There’s an old investing adage that you should put your money into what you know. Famed value investor Warren Buffett calls this “the circle of competence.” The more familiar you are with an industry, the more likely you’ll be able to judge whether a company in that industry is doing well. Based on that, readers of Canadian Grocer should load up on the stocks of grocery companies, right?
Perhaps, but do professional investors think grocery chains are a smart buy? For Canadian stocks the options are limited to the Big Three chains: Loblaw, Metro and Sobeys, all of which are publicly traded (although Sobeys does so as part of parent company, Empire). A closer look at each not only suggests which are the smartest investments, but also shows how investors look at the grocery industry in Canada overall. And that has ramifications for anyone who works in this industry.
The good news is that grocery stocks have generally been quite poplar with investors. And unlike, say, manufacturing, grocery isn’t seen as a bad investment during sluggish economic times. There are a number of financial metrics that investors really care about. For instance, price to book value (P/B), which shows a company’s stock market value relative to its net value.
Companies with lower P/B values tend to be better investments, says Norm Rothery, a well-known Canadian investor and founder of the Stingy Investor newsletter.
In that regard, Loblaw, Sobeys and Metro seem like good buys. They trade well below Wal-Mart Stores Inc., their biggest competitor. Wal-Mart trades for roughly three times its intrinsic value, reflecting positive investor sentiment about its growth prospects; while the Canadian chains trade for between 1.2 and 1.8 their book values.
$53.47: price per share of Sobeys parent company Empire. Metro’s share price as of early April was $45.91 and Loblaw’s shares were trading for $38.11
Of course, sometimes companies trade at a low multiple for a reason. But Canadian grocer stocks don’t seem to be unduly low to raise any red flags. Sobeys’ parent company, Empire, has the lowest P/B ratio, but that could be a reflection of the fact it is not solely a food retailer. While Sobeys contributes the bulk of Empire’s revenues, profits are more dependent on its real estate and investing operations.
Scott Clayton of the Successful Investor says he looks for stocks with a low price to earnings ratio (P/E) and then looks at their earnings prospects to make sure that ratio is sustainable or increasing. The Successful Investor has a Buy rating on both Loblaw and Metro. Both chains have been restructuring operations–Loblaw by upgrading its inventory management and distribution systems and buying Asian-food retailer T&T; Metro by converting its A&P and other banners to Metro, which should bode well for the future. Loblaw’s shares currently trade for a premium at 13 times estimated 2011 earnings and 10.9 times estimated 2012 earnings.
Overall, analyst consensus, according to Thomson Reuters, is that all three chains are a Buy. Analysts generally look a year ahead, meaning the invasion of U.S. discounter Target into Canada sometime in 2013 may not yet factor in their Buy/Sell ratings.
Investors who are worried about a chain’s future will check out the debt load and interest coverage, says Rothery. If cash flows slow down, paying off higher-interest debt could become more challenging. But in competitive food retail, there likely aren’t going to be major balance sheet differences. The key is often how management executes.
All three chains seem to have seen the competition coming so they’ve upgraded all their stores. That seems to be a pretty big thing with food shoppers: a clean store with a nice flow to it, says Clayton. And what matters to grocery consumers, clearly counts a lot with grocery investors, as well.