Loblaw Posts Sharp Profit Decline

JON SPRINGER

TORONTO — Aggressive price investments hacked deeply into profits at Loblaw here during the fiscal third quarter, the retailer said last week.

The pricing actions sparked an overall sales increase of 1.4% and comparable-store increases of 2.8%, but helped to send operating income down by 37.8%, EBITDA by 16.1% and earnings per share by 45.9% during the 16-week quarter that ended Oct. 7. Adjusted earnings of 56 Canadian cents per share were far below analyst expectations of 77 cents.

“This has been a tough quarter,” Galen Weston, executive chairman, confessed in a conference call. “When we first laid out our plan for turning around the company, we were clear the road would be long and difficult, and we hit some bumpy patches along the way. All of those characteristics were evident in our third-quarter results.”

Weston said the reduced profitability was the cost of ongoing turnaround initiatives, led by an effort to lower prices throughout the chain. Like Kroger in the U.S., Loblaw intends to invest corporate cost reductions into lower everyday retail prices. Those efforts are expected to continue into the future as the company executes a turnaround that's expected to take three to five years.

Also included in the transformation are initiatives to improve product availability and freshness, and the revamping of the company's Real Canadian Superstore banner.

The convergence of these efforts has put Loblaw in what Weston described as a “period of maximum risk” while new processes are rolled out, some staffing is reduced and employees learn new roles, and price investment to drive new business continues. Bill Wells, chief financial officer of Loblaw, said he anticipated that sales volume will continue to grow, and margins continue to shrink, over the short term. Sales increases will be harder to come by next year as Loblaw begins to lap its initial price investments, he added.

“We are now about halfway through this period and feel good about our progress today, but we will have some bumps along the way,” Weston said. “We expect continued margin pressure and risk to earnings. We remain committed to our strategy. The challenges evident today underline the necessity of what we are doing and strengthen our resolve to make Loblaw the best again.”

Perry Caicco, an analyst at CIBC World Markets, Toronto, said price investments were so aggressive, they obscured whatever gains might have come from efficiency initiatives at Loblaw.

“It was difficult to tell how much productivity benefits occurred. If there had been some, it's been buried in pricing,” Caicco told SN. “But it doesn't look like there was a whole lot of it, and they seemed to indicate it would be into next year before you'd start to see that.”

Price investments through the end of the third quarter helped Loblaw achieve overall price levels equal to or better than competitors at its superstore and discount divisions, Weston said. The chain has also lowered prices in conventional grocery stores in Ontario and Quebec.

Overall sales for the quarter increased 1.4% to $9.5 billion (U.S.), with traffic counts and basket sizes also increasing. General merchandise sales for the period decreased as Loblaw delayed the launch of some Joe Fresh apparel lines and restricted new inventories while the company worked on realigning its product mix.

Operating income of $260.2 million for the quarter was a decrease of 37.2%. Price investments contributed to a gross margin decline of $62.4 million, or 0.7% of sales. Margins also slipped as Loblaw's sales mix shifted toward its discount and superstore formats, Wells said. Consulting costs of about $47 million also contributed to the decline.

“Clearly, our cost-reduction efforts are lagging behind the price investments that we are currently making,” Weston said. “We also knew that that was going to be the case.”