Looking for a stock that offers a nice combination of safety, growth and a rising dividend? You might consider putting Loblaw Cos. Ltd. on your shopping list.
Canada's largest chain of grocery stores (its banners include Loblaws, No Frills and Real Canadian Superstore) and pharmacies (Shoppers Drug Mart and Pharmaprix) provides one-stop exposure to some of the country's best-known retail brands, with a focus on food and drugs that conservative investors should find appealing.
Yet even with its defensive attributes, Loblaw has produced some sizzling gains.
Over the past three years, the stock has posted an annualized return of about 20.5 per cent (including reinvested dividends), trouncing the S&P/TSX composite's annual total return of about 3.1 per cent over the same period. That outperformance is not surprising, given that the TSX has been weighed down by exposure to energy and mining.
While it would probably be asking too much to expect such scorching returns to continue, Loblaw appears poised to deliver solid gains over the long run. Here are five reasons I like the stock and would consider purchasing it on a pullback.
The dividend is growing
With a yield of 1.4 per cent, Loblaw's dividend alone isn't going to make you rich. But the dividend has been growing steadily – it's risen 19 per cent in the past five years, or about 3.5 per cent on an annual basis – and more increases are coming: Loblaw has said it plans to raise its dividend every year, with announcements timed to coincide with its first-quarter results that are typically released ahead of its annual meeting in early May. Bloomberg forecasts that the next increase will be 2 per cent, but I wouldn't be surprised to see Loblaw top that.
More buybacks are coming
Having paid down about $1.9-billion of debt since closing the acquisition of Shoppers in 2014, Loblaw announced last fall that it would begin using its excess free cash flow to repurchase shares. The company made good on that promise in the fourth quarter by gobbling up more than 2.9 million shares for about $185-million. Many companies buy back shares at inflated prices, but not Loblaw: It paid an average price of about $64 a share – substantially less than Tuesday's closing price of $70.16 a share on the Toronto Stock Exchange – indicating that the repurchases created value for shareholders.
Cash flow is growing
Loblaw's cash flow is poised for a further boost now that a huge and complex systems upgrade is done and paid for, allowing Loblaw to reap the benefits. CIBC World Markets projects that Loblaw's "prolific" free cash flow will climb to about $1.7-billion in 2016 and nearly $1.9-billion in 2017, up from less than $1.4-billion in 2015. "With the massive system spend behind it, the company is edging toward harvest mode. Share buyback activity will pick up materially, and dividend increases will be an annual event, in our view," CIBC analysts including Perry Caicco and Mark Petrie said in a note.
The Shoppers acquisition is bearing fruit – literally
Selling fresh produce in some Shoppers stores is just one visible sign of how Loblaw is benefiting from the merger. By eliminating overlapping functions and capitalizing on other savings, Loblaw has said it is on track to achieve its target of $300-million of annual synergies in 2016. At the store level, consumers are responding: Last year, Shoppers sold more than $250-million of President's Choice and No Name products in its stores "and we continue to see that number grow," Loblaw president and executive chairman Galen G. Weston said on the fourth-quarter conference call.
Shoppers' expanded food selection helped to drive a 5.7-per-cent increase in comparable sales for "front-store" items in the fourth quarter, compared with growth of 4.2 per cent for Shoppers' pharmacies and 3.1 per cent at Loblaw. And there's more to come: "We are just beginning to see the benefits of combining Shoppers and Loblaw from a revenue generation perspective," Desjardins Securities analyst Keith Howlett said in a note.
The stock is reasonably priced
Analysts project that Loblaw's earnings a share will rise to $3.91 in 2016 and $4.40 in 2017, up from adjusted earnings of $3.46 in 2015. Using those estimates, the stock trades at a multiple of about 17.9 times this year's projected earnings and 15.9 times next year's estimates – in the middle of the valuation pack for Canadian and U.S. grocers. However, based on a sum-of-the-parts analysis of Loblaw's businesses – including its retail operations, majority-owned Choice Properties Real Estate Investment Trust, properties not in the REIT and PC Financial – CIBC estimates the stock's 2017 net asset value at $91.45 a share. Applying a 5-per-cent discount to that number produces CIBC's 12-to-18 month price target of $87. Although CIBC has the highest price target on the Street – the average is $78.08, according to Bloomberg – other firms are also bullish on the shares: Of the 14 analysts who follow Loblaw, 11 rate it a "buy" or equivalent, with three holds and zero sells.
There are no guarantees that Loblaw's shares will reach analyst price targets, of course. Competition in the food industry, price inflation, drug reforms and the sluggish economy could weigh on Loblaw's results. But the company's well-entrenched retail chains and the far-reaching benefits of the Shoppers merger – plus the tailwind of an aging population that is expected to consume more drugs and other health products – all bode well for Loblaw in the long run and should help to keep its dividend growing. Do your own research before investing in any security and make sure to stay diversified.