEO Per Bank, who used to lead Denmark’s largest retailer Salling Group.

Diversification is central to the long-term roadmap of Choice, which has made strides in recruiting staples retailers beyond Loblaw’s network. The firm also expanded into office and industrial properties via acquisitions and forged partnerships to access top assets and development pipelines. These investments may bring higher risks, but we think Choice’s business remains firmly supported by the stable tenancy of Loblaw.

We think George Weston’s strategic execution is on track, but we see many challenges, including intense competition, unfavorable drug price regulations, and labor disputes. That said, we believe the veteran management team is no stranger to these risks and can leverage its experience and tools to keep the firm’s prospects intact.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
George Weston Ltd181.11 CAD-0.22Rating
Loblaw Companies Ltd146.43 CAD0.47Rating
Metro Inc74.08 CAD1.13Rating

About Author

Ruth Saldanha

Ruth Saldanha  is Editorial Manager at Morningstar.ca. Follow her on Twitter @KarishmaRuth.

 
 
 

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