Report
Dan Wasiolek
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Morningstar | Loblaw's Investment Not Enough to Build Competitive Advantage

Loblaw is the largest grocery chain in Canada and owns four of the top ten brands, including Canada's number-one (President's Choice) and number-two (No Name) private-label brands. Around 25% of sales are derived from pharmacy after its 2014 Shoppers Drug Mart acquisition, which should bring ample cross-selling opportunities for its private-label products over the near to medium term. Loblaw is diversified, operating through four different formats and 25 banners, allowing it to target a wide range of consumers, geographies, and glean insights from each respective segment.Despite these strengths, Loblaw hasn’t been able to garner strong profitability, most directly shown in its return on capital that barely clears its cost of capital. We attribute these hardships to the competitive environment in which it operates, the low-switching-cost grocery industry, and a value proposition not able to protect economic profits. The company strives to bolster traffic by using its loyalty program, but results suggest competition may be too much to fully capture the benefits one would expect.Shoppers Drug Mart enhanced Loblaw’s scale (garnering synergies totaling around 3% of sales) and brought a higher operating margin business into the mix, but we believe the competitive threats posed by well-capitalized competitors like Walmart and Costco will continue to constrain profitability for the company over the next decade. Beyond this, several Canadian provincial governments cut generic drug prices in calendar 2018 with pressure continuing in 2019, which does not bode well for Loblaw’s profitability. Lastly, the firm is facing an increased minimum wage in at least two of its markets, Ontario and Alberta, which may further hinder profitability if it cannot find efficiency offsets or pass higher prices on to consumers, which may prove difficult in this competitive arena.
Underlying
Loblaw Companies Limited

Loblaw is a Canadian food distributor and provider of general merchandise, drugstore and financial products and services. Traditional food offerings remain at the core of Co.'s business. Co. operates conventional, superstore, and hard discount stores. Co. offers products through control label program with famous brands including President's Choice, no name and Joe Fresh Style. Co. also offers President's Choice Financial services and offers the PC points loyalty program.

Provider
Morningstar
Morningstar

Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The company offer an extensive line of products and services for individual investors, financial advisors, asset managers, and retirement plan providers and sponsors.

Morningstar provides data on approximately 530,000 investment offerings, including stocks, mutual funds, and similar vehicles, along with real-time global market data on more than 18 million equities, indexes, futures, options, commodities, and precious metals, in addition to foreign exchange and Treasury markets. Morningstar also offers investment management services through its investment advisory subsidiaries and had approximately $185 billion in assets under advisement and management as of June 30, 2016.

We have operations in 27 countries.

Analysts
Dan Wasiolek

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