After a seven-year, multibillion-dollar technology upgrade, grocer Loblaw Cos. Ltd. is finally seeing the fruits of its labour, just as the competitive environment becomes even more brutal.
The supermarket retailer's progress, underscored on Wednesday by Loblaw's better-than-expected second-quarter results, gives it a solid foundation to prepare for a $12.4-billion acquisition of drugstore leader Shoppers Drug Mart Corp.
However, company executives warned that the road ahead may still be rocky, as U.S. giants Wal-Mart Stores Inc. and Target Corp. continue to expand.
"We feel pretty good on the performance that we have," said Vicente Trius, president of Loblaw, told analysts. "Having said that, we should not underestimate the dynamics of the market with over 3 per cent square-footage growth and having an additional, let's say, 70 Target stores opening before the end of the year."
Under the leadership of executive chairman Galen G. Weston, scion of the family that controls Loblaw, the grocer is forging ahead with its transformational deal to take over Shoppers after spinning out much of its real estate in an income trust earlier this month. Now the hard slogging begins as Loblaw prepares to implement the takeover, which is expected to close early in 2014, and attempts to overcome what in the past have been major hiccups in introducing and integrating new systems to its own operations.
"It's a huge task," said Alex Arifuzzaman, partner at retail-real estate specialist InterStratics Consultants Inc. "But if they do it right there's the opportunity for huge increases in efficiencies and profit."
The agreement, unveiled 10 days ago, is crucial for Loblaw because industry estimates indicate that incumbent grocers' sales performance will be close to stagnant in coming years, as players such as Wal-Mart, Target and Costco Wholesale steal away business. The shifting dynamics put pressure on Loblaw to find new ways to win customers.
"The environment will get tougher as the sheer weight of competitive square footage additions absorbs available sales growth," Perry Caicco, analyst at CIBC World Markets, said in a report last week. The basic grocery market growth in Canada in 2013 is projected to be about $1.6-billion, which includes little or no inflation, he estimated. "The trouble this year is that square footage growth will eat up most of the sales growth."
The competitive intensity was a key factor in Loblaw moving on the Shoppers deal, Mr. Weston said. "Today, with a strong foundation built on the completion of our supply chain project, entering the last phase of the implementation of our IT infrastructure, clear traction in improving our customer proposition, and as a result increasing competitiveness, the timing now makes sense."
Rival Sobeys, owned by Empire Co. Ltd., announced its own $5.8-billion agreement in June to swallow Safeway Inc.'s profitable Canadian division as a way to carve out more business.
Loblaw's improved second-quarter results signal that it is more ready to handle a major acquisition than at any time over the past decade, said Kenric Tyghe, retail analyst at Raymond James. "This is [a] a strategic imperative for both players," he added.
In its second-quarter, Loblaw's profit rose to $178-million, or 63 cents a share, from $156-million, or 55 cents, a share a year earlier. Revenue grew to $7.5-billion from $7.4-billion.
Brampton, Ont.-based Loblaw raised its outlook for 2013 to mid-single-digit operating profit gains, from an earlier forecast of low-single-digit growth.
Second-quarter sales at stores open for more than a year increased 1.1 per cent, driven by more store traffic, higher purchase amounts and shifts in what customers are buying, such as more fresh vegetables and fruit, executives suggested. Its Joe Fresh apparel sales also performed well despite the bad publicity in the spring tied to the line being produced in a Bangladesh building that collapsed, leaving more than 1,100 people dead.
Loblaw's new PC Plus loyalty program, being tested in 44 stores in Ontario since May, is also gaining traction, Mr. Trius said. Already 30 per cent of sales in those outlets are being done with the rewards card, he said.