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Harry Koza

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Comparison shopping

Harry Koza


TORONTO (GlobeinvestorGOLD) — Although this month's theme is retail stocks, I must admit to a lack of expertise in the field (not that that has ever stopped me before).

Sure, I make the occasional run to the local hardware store or the Home Depot for materials to tackle the unending sequence of home maintenance and gardening projects that my wife assigns me lest I have time to get horizontal in the shade with a book and a frosty, but basically, my only regular exposure to the retail world is on my weekly excursion to the grocery store.

I'd rather drink Lysol than go to a mall, but I love grocery shopping. When we first moved to the burbs, I went to a different grocery store every week until I'd tried all the stores within convenient driving range — Price Chopper, Dominion, Loblaw's, No Frills, Sobeys, IGA, Weston Produce. They all have their strengths and weaknesses.

Loblaw is the 300-pound gorilla in the Canadian grocery business: $27-billion in annual sales, stores under 15 different banners nationwide, 130,000 employees. They're not only the biggest food distributor in Canada, they're also purveyors of car and home insurance, banking and Mastercard services. Their President's Choice and No-Name brands are ubiquitous. Their trailing 12-month earnings as of June 18 were $3.46 a share, with 84 cents in dividends paid (for a yield of 1.19 per cent).

On the ROB 1000, they rank 25th in profit, 5th in revenue and 41st in assets. The stock has been beat up a bit lately and is down about $5 since the end of June, currently around $68 a share. I've been thinking about buying some if it gets a little cheaper, so I thought it appropriate to go check out a store.

There's a huge new Loblaw Super Store just up the road in Aurora. It's a pretty nice store, and is extremely busy on a Saturday morning. It's full of people. I am convinced that one of the secrets to a long and happy marriage is to not bring your spouse along with you to the grocery store, yet there are whole families here, clogging up the aisles, Mom and Dad each glumly pushing a cart with two howling kids in it, sometimes with a Mother-in-Law trailing along disapprovingly in their wake (yeah, let's make shopping fun for the whole family. Just wait until you get to the candy racks near the checkout!).

Anyway, I walk into the store and there's a guy making sushi, right next to another guy manning a giant wok — I'm in the take-out food section. Next is the fish counter, the deli, coolers full of cheese, frozen shrimp, and hundreds of President's Choice items. Beyond that is the baked goods area. They have a large bakery and must have 47 different kinds of bread ranging from Wonder Bread to loaves made with sorghum or flax or soya, or that are gluten-free or carb-reduced, but a simple pumpernickel — forget about it. Every time I've been to this store, there hasn't been a dark rye to be had.

The produce department has lots of strange vegetables I've never heard of, plus a couple they must have recently invented in a lab somewhere, not to mention about fifty kinds of ready-made salads in bags. But a lot of the produce looks like the guys on the loading dock have been playing road hockey with it. A big chunk of the produce area is devoted to organic fruits and vegetables, which are even more bogey-looking, only pricier.

The meat department is having a special on giant racks of beef ribs. People are loading their carts with them. You'd need a barbecue the size of Fred Flintstone's to cook those puppies, so I ask the butcher if he has any briskets, and he gives me a very surprised look. Apparently, no one had ever bought a whole brisket there before. After he weighs and wraps one for me, he leans over the scales and asks, a little sheepishly, "er, what are you going to do with it?"

"Why, barbecue it, of course," I reply, "I'm going to slow-cook it on the grill for six or seven hours, flipping and basting it with home made BBQ sauce every half-hour, till you could cut it with a dull spoon. It's way less work than grilling burgers or steaks for a crowd, and will impress your guests no end." (Plus, it's cheap).

I walk all the grocery aisles. There's a huge amount of floor space also dedicated to non-grocery items — I don't know what exactly, because I never go in that area, it looks too much like a mall, and makes me veer off towards the Lysol.

There are line-ups at the checkout counter, which allows those families shopping together to let Mom to unload the cart while the kids drag Dad down to the conveniently located Home entertainment section to buy new DVD's and X-Box games. They also have a few of those new self-check-out scanners. I guess the idea is to cut costs by eliminating the cashier, but they are slow and frustrating to use and it seems like there are at least two employees supervising each one, so I don't see the benefit.

All in all, it's a decent store, but deduct marks for produce, and you'll likely go home with a bunch of President's Choice products that you never knew you needed.

On to the competition.

