After a spectacular series of mega-deals in 2013, the retail sector is expected to focus on smaller takeovers this year.
Retailers are gearing up for more consolidation as merchants race to take on rising competition from U.S. behemoths Wal-Mart Stores Inc., Costco Wholesale Corp. and Target Corp.
The expansion of the low-cost American giants in Canada is prompting a shakeup in retailing that will likely push out weaker players and force others to team up.
The trend is already well advanced. While mining and energy usually provide most of the big deals in Canada, the three biggest acquisitions last year were all in the retail sector.
The fireworks began last June when grocer Sobeys, owned by Empire Co. Ltd., unveiled a $5.8-billion deal to swallow rival Safeway Canada. About a month later, Loblaw Cos. Ltd., the country's largest supermarket chain, sealed a mammoth $12.4-billion transaction to buy Shoppers Drug Mart Corp.; soon after, Hudson's Bay Co. snapped up U.S. luxury rival Saks Inc. for $2.4-billion (U.S.).
On another front, Loblaw and Canadian Tire Corp. Ltd. spun off properties into real estate investment trusts, and in early 2014 HBC sold its flagship downtown Toronto store and adjacent office building to Cadillac Fairview Corp. for $650-million (Canadian).
In 2013, retail activity was "very busy," said Geoff Belsher, group co-head of wholesale banking at CIBC, which had a hand in the major merchandising deals of the year. "We don't think we're going to see a repeat of the retail M&A activity that we did last year. … We may not see it that busy again for some time."
Observers say merger and acquisition activity this year will focus on the still lucrative though challenged drugstore field, the grocery industry and the highly competitive discount merchandising or "value" sector.
"People are still focused on the value sector," said Carrie Cook, managing director of consumer and industrial products group at RBC Capital Markets, which was involved in all the big retail deals of 2013.
"That's a consumer trend we expect to continue. We've seen that through the growth of the dollar stores."
She also expects retailers to try to capitalize on consumers' quest for what they perceive as health and wellness products, which was part of what drove Loblaw's deal for Shoppers, she said. Meanwhile, retailers such as Loblaw are looking for smaller, urban stores that can cater to the growing number of people living in downtown condominiums, she said. Loblaw was drawn to Shoppers partly because of its urban drugstore locations.
In 2014, there could be further pharmacy consolidation as drugstores grapple with new provincial rules designed to pinch profits on the dispensing of generic prescription drugs, said Dany Beauchemin, a managing director at Scotiabank, which worked on the Empire-Safeway takeover.
As well, Loblaw may divest some of the stores it acquired when it bought Shoppers, the country's largest drugstore chain, he said. Retailers that may be interested in snapping them up include Katz Group Canada Ltd. (which owns Rexall), Jean Coutu Group (PJC) Inc., London Drugs and Uniprix, he said. "There may be a wave of consolidation in pharmacy."
About half of the pharmacy sector is still made up of small independents, which may decide to look for partners, he said. He doesn't expect a mega-deal to emerge from the consolidation "but possibly there will be some smaller acquisitions."
On the grocery front, Metro Inc., which operates in Quebec and Ontario, could take a run at a drug purveyor, such as Jean Coutu, Familiprix or Uniprix. Or it could try to acquire British Columbia's Overwaitea Food Group grocery chain, although owner Jim Pattison may not be ready to sell it, they say.
Metro remains the only major supermarket chain without a plan to bulk up by acquiring a competitor after the deals announced last year by Loblaw and Sobeys, the No. 1 and No. 2 grocers, respectively.
Eric La Flèche, chief executive officer of Metro, said last month it is ready to make a major retail acquisition if the right opportunity comes along, but feels no pressure to do so quickly. "We can consider just about any acquisition in Canada."
Mr. La Flèche acknowledged that organic growth isn't easy in a context of low food inflation, high consumer debt and beefed up competition. "Organic growth is a challenge, but we've met that challenge over the past few years and we expect to continue to meet it."
David Hartley, retail analyst at Credit Suisse, has raised the possibility that Dollarama Inc., the fast-growing Montreal-based dollar store chain, could be a takeover target for Canadian Tire or a U.S. dollar-store chain.
But Dollarama has a high valuation and would be a pricey purchase, RBC's Ms. Cook said. Wal-Mart would probably prefer an acquisition that would allow it to pick up a struggling retailer's leases, rather than an operating company, Mr. Beauchemin suggested.
Canadian Tire will soon have more cash as it embarks on selling its credit card receivables and the retailer may look for acquisitions, analysts say. It did well with its 2011 takeover of sporting goods retailer Forzani Group Ltd., which owns Sport Chek and other chains, and may consider other specialists such as Golf Town or a U.S. chain such as Cabela's Inc., a purveyor of outdoors gear.
On the real estate front, HBC's deal to sell its downtown Toronto flagship property raises questions as to whether owner Richard Baker, the U.S. real estate mogul, will spin off other properties into a REIT or continue to sell off valuable real estate in separate deals.
"Hudson's Bay clearly has a very valuable real estate portfolio," said Ryan Veogeli, managing director and co-head of diversified industries and telecom in investment banking at CIBC, which was a book runner on Loblaw's $460-million IPO of Choice Properties REIT last year.
"Whatever Richard does is going to drive value for Hudson's Bay."