TSX Commentary

Empire reported Q2-F10 fully diluted EPS (excluding capital gains/losses) of $1.06 vs. $0.96 LY, better than the consensus estimates of $0.97. Food EPS improved by 17% to $0.96. Since Empire’s grocery business (Sobeys) accounts for 98% of its sales and 90% of its EBITDA, the analysis below focuses on Sobeys. Sobeys’ SSSG was impressive at +2.7%, despite negligible food price inflation. Management attributed two-thirds of the SSSG increase to an increase in sales per transaction and the remainder to an increase in customer count. Sobeys’ gross profit margin improved by 57bps to 23.58% mainly due to improved productivity, and it is in line with the gross profit margin improvement reported by Loblaw and Metro in their most recent quarters. Similar to Loblaw and Metro, Sobeys exhibited tight expense control, reporting a flat SG&A margin at 18.67%. As a result, EBITDA margins improved by 20bps to 4.91% and EBITDA increased by 8.5% to $186.8M.
The current progress in Wal-Mart’s supercenter rollout confirms RBC CM’s belief that there should be 83 WMSCs in Canada by Jan.10 compared to 56 in Jan.09. Among the 26 new WMSCs, 22 will represent conversions from existing Wal-Mart discount stores. As indicated in the Canadian Grocery Industry report on Sept.30, Sobeys has to make price investments in order to be competitive with WMSC. Veritas reiterates its thesis that Sobeys will have the most negative impact from the rollout of WMSC due to the highest conventional exposure to Walmart stores and a weak discount banner positioning. Price Chopper is Sobeys’ discount banner with stores mainly located in Ontario. Veritas estimates that Sobeys generates only 11% of sales from discount stores vs. 33% at Metro and 57% at Loblaw. Veritas’ $39 intrinsic value of Empire incorporates expected pricing investments at Sobeys and potential volume loss to WMSC. Veritas believes that Empire is overvalued by about 12% at the current price of $44.50.