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Weston Bakery truck trailers.
Weston Bakery truck trailers.

Vox

Weston's a buy; Loblaw's not Add to ...

Fabrice Taylor is a chartered financial analyst.

If you want to know whether Loblaw is worth buying or not, don't turn to the analysts. I read half a dozen opinions and they didn't make a convincing case either way, although I am certain that no detail is too minute for analysts.

Almost two years ago, when the stock was $31 (it's $32 now), I called it a value trap, and indeed it was. That wasn't a tough call frankly. Now? It's a tougher call, which in my view means don't bother. But there's a better idea, one that lets you own Loblaw on the cheap: Buy the parent, George Weston. It's far more interesting and it makes it easier to sleep at night.

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First, let me argue against buying Loblaw now. The company put out a surprisingly good quarter recently, but when you dissect the numbers, you realize it wasn't so great after all. The good news is that the turnaround is going reasonably well, and there's more to come on that front. The bad news is that the big trends, which management can't control - food price inflation, competition - are not friendly.

The general consensus, which basically comes straight from management, is that the next few quarters are going to be tough. No, we don't buy blue-chip stocks based on six-month returns, but we also hate to buy them and watch things get worse.

Buying the stock seems like a bet that the price-to-earnings multiple will expand. If true, fine: one point gives you an almost 8-per-cent return, all else equal. But it's unlikely to go beyond 15 times, and it's around 13 and a half now. An expanding multiple depends on big investors becoming more comfortable - they seem to be - but do you want to bank on it?

Here's the better idea in my view: invest in George Weston. Weston owns 62 per cent of Loblaw. Each Weston share includes 1.32 Loblaw shares (Weston owns more Loblaw shares than it has shares outstanding). Today, that's worth about $43 bucks. Weston shares are quoted at $59, so after Loblaw you get the rest of the Weston business - bakery, food and a lot of cash - for $16. The cash is worth about $10 a share, meaning you get the other operating businesses for about $6.

That's cheap. The bakery business is probably worth at least twice that.

Then why is it cheap? It's the holding company discount of course: investors like pure plays. They'd rather own Loblaw outright than Weston. This means, of course, that the discount is likely to persist.

Maybe, maybe not - more on that in a second. First, though, assuming it does, you still get to play Loblaw through Weston, whose shares respond to Loblaw's share price movements. You also get a little bit of diversification. All good.

But you have to assume that something is going to happen at Weston given all that cash. They're not going to let it just sit there.

There are a few options: management could buy back shares or pay a special dividend. It could also pay down debt. These options might create value for shareholders.

Another possibility is an acquisition - or more than one. There might be some good buys out there, especially if the recession keeps going. And there are some privately owned bakeries. Buying one or more of these might be interesting in that Weston could wring out some savings and get a valuation lift (I assume a private deal is done at a lower multiple or price than an identical public company would fetch.)

Finally, as an outlier, Weston could either take Loblaw private or the family could take Weston private. The former doesn't seem likely: it looks hard to do in a way that's accretive for Weston.

The latter? Maybe. The family has 60 per cent of the stock now, and access to a lot of cash to help finance the purchase.

And while they won't rush to decide how to put that cash to use, eventually, I think, investors will start to close the discount. It's a lot bigger than it should be.

*******

Weston's numbers

By buying Weston, it appears that investors are getting a deal on Weston's bakery business and its stake in Loblaws.

Weston market cap:

$7.6-billion

Loblaw market cap:

$8.9-billion

Weston's Loblaw stake:

62%

Value:

$5.5-billion

Weston cash:

$3.7-billion

Weston debt and preferred shares:

-$2.4-billion

Net value:

$6.9-billion

Implied value of non-Loblaw business:

$755-million

EBITDA of non-Loblaw business:

$200-million

Value to EBITDA:

4 times

Report on Business Company Snapshot is available for: GEORGE WESTON LIMITED

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