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A customer shops at a Loblaws in Toronto on Sept., 11, 2020.Christopher Katsarov/The Globe and Mail

With soaring inflation weighing on the stock market this year, the latest quarterly financial results from Loblaw Cos. Ltd. L-T should make for riveting reading.

The grocer and pharmacy giant, which is scheduled to drop its second-quarter earnings this coming Wednesday, was able to pass along price increases to its customers at the start of 2022.

That helped make the stock a rare winner in this unusual economic environment. With gains of more than 15 per cent this year, Loblaw shares have outperformed the S&P/TSX Composite Index by about 26 percentage points.

But are consumers reaching a breaking point?

“The current levels of food at home inflation are much higher than grocers feel comfortable managing and are well beyond the levels generally viewed as tailwinds for the group,” Patricia Baker, an analyst at Bank of Nova Scotia, said in a note this week.

The Canadian inflation rate was 8.1 per cent in June, annualized, up from 7.7 per cent in May. That marks the briskest pace of price increases since 1983.

Yes, gasoline was partly to blame here. But there were other culprits in the overall inflation figure: In particular, the price of food rose 8.8 per cent year-over-year in June – about the same rate as in April and May.

Inflation was already bubbling higher when Loblaw reported its last quarterly financial results, for the first three months of the year: It rose from 5.1 per cent in January to 6.7 per cent in March.

Yet investors were delighted. Loblaw’s first-quarter profit increased by nearly 40 per cent, year-over-year, to $437-million.

Okay, profits were boosted for a number of reasons. As pandemic restrictions eased, consumers returned in greater numbers to stores – without the demoralizing lineups – and added beauty products and over-the-counter pharmaceuticals to their elevated levels of grocery purchases.

Online sales remained strong, if down slightly from lockdown highs. And COVID-19-related costs declined.

But inflation certainly didn’t hurt results. And that was because of that ability Loblaw has to pass along rising costs to consumers – and then some.

The company’s revenue in the first quarter increased by 3.3 per cent, year-over-year. And gross margins – a financial figure that reveals how much revenue is left after subtracting the cost of goods sold – expanded to 31.1 per cent in the first quarter, up from 30.3 per cent in the same period last year.

This is old news, though, which is why the financial results coming next week will provide important insights into how Loblaw is faring amid worsening inflation.

Investors may be in a forgiving mood, since the standout performance of the stock this year has a broader underpinning: As interest rates rise and economists grow concerned about slowing economic activity, investors have turned to defensive stocks to weather the storm.

The consumer staples and utilities sectors within the S&P/TSX Composite Index are both up this year.

But there are several reasons the stakes are high.

Loblaw’s stock has a premium valuation relative to its peers, which puts more pressure on the company to perform well. The stock trades at 20.3 times trailing earnings. That is slightly higher than Metro Inc.’s price-to-earnings ratio of 20, and much higher than Empire Company Ltd.’s P/E of just 14.

U.S.-based Kroger Co., which last month reported shrinking quarterly profit margins as U.S. inflation accelerated to four-decade highs, has a P/E of 16.

Another reason next week’s results are nail-biters: Analysts are generally upbeat with their forecasts for Loblaw, suggesting investor expectations are high.

On average, analysts expect Loblaw will report an adjusted profit of $1.60 a share, up nearly 19 per cent from the same period last year – bolstered by rising sales and steady margins.

The company’s ability to offer discounted products will also help, as consumers become more price-sensitive.

“Surging food inflation is leading to more customers shopping in discount stores and trading down to private-label brands,” Michael Van Aelst, an analyst at TD Securities, said in a note Friday.

That’s not a problem for Loblaw: 60 per cent of its food sales come from discount banners, such as No Frills, which is a greater share than its competitors report. And private-label brands, such as No Name, account for 30 per cent of the company’s food revenues.

Loblaw seems to be in a good position, then, to deliver strong results. But with inflation soaring to uncomfortable levels, uncertainty is rising – and the stock could be a test case for how companies are navigating these unusual times.

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