The start of 2016 has been a very painful period for investors with equity markets tumbling. In just a few short weeks, portfolio values have been significantly slashed. Preservation of capital has become a key objective for investors.
The global economic backdrop is on uncertain ground. Sliding oil prices are weighing on the energy-heavy TSX index, the Canadian dollar, and Canada's economy. Valuations are contracting for stocks, buying activity is limited with investors acting prudently – trimming stocks with gains, and rotating into bonds and cash.
For investors seeking some stability, stocks from the relatively defensive consumer staples sector are options to consider. One such consumer stock, Loblaw Cos. Ltd., is discussed below.
The company
Loblaw is set to report its fourth-quarter earnings on Feb. 25. Looking at past winners during previous earnings seasons, Loblaw is a key stand-out. The stock price has delivered a positive price reaction on the day it reported its quarterly results for the past eight quarters. Price reactions have ranged from a half-a-per-cent increase to a 4.8-per-cent gain.
This quarter, the Street is forecasting Loblaw to report earnings per share of 91 cents, down from 96 cents reported last year. Lower fees from health-care reform measures are expected to negatively affect the company's results. However, food inflation remains high, a positive for the company as prices can be passed on to customers. In December, prices for food purchased from stores jumped 4.1 per cent year-over-year. In addition, the competitive landscape has been rational; we are not seeing aggressive competitive pricing practices erode profitability.
Looking beyond the quarterly results and into 2016, prescription-drug reforms will continue to weigh on the company's profitability, earnings momentum may decelerate and realized synergies from the Shoppers acquisition are anticipated to moderate. These issues may limit the upside in the stock's price in the short-term.
Returning capital to shareholders
Management indicated on the third-quarter conference call that it plans to use free cash flow to raise its dividend and repurchase shares now that the company has met its debt-reduction objectives.
Management indicated that the company plans to increase its dividend every year and is targeting a payout ratio of about 25 per cent. The dividend has been increased annually for the past three years.
The company currently pays shareholders a quarterly dividend of 25 cents per share, or $1 a year, equating to an annualized dividend yield of approximately 1.6 per cent.
Valuation
Its valuation appears reasonable, trading at a discount to Metro and a premium to Empire.
Analysts' recommendations
According to Bloomberg, there are 10 analysts with buy recommendations, three analysts with hold recommendations and no sell recommendations.
Analysts calculate their target prices based on a sum-of-the-parts methodology, establishing a value for Loblaw and combining it with a value for the company's 83-per-cent interest in Choice Properties Real Estate Investment Trust. Target prices range dramatically from a low of $71 to a high of $88. The average one-year price target is $78.17, suggesting the share price may appreciate 22 per cent over the next year.
The consensus earnings-per-share estimate is $3.47 in 2015, rising 14 per cent to $3.95 in 2016. The Street's 2016 EPS forecast may be too high and we could see some downward revisions.
Chart watch
Despite the relative defensiveness of this consumer staples company, the stock has not been immune to market weakness. Year-to-date, the stock price is slightly in negative territory, and shares of Loblaw have fallen roughly 7 per cent since the beginning of the fourth-quarter in 2015. Earlier this month, the stock experienced a "death cross," meaning the shorter-term 50-day moving average crossed below the longer-term 200-day moving average – a bearish technical signal.
The stock is in a downtrend, with the next major support level around $60. There is upside resistance at $65, close to the stock's 50-day moving average, and then around $67, near its 200-day moving average.
Bottom line
Loblaw is a solid operator and represents an excellent core holding for long-term investors. However, in the near term, the stock may struggle to gain sustainable positive price momentum and multiple expansion. If there is further price weakness, it represents a buying opportunity.
I strongly encourage readers to consult a financial adviser, and to do their own proper due diligence before taking any investment action.
