LBLCF - Loblaw: Drug Retail Sales Could Lift Overall Earnings

2023-05-12 17:19:02 ET

Summary

• Loblaw has seen a recovery in its stock price in the most recent quarter.
• However, sales across Food retail could start to moderate as inflation starts to plateau.
• While the stock could see further upside going forward, I would ideally like to see more evidence that Drug Retail sales can ultimately lift overall earnings.

Investment Thesis: While Loblaw has seen a recent recovery in its stock, I would ideally like to see more evidence that the Drug retail segment can continue to lift overall earnings growth going forward.

In a previous article back in March, I made the argument that Loblaw Companies ( L:CA ) could see little upside in the short to medium-term, on the basis that growth in food retail sales has been significantly down to rising prices rather than growth in organic demand - and continued inflationary pressures could be set to place further pressure on demand going forward.

In spite of this, the stock is up by nearly 8% since my last article:

The purpose of this article is to assess whether the rebound in the upside that we have been seeing in the stock can continue from here - taking recent quarterly financial performance into consideration.

Performance

When looking at performance for Q1 2023 , we can see that Loblaw Companies saw growth of 3.1% across same-store sales (same-store sales meaning a comparison of sales across time periods that excludes new stores or those which have closed to ensure a like-for-like comparison). While this was higher than the growth of 2.1% seen in the previous year, it still remains below the growth seen across the Drug retail segment on a percentage basis.

To put same-store sales growth for the Food Retail segment into a wider context, I decided to generate a heatmap of percentage growth for each quarter from Q1 2019 to the present.

When analyzing the above, it is notable that the highest periods of growth for Loblaw were for all quarters of 2020, in addition to Q3 and Q4 in 2022. Outside of these quarters, the highest level of growth achieved was 3.1% for Q1, 2023.

2020 was marked by supply chain disruptions as a result of the COVID-19 pandemic, with the World Economic Forum citing that global food prices in December of that year were the highest for any month over the past six years.

Additionally, Loblaw cites that the Consumer Price Index for Food Purchased From Stores was 9.7% for the whole of 2022 - up from that of 2.2% in 2021. In this regard, the growth in same-store sales that we have seen for the latter two quarters of 2022 is not surprising.

While drug retail was not immune to the effects of inflation either, the segment nonetheless did benefit from an increase in demand for cosmetics and over-the-counter product sales as consumers started to return to pre-pandemic purchasing habits in 2022.

In this regard, while I expect that we could see a plateau across food retail as inflation starts to level off and growth in demand is expected to remain modest given macroeconomic concerns – drug retail sales could nonetheless continue to see growth from here.

Moreover, with high-margin beauty and cosmetics products continuing to lead growth across this segment, we can see that the adjusted EBITDA margin for Loblaw’s as a whole has continued to see growth over the past three years:

Additionally, adjusted EBITDA margin for the most recent quarter was up slightly to 11.1% from 11% for the same quarter in the previous year.

Risks And Looking Forward

Going forward, my overall view on Loblaw is that while growth across the food retail segment may be likely to dip back to levels seen in the absence of inflation, sales of higher-margin products across Drug Retail could continue to lift net earnings - adjusted diluted net earnings for this quarter were up to $1.55 from $1.36 in the same quarter of the previous year.

From a P/E standpoint, we can see that EPS (on a normalized diluted basis) has continued to rise, while the P/E ratio continues to trade near a five-year low.

Additionally, when comparing the stock's P/E ratio to competitors - we can see that while Loblaw trades at a higher P/E ratio to that of competitor The Kroger Co ( KR ) - the stock still sees a similar P/E ratio level to that of Metro Inc (MRU.TO).

From this standpoint, I do not see signs that Loblaw is overvalued at this point, and the stock could still see upside given continued earnings growth.

The main risk I see for the company is a moderating of sales performance across the Drug retail segment. We have seen that sales of higher-margin products across this segment have helped to boost earnings - while that of Food retail has seen modest growth when adjusting for inflation. However, should we also see moderation in sales growth across Drug retail, then I expect that this could place pressure on earnings going forward.

Conclusion

To conclude, Loblaw Companies has seen a recovery in the most recent quarter despite concerns over sales growth across the Food retail segment. While I take the view that the stock has the potential for further earnings growth - I would ideally like to see more evidence that the Drug retail segment can continue to lift overall earnings growth going forward. Should this prove to be the case, then my view on the stock would become more bullish.

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