Higher margins compared with U.S. key for Canadian grocers

There is a serious downside risk to Canada’s grocery sector if the superior margins it enjoys compared with the U.S. decline over the next two years, a new industry report says.

The big three grocers have long had substantially higher margins than their U.S. counterparts. But if they were to erode under unrelenting competitive pressure, Loblaw Cos. Ltd. shares could decline by 24 per cent to $32, Metro Inc. shares by 30 per cent to $44, and Sobeys’ owner Empire Co. shares by 39 per cent to $44, according to an analysis published Wednesday by BMO retailing analyst Peter Sklar.

“With already intense competitive activity expected to continue, an absence of food inflation, a strong U.S. dollar (which increases procurement costs), and a cautious consumer, we believe the major Canadian incumbent grocery players — namely, the three publicly traded grocers Loblaw, Sobeys and Metro — will have a tough hill to climb in the foreseeable future,” he said in the report.

The rapid expansion into Canada’s food-selling business by U.S. giants Walmart, Target and Costco accounted for roughly two-thirds of the industry’s three per cent growth in square footage over the past year.

“The three per cent industry square footage growth in 2013 was well in excess of Canada’s demographic growth rate of about one per cent,” Sklar said.

The stepped-up competition in the Canadian grocery sector has already affected retailers.

Both Sobeys and Metro have experienced decelerating operating profit growth over the past few quarters and the trend continued into negative territory over the past two reported quarters, Sklar said.

Grocers have watched the trend with rising alarm. Metro chief executive officer Eric La Fleche last fall warned the pace of growth was not sustainable.

“If your square footage in the market is growing at three per cent to four per cent, and the total market is growing less than one per cent, that is not good news, so I think at some point there has to be more of a balance,” he said. “The population is not growing that fast, so it has and will have to balance out.”

But balance does not appear to be in the tea leaves.

Walmart Canada last week said that it will spend about $500 million this year on 35 building projects, including six new stores between now and next January to bring its Canadian store count to 395. All of the building projects will add more food space inside the retailer’s cavernous stores, and it will sell groceries at 282 of its stores by next year.

“Every store where I can put food, I will put food,” Walmart Canada CEO Shelley Broader told the Financial Post in an interview last week.

Costco, meanwhile, plans to build up to 25 more warehouse stores in this country.