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Morningstar | No-Moat Loblaw Digital and Data Initiatives Offset by Several Headwinds; Shares Slightly Overvalued

We don't expect a material change to our CAD 55 valuation, after no-moat Loblaw reported 1.8% sales growth (up 0.2% year to date) versus our 1% lift 2018 forecast. Loblaw continues to face several headwinds (wage inflation, transportation costs, drug price deflation, competition, and tariffs), offset by digital and data initiatives. We see shares as slightly overvalued, trading at 15-16 times our existing 2019 earnings per share estimate.

Loblaw's top-line results in its food retail (73% of sales) segment highlight our concerns that ongoing competition from the likes of wide-moat Walmart will remain intense. This is illustrated by the 0.9% food retail same-store-sales increase in the quarter (1.1% year to date), tracking near our 1% 2018 estimate. Also, Loblaw's food inflation saw a marginal decline versus the national 0.3% increase, although when adjusting for mix the company experienced basket growth just slightly below the market. This is a signal that the company is challenged to pass pricing along to its customers.

Meanwhile, Loblaw's drug store segment (27% of sales) performed a bit better, showing same-store-sales growth of 2.5% (2.6% year to date), above our 1.5% 2018 estimate. Still, headwinds from several Canadian provinces cutting generic drug prices and increasing wage growth present ongoing challenges and frame our forecast for low-single-digit annual consolidated sales growth the next five years with gross margins dropping to 27.5% in 2022 from 28% in 2019 (the first full-year post the Choice Property spin-off this November).

Loblaw's digital and data efforts are aiding profit, helping to mitigate the competitive headwinds. To illustrate, data is allowing Loblaw to customize offerings to its 15 million loyalty members versus prior mass mail, allowing for a 200-basis-point lift in promotional margins. Further, locations with click and collect (in over 500 units) are seeing meaningful same-store-sale improvement (unquantified).