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A father and his children shop for cereal at the Loblaws at Maple Leaf Gardens in Toronto on Wednesday, July 23, 2014.Matthew Sherwood

Loblaw Cos. Ltd. is enjoying a sales lift from focusing more on fresh foods despite pinched margins from not being able to raise prices enough to cover steeper wholesale costs.

Customers are shifting to buying more fresh foods – fruits, vegetables and meats – rather than packaged goods, which generally carry even lower profit margins, Galen G. Weston, executive chairman and president of Loblaw, said on Thursday.

The country's largest supermarket retailer is benefiting from stocking a wider array of fresh foods in more attractive presentations, he said. The trend suggests "a more sustained shift in consumer preference," Mr. Weston told his first quarterly analyst conference call since taking on an expanded leadership role as president, replacing Vicente Trius. "They're just buying more fresh food."

In the second quarter, Loblaw's same-store sales at stores open a year or more – a key retail measure – rose 1.8 per cent.

Loblaw joins other grocers that are working to improve and expand their fresh food offerings in a bid to boost profit margins and cash in on inflationary trends in those categories. Loblaw is betting its recent $12.4-billion acquisition of Shoppers Drug Mart Corp. will further shore up its food business as it prepares to start testing fresh fare at Shoppers' smaller, often more convenient urban locations.

Still, Loblaw and other grocers have been unable to pass on to consumers – through higher prices – all of their higher wholesale prices. The "acceleration in food price inflation typically leads to modest gross margin erosion as food retailers absorb only part of the rising input costs, particularly against the current backdrop of intense competition," said Irene Nattel, retail analyst at RBC Capital Markets.

In June, food prices rose 2.9 per cent, with bacon prices up 27 per cent from 12 months earlier, the result of an incurable virus that is killing piglets, while pork chop prices jumped 18 per cent. Beef prices are also soaring – sirloin steak and ground beef prices rose 15 per cent in the year ended in June following a severe dry spell in the United States that drove up the price of corn and other crops grown for animal feed, prompting farmers to cull the herds. Carrot and onion prices picked up by 10 per cent and 18 per cent, many of them coming from drought-stricken California.

Partly as a result of higher costs that couldn't fully be covered by higher prices, Loblaw posted second-quarter adjusted gross profit percentage of 22.1 per cent, down 0.20 percentage points from a year earlier.

Still, consumers aren't very price sensitive when it comes to some fruits and vegetables, despite the dent in their budgets, Claudia Schmidt, a senior research associate at the George Morris agricultural research centre in Guelph, Ont., said.

Loblaw has beefed up its space dedicated to fresh foods as much as 10 per cent in some of its conventional stores over the past three years, spokesman Kevin Groh said. The grocer's goal is to grow its sales of fresh foods at twice the rate of packaged foods, he said. "We're tracking well."

Mr. Weston said customers have responded well to Loblaw's new juice bars in 50 of its stores even though the freshly squeezed orange juice is "quite a few dollars more than the typical carton of Tropicana. … So customers appear to be trading up in fresh for what they perceive to be significant improvement in quality."

He added the company can do even better in fresh food at its discount No Frills outlets.

To help become more efficient over all, Loblaw is shrinking the size of its stores, aiming to sell more products in smaller spaces. Other retailers also are downsizing to respond to more consumers moving to city centres or just preferring the convenience of a smaller store – or shopping more online.

"We will be reducing the size of all our stores," Mr. Weston said.

In its first full quarter following its Shoppers acquisition, Loblaw reported a second-quarter loss of $456-million or $1.13 a share, compared with a profit of $177-million or 63 cents a share a year earlier. Revenue rose 37 per cent to $10.3-billion from $7.5-billion. But adjusted profit, excluding items such as costs related to the acquisition of Shoppers, beat analysts' estimates, jumping to $301-million or 75 cents a share from $181-million or 64 cents a share. In the latest quarter, analysts had expected adjusted profit of $276.5-million or 67 cents a share and sales of $9.59-billion, according to data compiled by Thomson Reuters.

Perry Caicco, retail analyst at CIBC World Markets, said while same-store sales were strong, they were driven by a big 2.5 per cent inflation rate. Actual sales volumes – excluding the effect of higher pricing – were lower in the quarter than a year earlier, he suggested.