Investors are driving up prices for Canadian food and pharmacy stocks, betting that more deals may be on the horizon following two major takeovers in the sector within a month.
But the stocks are getting so expensive that those hoping for a quick payoff may wind up disappointed.
Shares in Jean Coutu Group (PJC) Inc., the drugstore chain, jumped 7.5 per cent on Monday, while the stocks of convenience store operator Alimentation Couche-Tard Inc. and grocer Metro Inc. each climbed more than 3 per cent.
The immediate cause for the run-up was Loblaw Cos. Ltd. $12.4-billion takeover bid for Shoppers Drug Mart Corp. That follows the $5.8-billion purchase last month of Safeway's Canadian assets by Empire Co. Ltd., parent of the Sobeys grocery chain.
Both Loblaw and Empire are bulking up as U.S. giants such as Wal-Mart Stores Inc. and Target Corp. increase their presence in Canada.
Since the Empire-Safeway deal was announced, Jean Coutu shares are up nearly 12 per cent, Couche-Tard shares have advanced 6 per cent and Metro has risen 7 per cent.
The gains suggest that investors are expecting more consolidation in the sector and hope to benefit from the premium prices that acquirers typically pay to shareholders of the firms they target.
Those hopes may be thwarted, as analysts and fund managers say that stock prices have now reached a level where further deals are becoming less likely.
Loblaw is paying about 11.3 times EBITDA (earnings before interest taxation depreciation and amortization) for Shoppers, similar to the price that Empire paid for Safeway.
By comparison, Jean Coutu is trading at 12.1 times EBITDA , according to data from Bloomberg, meaning that a potential acquirer would have to pay a far richer price than either Loblaw or Empire did to make a deal work.
Similarly, Couche-Tard shares are changing hands at 10.7 times EBITDA, making it an expensive acquisition once a premium to the current share price is factored in.
Fund managers recommend that investors either wait for a pullback or avoid the sector altogether.
"In the short term, I wouldn't touch [these stocks]. In the long term, I would wait for the fervour to die off," said Robert Sneddon, president and founder of portfolio management firm CastleMoore Inc.
Once prices fall back to more reasonable levels, pharmacy chain Jean Coutu would be the next logical takeover candidate in the sector, Mr. Sneddon said. Other potential targets may include such specialty brands such as Saputo Inc., which also saw its stock climb nearly 2 per cent Monday, or Maple Leaf Foods Inc.
As for deal makers, Mr. Sneddon said Loblaw parent George Weston Ltd. could be out to buy more assets, but noted that Metro is probably feeling the most pressure to make a move right now.
"These latest deals might force Metro's hand," said Mr. Sneddon.
In addition to valuation concerns, there are a lack of potential acquisitions that make sense from a competitive viewpoint, say money managers. "If you're looking in the public space, there's not a lot," said Bob Gibson, an analyst with Octagon Capital Corp.
He says the next consolidation moves could involve private firms, such as Katz Group of Companies, which owns about 420 Rexall and Rexall Pharma Plus locations across Central and Western Canada, as well as stores in the U.S.
Some funds are avoiding Canadian grocery and pharmacy stocks altogether, arguing the incursion of U.S. retailers is likely to eat away at profit margins.
"My view is that the lines are becoming so blurred and the competition so severe, why bother?" said Peter Brieger, CEO and managing director of GlobeInvest Capital Management, which sold its position in Loblaw a couple years ago.
He called the Canadian grocery and pharmacy space "overcrowded and uninteresting" for investors.
Rather than shopping for potential acquisition targets in Canada, Mr. Brieger said his fund has invested in international retailers such as Yum Brands Inc. and Louis Vuitton, which he says have growth opportunities in emerging Asian markets, where there's a rising middle class ready to spend.