Loblaw Earnings: Consumers Flock to Cheaper Banners and Private Labels; Shares Rich

We don’t plan a material change to our CAD 109 fair value estimate (beyond time value) after digesting no-moat Loblaw’s L solid second-quarter results—6.9% revenue growth (to CAD 13.7 billion) and CAD 1.94 in adjusted EPS (up 14.8%). Despite a 2% post-print slip, shares trade roughly 7% north of our existing intrinsic valuation, rendering the shares slightly overvalued.

Narratives flipped relative to the prior quarters, with food retail (70% of sales) leading the way. Here, same-store sales growth marked 6.1%, versus 5.7% in its higher-margin drug retail arm, primarily as Loblaw cycled a mere 1% same-store sales growth in food and lapped elevated cough and cold sales during the same period last year. Management qualitatively stated that consumers are engaging with more frequent, yet smaller basket size per trip, signaling that their search for value persisted in the quarter. Its discount banners saw a peak in customer counts (grew double digits), with lower-priced private brands outpacing national brands as consumers attempted to stretch dollars. More importantly, food same-store sales once again lagged the internal food inflation of 9.1%, implying that Loblaw failed to fully pass along higher vendor pricing to its customers, underpinning our no-moat rating. This, along with higher shrink (Loblaw is working to prevent such incidents with additional lock-up aisles in its stores), pressured adjusted gross margin by 30 basis points to 31.1%. Still, we believe Loblaw is taking the right steps to better serve its value-oriented consumers through investing in its e-commerce capabilities (sales up 13.9%), store network, and private label assortment, while maintaining competitive price levels.

On balance, despite the near-term pressures and intensely competitive landscape, our long-term prospect of the business remains intact. As such, we maintain our low-single-digit average top-line growth and mid-single-digit operating margins over our 10-year explicit forecast.