Supermarket Companies Profiles

Shoppers Drug Mart Gives Loblaw Companies (tsx L) More Flexibility, Improves Profit Margins But Not Food Sales

    shoppers first half financial data     size of company    structure of deal

           After Sobeys greatly expanded its market reach by acquiring Safeway last month it was only a matter of time until main competitor Loblaw Companies made a move, but few could've imagined it being this big:  A $12.4 billion offer (29% premium to 20-day avg, 11.4X ebitda) for Canada's leader in prescriptions filed, a company with annual sales only a third of Loblaws ($10.782b vs $31.604b) yet profits 87% as much ($608m vs $695m).  Yes, this deal easily improves both gross and net margins at Loblaws by more than quadrupling the number of prescriptions up to 125 million (market share at 25%, pharmacies have margins 2-3X that of food and general merchandise).  Prior to this deal loblaws held a 7% share of the pharmacy market in Canada with the last major boost to its share happening in March when it paid $35m for Zellers prescriptions.  The number of pharmacies run by Loblaw goes from ~ 500 in-store to 1797.  With Loblaws' margins improving on the back of pharmacy sales you can be sure Empire Company and Metro Inc are seeking out other potential targets.  This makes Jean Coutu Group (PJC.A) in Quebec a possible M&A target  (stock price responded nicely, up 7%).

Combined Company Will Be Big

65 million square feet of retail space, 2348 locations, 1 billion annual customer transactions.  Financials estimates : revenue of $42 billion, ebitda of $3 billion.  Cost synergies averaged over three years estimated to be $300 million.  624 of 2348 locations are in the West (26%), that compares to 424 of 1523 for Sobeys (28%, excludes gas stations) despite the West being home to 31% of the national population (10.8m / 34.8m).

Drug Rules In Canada Affect Revenue

New drug rules have already begun to affect the value of prescriptions at Shoppers, that's because provincial drug plans lowered the amount their willing to pay for generic prescriptions.  Generic brands affected include HealthWATCH and Life Brand.  In Shoppers Drug Mart's 1st quarter of 2013 the average value for prescriptions was down -4.8%.

Deal Improves Profit Margins But Doesn't Really Counter Sobeys' Safeway Move, market share remains unchanged

According to the Usda 2013 report on the state of Canada's food industry, only $610 million of Shoppers Drug Mart's $10 billion in annual revenue comes from the sale of food meaning that, although Loblaws pro forma revenue goes from $31b to $42b, sales of food products increases only marginally with the total being in the $30 to $31b range.  So competition between them and Sobeys remains just as intense as it was prior to the deal.

Sobeys deal gave it 199 additional in-store pharmacies compared to a gain of 1363 for Loblaws in the Shoppers deal.

Shoppers latest quarterly financial stats

2013 at the half - total revenue $5.024b +3.6% (1q $2.486b +3.8%, 2q $2.538b +3.3%).  same-store sales +2.2% (1q +2.2% 2q +2.0%) with same-store increase in retail pharmacy roughly double that of the store front (5.3% vs 2.9%).  Revenue contribution by product : pharmacy $2.415b +3.2% (1q $1.207b +3.3%, 2q $1.208b +3.1%), store front $2.609b +3.9% (1q $1.278b +4.3%, 2q $1.331b +3.6%).  retail prescriptions +7.1%.  Pharmacy revenue increases is partly attributable to the MediSystem Technologies business, it could've been higher if not for a drop in the value of the average prescription.  net earnings per share $1.31 +4.8% (2q +5.8% better than 1q +5.4%).

1q2013 - revenue split between pharmacy ($1.207b +3.3%) and store-front (cosmetics, food, toiletries $1.278b +4.3%).

Structure Of The Loblaws Shoppers Deal

Like the Sobeys deal, financing for the Shoppers takeover relies on equity issue;  Shoppers Drug Mart shareholders will get $5.7 billion of existing Loblaws equity in addition to $6.7 billion in cash - the $6.7b cash comes from incremental debt financing ($4.6b), available cash ($2.0b) as well as some help from parent company George Weston Ltd ($500m).  One result of the transaction is that for the first time George Weston Ltd will own less than 50% of Loblaw Cos stock (46%).  Former Shoppers Drug Mart shareholders will own 29% of the new company.  Sobeys' Safeway deal was smaller and a bit easier to finance;  $1.0b in financing for their deal came from asset sales $255m from the sale of Empire Theatres.

other notes - agreement was made on July 15, 2013.

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