One of Loblaw's main rivals is Sobeys, which currently around $37 a share, with 1,311 stores across Canada. In Ontario, Sobeys operates 117 IGA stores, 65 Sobeys stores, 98 Foodlands, 15 Commisso's and 81 Price Choppers. Total annual sales are just over $12-billion. The company earned $2.86 a share and paid a 50-cent dividend (for a yield of 1.34 per cent). On the ROB 1000, they rank 88th in sales, 28th in revenue and 99th in assets. Sobeys stock has been beaten up lately, too, gapping down sharply on Metro Inc.'s recently announced takeover of A&P Canada's 236 stores for $1.7-billion.

The local Sobeys, just down the road from the new Loblaw Super Store is also pretty good. Their produce section is small, and no better than Loblaw's, but they have a better fish counter, a good deli, and always have dark rye bread in stock. It's also a very busy store, but I always find it somehow less frenetic than the big Loblaw's up the street.

Sobeys' discount outlet Price Chopper has the best bags — they're big enough to fit the kitchen waste bin, and don't rip as often as Loblaw and Sobeys bags. Plus, unlike No Frills (Loblaw's discount outlet), they have a deli counter and bakery.

Our local No Frills is quite good, although the selection isn't as wide as you might like, but they have a better produce section than the Loblaw Super Store. They don't have all the alien and organic veggies, but what greens they have are always fresh.

The local Dominion (about to become Metro) is okay, too, but their produce department doesn't measure up to their two main rivals. Otherwise, they stack up pretty well against the bigger chains, and they give Air Miles to boot. Back when I was in MBA school, we did a case study of Dominion Stores. For years they had advertised with the slogan, "Mainly because of the meat," despite consumer surveys routinely pointing out that the number one thing grocery buyers listed as the most important in a grocery store was the quality of the produce, and meat barely made the top ten.

My favourite grocer, however, is Weston Produce. They have absolutely the best produce area, with the best assortment of the freshest fruit and vegetables of any big grocer in our area. Loblaw, Sobeys and Dominion should visit to see how it's done. They have a huge deli counter, a good butcher and baker, and an entire aisle dedicated to pasta. They also have shorter line-ups at the checkout counter than does the Loblaw Super Store. Sure, a lot of the non-perishable products have labels written in Italian, which can be challenging at times, but it's not an insurmountable obstacle. Weston Produce, however, is not a public company, so you can't buy the shares.

Metro Inc., currently around $31 a share, once it closes its acquisition of A&P Canada, will have 579 stores, including 283 in Ontario with sales pushing the $11-billion mark. (Currently, Metro generates about $6-billion in annual sales). The take-over vaults Metro ahead of Sobeys nationally and makes it second to Loblaw in the key Ontario market. Metro shares have shot up since the announcement.

Now, between the threat of Wal-Mart entering the increasingly crowded grocery sector, and Metro's bulking up to become a major force in the market, the price of Loblaw and Sobeys shares has been hammered recently. It's too early to guess which of these three companies will prevail, although the average GlobeinvestorGOLD.com buy-side rating for Loblaw and Metro is a "hold," and for Sobeys, a "sell."

On the plus side, the grocery business is pretty much recession proof — good times or bad, you've still got to eat. And Loblaw, Sobeys and Metro are all solid, well-run companies, with steady dividend histories. Any of them would make a good addition to my portfolio.

But the grocery space is getting kind of crowded, and there is likely not room for all three contenders to grow. Future sales growth will have to be squeezed out of someone else's market share, and all three of these companies have got to be worried that it might be Wal-Mart doing the squeezing.

I think that Loblaw, given its awesome marketing capability, will continue to prosper. Sobeys, with its focus on customer service, should also continue to do alright, although it risks being swamped by its two larger rivals and may become more of a niche player. As for Metro, it remains to be seen how well they will revamp the rather tired A&P Canada stores. So bottom line, it's going to be something of a food fight for a while, and these three stocks will all bear watching.

I'm leaning towards buying some Loblaw shares on a pull-back below $65. I also might take a shot at Sobeys if it gets down around $32. And as for Metro, I hate to buy stocks after they've spiked up sharply, so I'll wait and see how the acquisition works out, and take another look when the initial ebullience over the news dies down.

Anyway, all this talk about groceries is making me hungry, so I'll end this here and go make some lunch.

Harry Koza is Senior Analyst in Canadian markets for Thomson Financial/IFR. At various times in his career, Mr. Koza has been a prospector, metallurgist, project manager, engineer, as well as an institutional bond salesman for 15 years. His current area of expertise is in high-yield distressed securities and corporate bonds in general.

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