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Weston’s bakery division is feeling the pinch of lower fresh bread sales, which made up 36 per cent of the firm’s total sales in 2011. In its third quarter, fresh bread sales fell 4.6 per cent following drops of 4.7 per cent and 0.5 per cent in its second and first quarters, respectively.

Deborah Baic/The Globe and Mail

George Weston Ltd.'s bread business is getting squeezed, and a big part of the problem comes from an unlikely source: its Loblaw grocery arm.

Struggling with declining fresh bread sales, the Weston family's food company is racing to catch up with the fast-changing trend of consumers switching to alternatives such as flat breads and gluten-free offerings.

But at the same time, the bakery giant is grappling with perhaps a deeper dilemma. Because it owns Loblaw, the country's largest grocer, rival discounters – including Wal-Mart Canada, Costco Wholesale and Dollarama – don't like to give their business to Weston. And discounters are growing faster than conventional supermarkets.

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"There's obviously a decline in the traditional grocery channels," Jairo Senise, president of the company's Weston Foods division, said last week. "And there is growth in the alternate channels, but we're under-represented there and that's obviously something that we are continuing to try and address."

Weston's bread predicament underscores the profound effects that discounters are having on both the retail and supplier segments as these non-traditional players push to add more stores – and food offerings – and steal business from incumbents. It also highlights the pressures on Weston to update its bread offerings and try to become the supplier of choice of low-cost merchants as well as conventional players.

Weston is counting on being able to quickly introduce new products that will attract alternate retailers and do it better than competitor Canada Bread, which also is rushing to grab new business with a modern new baking plant.

Today the bulk of Weston's fresh bakery production goes to Loblaw. But the supermarket channel in general is suffering from more grocery sales shifting to discounters, dollar stores and even drug stores, said Irene Nattel, retail analyst at RBC Dominion Securities, in a report last week.

Weston is working to pump up its supply presence outside of Loblaw, but given common ownership at Loblaw and Weston, retail rivals "have historically been somewhat reluctant to indirectly support a competitor," Ms. Nattel said. Another challenge: discounters' business can come with skinnier profit margins.

Weston's bakery division is feeling the pinch of lower fresh bread sales, which made up 36 per cent of the firm's total sales in 2011. In its third quarter, fresh bread sales fell 4.6 per cent following drops of 4.7 per cent and 0.5 per cent in its second and first quarters, respectively.

As a result of the weakness, Weston last week lowered its overall sales guidance for the year, saying they would be slightly lower than 2011 rather than in line with the previous year.

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"We're just being a little bit conservative in terms of the outlook," Pavi Binning, president of George Weston, told analysts.

Across North America, commercial fresh bread sales have slipped in the "low to mid-single digit" range, Ms. Nattel noted. Maple Leaf Foods, which owns Canada Bread, has also felt the pain.

Weston executives said they're working to develop new products. And they're trying to shore up their business in non-traditional retail segments. They even hinted they're in talks with U.S. discounter Target Corp. to supply it with bread when it opens its first stores in Canada next year. (Grocer Sobeys has signed an agreement with Target to become its principal distributor here.)

Mr. Senise said most of the declines in bread sales are in white and whole-wheat products. Weston is racing to introduce in the next few months new offerings that will include grains, he said. Already, under the Flat Oven Bakery label, it launched flat breads and, about a month ago, it introduced a President's Choice line of gluten-free products at Loblaw. "The products are flying off the shelves," Mr. Senise said.

While Weston's bakery operations are well run, they have the unusual foundation of being heavily dependent on a company it owns, retail analyst Perry Caicco at CIBC World Markets said. As a result, Weston probably keeps operating margins relatively high because of easier negotiations between the arms-length parties, he said. The flip side is that Loblaw is barely growing. "The other problem is that when Weston tries to crack into new customers in Canada – essentially Loblaw's competitors – that business comes at low margins since the Loblaw-Weston relationship is always lurking in the background."

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