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Can grocery stocks stay fresh as Amazon enters the market?

A Whole Foods employee pushes a cart out of the store, in New York, Oct. 30, 2015.

DOLLY FAIBYSHEV/NYT

No one ever said that the grocery business is easy, but key Canadian grocery stocks have performed extraordinarily well over time.

Is that about to change?

The stock market certainly has its doubts. After Amazon.com Inc. announced its $13.7-billion (U.S.) takeover of Whole Foods Market Inc. on Friday, every company with a fresh-produce aisle wilted over concerns about new competitive pressures.

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Read more: Amazon shakes up grocery sector with $13.7-billion Whole Foods deal

In Canada, Loblaw Cos. Ltd. fell 3.6 per cent, Metro Inc. fell 2.9 per cent and Empire Co. Ltd. – which owns Sobeys – fell 3.6 per cent.

They joined casualties in the United States, where declines were more severe: Costco Wholesale Corp. fell 7.2 per cent, Wal-Mart Stores Inc. fell 4.6 per cent and Kroger Co. fell 9.2 per cent.

The fear arises from the belief that Amazon.com can do to food what it did to books and other retail items: Cut margins at the expense of profits and make competitors' lives very difficult.

This is likely an overreaction, though, and any meaningful pullback in the share prices of Loblaw and Metro looks like an opportunity to head on over to the discounted stock aisle.

These two Canadian companies, in particular, have navigated turbulent times exceptionally well, delivering outsized returns to investors.

(I've excluded Sobeys because the retailer's parent has been having trouble digesting its recent takeover of Canadian Safeway stores.)

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Consider this: Over 10 years, Loblaw's share price is up 298 per cent (including dividends) and Metro is up 73 per cent, versus a total return of just 45 per cent for the S&P/TSX composite index.

These figures include Friday's carnage. They also follow a period of intense competition, food-price deflation, flat sales growth and razor-thin profit margins.

Yet, over the past five years these two grocers have also outperformed. Over the past three years, Loblaw's return was 10 times larger than the TSX and Metro's return was six times larger. Even year-to-date, the grocers are winning the race with modest returns – that's including Friday's downturn.

What's remarkable is that these share-price gains coincide with a difficult operating environment.

At Loblaw, year-over-year sales rose just 0.2 per cent in the first quarter. Net earnings were a slim 2.2 per cent of revenue. Food prices shrank 3.9 per cent. However, apart from groceries, Loblaw offers everything from prepared foods to financial services to pharmaceuticals, which is giving it an opportunity to grab a larger share of the household wallet. Sales per retail square foot have risen more than 40 per cent over the past five years, according to Bloomberg.

Even though margins are slim, actual profits at both Metro and Loblaw have been climbing to record highs.

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But back to Whole Foods: Reports suggest that Amazon.com will use the high-end grocer – with just 13 stores in Canada – to enhance online shopping and chop prices, which raises some uncertainty about the future of the traditional grocery business.

I confess that part of my defence of traditional grocers rests on my stubborn refusal to believe that online food shopping is where grocery retail is headed in any meaningful way.

Ordering clothes, books and other nonperishable items online usually beats the mall. But salmon, apples, milk and dozens of other items I buy each week? Get me a cart.

In-store shopping also seems to offer a significant advantage for the traditional retailer. Order online and you're likely to skip impulse purchases; shop in-store and you'll come home with higher-margin ice cream, chips and chocolate bars. If I'm wrong and online sales take off, leaving me all alone as I peruse the produce section? Traditional retailers can respond with their own technology upgrades. They have adapted to significant challenges in recent years, rewarding patient shareholders along the way. Amazon.com won't change that.

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About the Author
Investing Reporter

David Berman has been writing about business and investing since 1995. He has written for a number of magazines, including Canadian Business and MoneySense. He worked at the Financial Post as an investing writer and daily columnist before moving to the Globe and Mail in 2008. More

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