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Investment Note: Loblaw Companies

GuruFocus.com

Loblaw Companies Ltd (TSX:L) is the largest food and drug retailer in Canada. The company is easily the most diversified among its competitors, operating well over a dozen different banners, catering to every geographic region in the country and appealing to every type of budget.

Loblaw boasts some of the most successful private labels in Canada, including President's Choice Life and No Name. Since acquiring the drug store chain Shoppers Drug Mart in 2014, the drug retailer continues to be a leader in same-store sales growth for the overall company. A key benefit of the merger was the amalgamation of both of the companies' loyalty programs to form the "PC Optimum program," allowing Loblaw to become a more data-driven organization.


The ability to leverage customer behavior data on over 16 million Canadian customers has helped the company find operational efficiencies in order to protect its gross margin in the face of challenges such as intense competition, rising wage costs and drug price reform. It has improved the management of working capital, reducing working capital by nearly $1 billion in spite of greater inventory.

Loblaw has robust free cash flow, with a significant portion allocated to shareholders. GAAP earnings have been shadowed by large depreciation and amortization expense, but core FCF (Free Cash Flow normalized for changes in working capital) has been trending up for over a decade. Loblaw generated over $3 billion in free cash over the last three years and spent roughly $1 billion in share repurchases in each of those years. Also, the company steadily increased its dividend by an average of 6% per year over the past eight years.

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Also, the company has started to pay down debt. Thus, shareholders have the trifecta of dividends, share repurchases and debt reduction working for them.

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Lziq58I.png

The company is a family business run by the Galen Weston family, which directly and indirectly controls 52.5% of the voting stock.

Valuation

Historically, the median price-book ratio has been a good metric for evaluating if Loblaw's was in the buy zone. Currently, the stock is trading above its median price-book line, indicating that it could be overvalued.

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Overall, I believe Loblaw is a high-quality Canadian stock that will fare well in a recessionary environment due to its financial strength and areas of operation. However, it is currently trading near or above its fair value. If the stock was to dip into the low 60's, I think it would be worthwhile to take a long position.

Note: Currency is Canadian dollars. The author does not own the stock at present.

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This article first appeared on GuruFocus.