Loblaw says profit growth comes from increased sales of cosmetics, not food

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Profits at two of Canada’s top grocery chains outshined analysts’ expectations on Wednesday, a bonus for shareholders that also risks attracting more scrutiny on the industry.

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Runaway inflation has thrust the big grocers into a harsh public spotlight this year, as consumer advocates, politicians and economists have questioned whether the chains are exploiting the situation to pad their profits. A parliamentary inquiry is set to investigate whether corporate greed is driving up prices, while the federal antitrust watchdog is studying whether a lack of competition in the industry made matters worse.

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Loblaw Cos. Ltd., the country’s largest retailer, used a conference call with financial analysts on Wednesday to address the allegations head on, strongly denying that inflation had anything to do with its recent run of success.

“Retail prices are not growing faster than costs and the company is not taking advantage of inflation to drive profit,” chief financial officer Richard Dufresne said on Wednesday.

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In its third quarter, Loblaw posted net earnings of $556 million — up 29 per cent from the same period last year — on revenue of $17.4 billion. On an adjusted basis, profit was $663 million, an increase of 22.8 per cent. Adjusted earnings per share of $2.01 beat forecasts of $1.92.

Retail prices are not growing faster than costs and the company is not taking advantage of inflation to drive profit

Richard Dufresne, chief financial officer, Loblaw

RBC analyst Irene Nattel said Wednesday’s results were “strong” and “better than expected.”

On the same day, Montreal-based Metro Inc. — the third-largest Canadian grocery chain, which includes Food Basics and the Jean Coutu pharmacies — reported a 9.4 per cent jump in profit to $219.4 million during the company’s fourth quarter, when adjusted to account for an impairment charge from Jean Coutu’s decision to pull out of the Air Miles loyalty program. On a non-adjusted basis, Metro’s quarterly net earnings were $168.7 million, a 13 per cent decrease year over year. Adjusted earnings per share of 92 cents surpassed forecasts of 87 cents, according to Natel.

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Metro said sales increased by 8.3 per cent to $4.4 billion, “mainly due to higher inflation this quarter.”

A Metro store in Ottawa.
A Metro store in Ottawa. Photo by David Kawai/Bloomberg

The results came as Statistics Canada released its latest Consumer Price Index on Wednesday, showing that grocery prices rose by 11 per cent in October compared to last year — slightly better than the 11.4 per cent food retail inflation recorded in September.

As inflation surged this summer, economists and progressive think-tanks questioned why the chains were reporting an increase in gross margin — a measure of how much profit a grocery outfit has left over after subtracting the cost of goods — which provides a clear gauge of whether price increases are outpacing inflationary pressure in the supply chain.

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Steven Salterio, a Queen’s University accounting and auditing expert who has studied the grocery sector, looked at five years’ worth of public financial data released by Loblaw, Sobeys’ parent Empire Co. Ltd. and Metro. In August, he found all three had improved their gross and operating margins in the past year compared with their five-year averages. Loblaw had the largest margin improvement, up more than 130 basis points, or 1.3 per cent, in the period.

Loblaw has insisted that the margin growth isn’t coming from the food aisles of its stores, but from the fact that sales are increasing in categories that have higher margins to begin with, such as beauty.

Loblaw owns the Shoppers Drug Mart chain, and benefited from an uptick in sales of cosmetics and fragrances as pandemic restrictions subsided and people went back to offices and social gatherings. In the latest quarter, Loblaw president Galen Weston said the drugstores got another bump, this time from an autumn surge in infections of COVID-19, as well as the flu and respiratory syncytial virus (RSV). That brought “more customers to our pharmacies, leading to all-time highs in the sale of cough and cold meds,” Weston said.

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The cold and flu section at a Shoppers Drug Mart store in Toronto.
The cold and flu section at a Shoppers Drug Mart store in Toronto. Photo by Jack Boland/Toronto Sun/Postmedia Network

Salterio and other experts have said growth in more lucrative categories is a plausible explanation for the higher gross margins, but there’s no way to confirm it using only Loblaw’s public financial reports, since they don’t provide detailed enough category breakdowns.

“If we really want to get to the bottom of it, there needs to be some objective, third-party analysis,” Robin Shaban, a former officer at the Competition Bureau and co-founder of a think-tank called the Canadian Anti-Monopoly Project, said in an October interview.

That type of analysis could start soon, as the industry faces a pair of federal inquiries. Executives from the top food retailers, including Loblaw, Metro and Empire, are expected to be summoned in front of the House of Commons agriculture committee in the coming weeks for a parliamentary inquiry into corporate profits during the inflation crisis. The Competition Bureau also announced last month that it is studying how market concentration in the industry is impacting price inflation.

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“I know it’s a bit of an awkward question,” BMO analyst Peter Sklar began during Wednesday’s conference call with Loblaw executives, before asking about the bureau’s investigation.

“As you would expect, we’re actively participating,” Weston responded. “Our objective is to make sure that we share in a transparent way all the most relevant information to make sure that the facts of what’s happening are properly understood.”

Loblaw reported gross margin of 30.8 per cent for all retail sales during the third quarter, representing an increase of 10 basis points compared to last year. The company doesn’t provide gross margins for the food or pharmacy segments in its financial reports, though Wednesday’s report said margins in the food business stayed “flat” in the third quarter compared to the same time last year.

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During Loblaw’s conference call on Wednesday, Dufresne said the company has been inundated with requests from food suppliers looking to increase their wholesale costs at a level “more significant than anything I’ve seen in my career.”

“Our objective is to make sure that our prices on the shelf do not rise faster than supplier costs,” he said.

To make sure Loblaw delivers on that goal, Dufresne said his team watches gross margin “very closely.”

“In every quarter since inflation took off last summer, gross margins in food have been essentially flat,” he said. “This gives us the confidence to say categorically that retail prices are not growing faster than costs and the company is not taking advantage of inflation to drive profit.”

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In a post on Twitter after the call, Loblaw said Wednesday’s update had given “clear evidence” to disprove the profiteering claims.

Metro, meanwhile, reported that its gross margins for its fourth quarter and 2022 fiscal year — 20.4 per cent and 20 per cent respectively — hadn’t changed from the previous year. Chief executive Eric La Flèche said margins on the food retail side of business were down slightly, but growth in the pharmacy division brought the overall rate back to even. Food margins dropped, he said, because Metro has opted to take less profit rather than pass on all wholesale cost increases to consumers, who have become more conscious about value as inflation surges.

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“Our ability to pass those cost increases through is very difficult,” La Flèche told analysts on a Wednesday conference call. “We absorb some of those cost inflations because we want to be at a price that will attract customers.”

Empire chief executive Michael Medline has said that his public financial statements, as well as those of his main competitors, are enough to prove there isn’t any profiteering going on. He also added that, in its most recent quarterly report, Empire’s profit dipped by $1 million to $187.5 million.

“You can look at our numbers, and they tell the whole story,” he said in an interview last month. “We would be doing better, if not much better, without inflation.”

Correction: IGA grocery stores in Canada are franchised or operated by Sobeys’ parent Empire Co. Ltd. Incorrect information appeared in an earlier version of this article. The Financial Post regrets the error.

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