When Sobeys' parent company Empire Company Ltd. (OTCPK:EMLAF) completed its C$5.8 billion acquisition of Safeway Canada at the end of 2013, there was an expectation from investors that this would help the company compete in Western Canada. Now just under three years later and rather than a reinvigorated Empire Co. we are seeing a company which has been plagued with losses, consumer rebellion and a stock price which is below the level it was at when the deal was finalized.
Following the merger, Empire Co. consisted of a large portfolio of grocery companies such as Sobeys, Safeway Canada, IGA, Foodland, FreshCo, Thrifty Foods, Lawton's Drug Stores and a 41% interest in Crombie REIT. It was the acquisition of Safeway's (NYSE:SWY) Canadian assets which was to be the cornerstone in Empire Co.'s plan to keep up with its Canadian competitors Loblaw's (OTCPK:LBLCF) acquisition of Shoppers Drug Mart, as well increased market share growth from Metro Inc. (OTCPK:MTRAF) in Eastern Canada. While Empire was also facing increased pressure from the Canadian branch of Wal-Mart (NYSE:WMT) and the failed expansion of Target (NYSE:TGT) into the great white north.
Unfortunately for Empire Co. and investors since the dust has settled on the merger the company isn't much better off.
Clean up on aisles 1 through 12
When Empire Co. attempted to assimilate the structure and operations of Safeway into the Sobeys culture it created a backlash from consumers. Who repeatedly complained about less stock, sale priced items not even in stores, the cancellation of Safeway rewards programs and the elimination of Safeway's house-branded items, not to mention a host of other internal issues. These issues have in turn driven away customers over the past couple of years leading to some troubling issues for Empire Co.'s financials.
When Empire released its Q4 2016 report in June it painted a very bleak picture for the company and sent a shock through its share price. Though the share price plummet wasn't as bad as it was following the release of its Q3 2016 which reported a net loss of C$1.36 billion. This includes a "C$1.59 billion writedown of goodwill associated with the Safeway purchase", which brings the total amount of Safeway writedowns in the past two quarters to C$3.02 billion.
While the post-earnings release day stock slump wasn't as drastic this time around, the net loss in Q4 2016 was much greater. The net loss in the quarter amounted to C$942 million (C$3.47 per share), which brought the total net loss for the year to C$2.11 billion (C$7.78 per share), erasing the Q4 2015 net income of C$426 million (C$1.51 per share). While overall sales have been up across Empire Co. with Q4 sales rising by 8.9% to C$6.28 billion from C$5.77 billion and 2016 sales rising to C$24.6 billion from C$23.9 billion same store sales still managed to fall by 1.8% in the quarter and 0.2% in the year.
The losses continue throughout the quarterly report as operating income in Q4 fell to -C$1.16 billion from C$115 million and 2016 operating income fell to -C$2.41 billion from C$436 million. EBITDA in Q4 also went into negative territory at -C$1.04 billion from C$236 million.
These results led Empire Co. to state the following in its quarterly report:
"Following the close of the Canada Safeway acquisition, the Company began integration of the acquired business with existing operations which has resulted in a number of operational issues that have had an impact on financial results. Merchandising issues such as the private label conversion along with produce supply chain issues impacted the offerings being made to customers at store level. In addition, increased promotional activity and a difficult economic environment mainly in the Alberta and Saskatchewan markets, resulted in sales, gross margin and earnings erosion in the West business unit. These have negatively impacted customer experience and resulted in a same-store sales decrease for the West business unit excluding fuel of 3.6 percent and 1.5 percent for the 14 and 53 weeks ended May 7, 2016, respectively."
The quicksands of the grocery sector
The financial reports from the past few quarters and the continued issues plaguing the company have now lead to the resignation of Sobeys and Empire CEO Marc Poulin, the architect and face of the Sobeys-Safeway Canada merger. This alone will do very little to ease the worries of investors and recoup lost customers as this will not change the current landscape of the industry. One of the driving factors in the drop in same store sales has been the mounting inflation of food in Canada since the merger was announced in 2013. Combined with a weaker Canadian dollar and the abyss that energy markets are in has led many consumers to other discount orientated store chains.
The Sobeys brand feels this shift the most as in Western Canada it has no place in the discount grocery market sector like it does in Eastern Canada with its FreshCo chain. This has led consumers to seek out alternatives such as Loblaw's No Frills discount chain, Wal-Mart, and growing Western Canadian chains Save-On and Price Smart (both owned by Overwaitea). This has left Safeway to essentially carry the burden of securing market share in Western Canada for Empire Co. but in a weakened state.
Now with projections that food prices will be growing at 1.4%, its slowest pace since 2014 this could act as a double edged sword for Sobeys and Safeway. On the one hand it could temper what revenue growth it has seen in the past two years. On the other hand much of that revenue growth has come from rapid inflation on the price of food which has been averaged at 4.5% in the past two years, and any drops in pricing could lure customers back. Either way it still doesn't paint a very positive outlook for the company.
Self-serve stock check outs
Of all of the different sectors represented on the TSX I believe that none are more contentious than the grocery branch of the retail sector. It is generally a hard sell to get investors excited for sales growth numbers below 1% or razor thin margins. Yet some have managed to mine companies such as Loblaw's which had a same store sales increase (excluding gas) of 2.6% for stable dividends, but still this is a very difficult market for investors to navigate in.
In terms of Empire Co. many are seeing the Safeway acquisition as taking too long to provide any form of net benefit. Even when we look at the stocks path on the TSX we see that it has gone from C$31.98 in February 2015 to C$18.64 on June 27. Going forward there appears to only be a slight hope for any stock price growth, a hope that is dwindling as the average price target has fallen in the past year from C$40.18 to C$21.70. Since March the average price target reports have been coming out with a total range of C$21.00 to C$26.00. I believe these to be quite optimistic given the current state of consumers and the overall economy in Canada.
Even Empire Co.'s modest dividend of C$0.41 annualized with a yield of 1.97% may not be enough to help it lure investors. While it may be true that Empire Co. should bring its stock up slightly in the next couple of months from where it is today, the threat of continued stock price crashes following earnings reports will remain until the company can remedy its issues. Understanding the lack of any upside over the next year should lead many investors to start looking for a safe way out of this stock.
Author's note: If you enjoyed this article and found it helpful, please "Follow" me on Seeking Alpha to receive notification whenever I publish a new article.
You may also be interested in other recent articles I have written for Seeking Alpha with my Canadian point of view that focus on stocks and stories that I have found compelling. You can also find my previous articles here for further study.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.