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The Loblaw Cos. Ltd. and Shoppers Drug Mart Corp. tie-up makes perfect sense over the long term, but the sympathy rally in other retail stocks on Monday does not. Domestic retail sales growth has been declining markedly in recent months.
The 7.5 per cent surge in Jean Coutu Group (PJC) Inc. yesterday could represent a recognition of the drug chain's bright future catering to the pharmaceutical needs of the burgeoning elderly population. If that's the case, the rationale makes sense. But if investors bought Jean Coutu Group hoping for a takeover, they should temper their optimism.
A combination of Metro Inc. and Coutu seems like a possibility. That aside, however, it would be a big surprise if a successful bid for Coutu came from from any company not based in Quebec. The Quebec government cobbled together a reason to block the Rona Inc. sale so I calculate the probability of Jean Coutu being taken out by a foreign entity at roughly zero per cent. This cuts down severely on the number of potential suitors.
For the Canadian retail sector as a whole, the outlook is far from promising (see chart). After the financial crisis, year over year growth in domestic retail spending has trended steadily downwards, dipping into negative territory at the end of 2012. Canadian retail stocks, meanwhile, have blithely continued higher.
In fact, I don't see much reason for optimism for the Canadian retail sector as a whole. At some point, consumer debt will peak and wages will be used to pay it down.
For American companies, the weakening Canadian dollar relative to the greenback is another reason Canadian retail chains are less interesting. They would likely prefer to expand in jurisdictions where revenues will come in U.S. currency.
Investing in individual retail stocks is always fraught with risk, no matter what the economic environment. Consumers are fickle and their behaviour hard to predict – just ask the management team at Sears Canada Inc.
The weakening spending environment provides more reasons to be very careful in Canadian retail stocks, and possibly just to avoid them entirely.
Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights , and follow Scott on Twitter at @SBarlow_ROB .