Loblaw (TSE:L) (LBLCF) is a food retailer that also sells medicine, general merchandise, and financial products and services. It operates through the following business segments: Retail and Financial Services.
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The company is in a good position to handle rising inflation due to the nature of its business and measurable competitive advantage.
Growth Catalyst
As an essential business, Loblaw is more insulated from inflation than other companies. This is because groceries and medicine are always in demand. Thus, consumers will cut spending in other categories in order to continue affording the essentials.
It also helps that the company owns discount grocery stores such as No Frills because it allows it to poach low-income customers from mid-tier stores if prices rise too much.
However, it’ll be interesting to see how its financial services segment will be affected, going forward. In theory, higher interest rates should allow the company to earn more interest income on existing loans, but it could also decrease borrowing. Nevertheless, it shouldn’t have a material impact on Loblaw’s overall operation.
Competitive Advantage
There are a couple of ways to quantify a company’s competitive advantage using only its income statement. The first method involves calculating a company’s earnings power value (EPV).
Earnings power value is measured as adjusted EBIT after tax, divided by the weighted average cost of capital, and reproduction value (the cost to reproduce/replicate the business) can be measured using a company’s total asset value. If the earnings power value is higher than the reproduction value, then a company is considered to have a competitive advantage.
For Loblaw, the calculation is as follows:
EPV = EPV adjusted earnings / WACC
C$51.293 billion = C$3.847 billion / 0.075
Since Loblaw has a total asset value of C$36.61 billion, we can say that it does have a competitive advantage. In other words, assuming no growth for Loblaw, it would require C$36.61 billion of assets to generate C$51.29 billion in value over time.
The second method to determine if a company has a competitive advantage is by looking at its gross margin trend because it represents the premium that consumers are willing to pay over the cost of a product or service. An expanding gross margin indicates that a sustainable competitive advantage is present.
If an existing company has no edge, then new entrants would gradually take away market share, leading to decreasing gross margins as pricing wars ensue to remain competitive.
In Loblaw’s case, its gross margin has increased in the past several years, from 23.5% in Fiscal 2012 to 31.7% in the past 12 months. As a result, its gross margins indicate that a competitive advantage is present in this regard as well.
Analyst Recommendations
Loblaw Companies has a Moderate Buy consensus rating, based on three Buys and three Holds assigned in the past three months. The average Loblaw Companies price target of C$121.66 implies 6.8% upside potential.
Final Thoughts
Loblaw is a solid choice for those seeking a hedge against inflation. However, it seems that analysts believe there isn’t much upside from here, suggesting that the positives may already be priced in.
