After Tumultuous 2007, Loblaw Eyes Further Price Cuts

JON SPRINGER

TORONTO — Loblaw Cos. officials here last week recapped events of a tumultuous fiscal 2007 and faced questions about 2008 as its complex turnaround slowly proceeds.

The retailer reported lower-than-expected earnings and reduced gross margins in the fourth quarter, which ended Dec. 30, as price investments continued in its discount and superstore formats. But those investments also resulted in volume and same-store sales increases, giving officials confidence that Loblaw's strategy was beginning to gain traction and could deliver intended results within the three-to-five-year time frame announced a year ago.

“We acknowledge and share in the disappointment in the reduced earnings of the last two quarters of 2007,” Galen Weston, executive chairman of Loblaw, told analysts in a conference call. “However, we view them in the context of the first year of a multi-year turnaround plan, a plan that has us investing in price ahead of the cost reductions and operational efficiencies required to support margins. As such, we anticipate continued pressure on earnings in 2008.”

Weston said the company would move in 2008 to make internal cost reductions in order to support profitability while price cuts continue, mainly in the company's conventional store portfolio. Until now, Loblaw's price reductions have been mainly focused on its discount and superstore banners, with a goal of having those stores priced at or below competitors, including Wal-Mart.

While officials say the company is largely satisfied with having met those pricing benchmarks, the activity is causing overall sales to shift toward those banners, which tend to carry lower margins. Quarterly operating margin of 3.3% fell from 4.4% in the same period last year.

“Loblaw's strategy at this point is clearly to drive volume through an improved value offering to the consumer, while working behind the scenes to improve its cost structure to support the lower-price environment,” Irene Nattel, an analyst for RBC Capital Markets, Toronto, said in a research note detailing a reduction in 2008 earnings forecast. “However, the impact of lower prices is immediate, while the cost adjustment takes much longer to realize.”

Officials did not specify the amount of cost reductions Loblaw would target but anticipates it would generate savings through improved labor productivity, shrink and corporate cost reductions. Some of those programs were already under way, the company said.

Loblaw also touted improvements in shrink performance and the completion of an “always available” in-stock program at 233 stores as evidence of progress. Certain “modules” from a recently opened Real Canadian Superstore pilot store in Milton, Ontario, including a redesigned checkout area, will be rolled out to additional locations based on their success, Weston said.

A move to centralize the company's merchandising programs was completed, but turned out to be more difficult than Loblaw had anticipated, Mark Foote, Loblaw's president and chief marketing officer, added.

“A lot of things had to change in Loblaw last year, and you can't direct all of your energy under that much change when you want your attention to be on your stores and customers,” Foote said.

Loblaw said earnings would continue to be under pressure for the first half of the year, but that the outlook was brighter for the second half, when sales comparisons get easier and cost savings begin to play a role.

“They came across very confident that they've established a firm bottom, and I would tend to agree with them,” one analyst, who asked not to be identified, told SN, noting that same-store sales of 2.6% and volume growth of 3.6% in the fourth quarter improved on the company's respective third-quarter results. “The problem is there's no catalyst for upside in the near-term. It could be six months to a year at least before things improve, and they'll need continued traction for that to happen.”

Loblaw reported net earnings per share of 43 Canadian cents vs. analyst expectations of 55 cents. Sales of $6.9 billion (U.S.) improved by 2.7% overall. The company reported a profit of $39.5 million vs. a $756 million loss in the same period a year ago. The earnings figure for both years was adjusted for several one-time items. Annual sales of $29 billion improved by 2.6%, while profits swung to $330 million in 2007 from a $219 million loss in 2006.