Two of the world's most sophisticated retailers are encroaching on the cozy world of Canadian supermarkets, but you wouldn't know it from the stock prices of the domestic grocers.
Shares of Loblaw Cos. Ltd., Metro Inc. and Empire Co. Ltd. (owner of Sobeys Inc.) are on a tear, with Metro and Empire teetering near all-time highs.
Empire vaulted almost 11 per cent on Thursday, in the first day of trading following news the company would spend $5.8-billion to acquire the Canadian assets of Safeway Inc. Even though the deal will add pressure on Sobeys' two biggest rivals, shares of both Loblaw and Metro caught Empire's updraft, gaining 3.9 per cent and 0.3 per cent, respectively.
Behind the enthusiasm for Canadian grocery stocks is a belief that Canadian supermarket chains are making necessary improvements to face their new U.S. competition. The market is also speculating about further consolidation in the sector.
But the optimism around the sector may not endure, as investors size up the magnitude of the challenge ahead.
When Wal-Mart and Target decided to go after a greater share of the U.S. grocery market a decade ago, supermarket giants Kroger Co. and Safeway saw their profits squeezed and share prices battered. In Canada, years of weak economic growth are already taking a toll on grocers, pushing annual same-store sales growth to only about 1 per cent or less.
While several analysts increased their price targets Thursday on Empire's stock, citing the potential gains in efficiency from the deal, they weren't moved enough to upgrade their ratings on the company. In fact, only two of the seven who follow Empire rate the stock a buy.
Empire says it will quickly deliver $200-million in annual savings from its Safeway acquisition. Marc Poulin, president of Sobeys, said the savings are expected to come from integrating and updating Safeway's distribution and information technology systems and reducing buying, administration and marketing costs.
"The deal will make Sobeys a stronger company. It's a great move for improving efficiency and productivity, and to bolster the company's position in the West," said Ed Strapagiel, an independent retail consultant in Toronto.
Empire isn't the only grocer girding itself for battle.
Loblaw recently unveiled plans to raise hundreds of millions of dollars by spinning off its property into a real-estate investment trust and Metro said it will get almost half-a-billion dollars from selling half its stake in the convenience store operator Alimentation Couche-Tard Inc.
The catalyst for these big moves has been greater competition from the giant U.S.-based retailers.
"I don't think that Loblaws spends many sleepless nights worrying about Sobeys. It spends more time worrying about Wal-Mart," Mr. Strapagiel said.
Wal-Mart Canada Corp. is rapidly adding more grocery aisles to its stores and Target Corp. has recently begun to open outlets north of the border. In addition, Costco Wholesale Canada Ltd. plans to expand its footprint to 110 stores, up from 85.
Wal-Mart and Target are the world's two most-advanced retailers when it comes to managing supply chains and Canadian companies are going to have to catch up, Mr. Strapagiel warns. Each of the U.S. titans has perfected a trend known in the industry as "category incursion," in which they expand their product lines to take business from other retailers in a given category of goods.
"Encroachment from the non-food sector continues to be a worry for Canadian grocers," he says. "The pressure will force more internal efficiencies so that they can put product on the shelves at more competitive prices."
Analysts have speculated for months that the big three Canadian supermarket operators would have to bulk up in the face of the new competition and Perry Caicco, of CIBC World Markets, says there will likely be more consolidation to come. "By making the first move, and doing so at a reasonable price, Sobeys puts pressure on the market to make similar moves – and likely at higher prices," he wrote in a report.
However, further industry consolidation will probably be much less dramatic than Sobeys' latest deal.
"Safeway was the last plum picked," says Mr. Strapagiel. "After this the pickings get smaller and smaller."