Competition Among Canadian Grocers Heats Up

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Loblaw (TSX: L), Canada's largest grocer, is testing a bargain format in an attempt to ramp up revenue from urban centers.

The new store was opened in Calgary recently, and is a relatively small 10,000-square-foot building with the name "The Box by No Frills." The store represents a trial for the company and could bring it a new market segment if the test venture is successful. 

Loblaw's current value

The current price of Loblaw justifies a purchase by investors who anticipate the expansion to a bargain-store format will result in company growth. Right now, the PE ratio of 20.3 indicates investors expect moderate growth for the company. The industry average is a 28.0 PE ratio, showing that Loblaw could be under-priced, particularly if the company does end up expanding. Considering its current operations, the firm appears fairly valued, with a price-to-book ratio of 2.1. That's up about 34% from last year. 

The bargain-shop format may be necessary for company growth. The firm faces tough competition from box-store heavyweights Empire (TSX: EMP.A) and Target (NYSE: TGT)

Empire is growing

Sobeys' (Empire's grocery chain) recent $5.8-billion acquisition of Safeway in Western Canada shows the company is looking to grow, and this threatens Loblaw's expansion potential. However, while the purchase is major news in the Canadian grocery industry, it's not a game changer. RBC analyst Andrew Calder told CTV News:

The new, bigger Sobeys will have 1,538 stores and $24 billion of revenue (Loblaw has 1,058 stores and $32 billion of revenue). But is unlikely to have a meaningful impact on overall competitive dynamics in the sector, in our view, considering what is likely to be a close review from the Competition Bureau, and Sobeys' focus on post-transaction integration and de-leveraging. 

The move bumped Empire shares by 11% on the day of the announced acquisition. However, the company looks to still be undervalued with an average price-to-book ratio of 1.4, which is below average in the retail sector. However, with a profit margin of just over 2%, the company's return on investment is below industry average.

Canada's Loblaw is threatened by U.S. retailer Target

Target is opening its first Canadian stores, and offering some grocery items. While Target's entry into Canada is a threat to domestic grocers, the store doesn't focus a lot of its attention on groceries. That means Loblaw could be relatively safe from the company's expansion. It's too early to tell what Target's impact on the industry in Canada will mean, but it is more competition and could drive down prices for consumers. Any reduction in prices would affect revenue at all Canadian grocers and potentially the net profit if the cost of revenue doesn't drop as well.

Despite its Canadian expansion efforts, Target still only has an industry average PE ratio of 16.5. According to analysts, the company's future doesn't look bright. The analysts have stated a forward PE ratio of 14.7, indicating they didn't factor in the Canadian expansion or they don't believe it to beneficial to the company's bottom line.

Competition is heating up

While Empire and Target have made recent moves that threaten Loblaw's expansion plans, the firm also faces threats from Wal-Mart and Costco Wholesale. Wal-Mart is expanding its grocery efforts by adding more aisles dedicated to food, while Costco has plans to build up to 25 additional warehouse stores, according to the Financial Post. However, Loblaw has proven its high compete-level by becoming Canada's largest grocer, and the test store in Calgary could be the beginning of further growth.

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