Weston’s Loblaw Doing Its Best to Digest Elevated Food Inflation

With no-moat Loblaw representing 99% of no-moat George Weston’s WN total revenue and having already announced its fourth-quarter results, there was limited fresh information for investors to consume in the company’s earnings release. We don’t plan a material change to Weston’s CAD 174 fair value estimate and view shares as being appropriately valued.

Utilizing its data and scale capabilities, Loblaw is managing through an increasingly promotional environment, driven by elevated inflation, which is eating away at consumer spending power. In 2022 total sales were up 6% versus our 5% estimate, aided by strong drug retail performance that was mitigated by competitive dynamics in the food business. Drug same-store sales rose 6.9% (versus our 5.5% estimate), aided by resilient beauty and cold and flu demand, while food same-store sales grew 4.7% (in line with our forecast). In the quarter, food inflation was an uncomfortable 11.2%, with Loblaw’s same-store sales growth of 8.4% lagging once again after its third-quarter sales growth of 6.9% was behind inflation of 10.7%. Loblaw noted on its earnings call last month that promotional activity had picked up and consumers continued to trade down, making it challenging to push significant price hikes, even though more than 1,000 of its suppliers were requesting them. As a result, food retail margins remain below mid-2021 peak levels, including a fourth-quarter retail gross margin of 30.6% that was down from 30.9% a year ago. That said, Weston’s 2022 EBITDA margin was up 30 basis points to 11.5%, near our 11.6% forecast, helped by a mix of higher-margin drug retail sales. Still, given limited visibility on inflation and economic growth, Loblaw did not provide much guidance for 2023, but it did say it expects gross margin to remain around the 2022 level, in line with our forecast. Also, Loblaw targets 2023 adjusted EPS to grow by a low-double-digit percentage; we plan to roughly maintain our 15% estimate for Weston this year.