Loblaw Companies Ltd T.L

TD Raise Target

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Loblaw Companies Ltd.

(L-T) C$117.09

Tonnage is Not What the Simple Math Suggests Event

• Raising our annual EPS estimates by 3-4% to reflect the Q2/22 beat, slightly higher Drug sales/margins, and slightly lower Retail SG&A growth. We now expect adjusted EPS growth of 18% in 2022E (guidance is for mid-high teens), and 9%/10% in 2023E/2024E.

• Rolling out our target valuation another quarter increases our target price to $130.00 (from $125.00).

  Impact: SLIGHTLY POSITIVE

  Q2/22 EPS jumped 25% y/y on the back of strong Drug gross margins (larger mix of pharmacy services, beauty/cosmetics, and OTC revenues) and less-than- expected opex growth. Despite the beat, and an increase in 2022E EPS guidance, the shares fell almost 4% yesterday. The shares were very strong heading into the quarter, but investor concerns around weaker-than-expected implied Food tonnage (and possible market-share erosion) seemed to fuel the underperformance. We view these concerns as unwarranted — the much lower-than-expected "Street math" tonnage (-8.7%) seems to be mostly related to the effects of trading down and channel mix shifts, rather than market-share erosion, as the inflation number (up ~9.6%) is based on a fixed basket, which does not capture trade-down and, as such, is an "inflated" figure. [We attempt to shed some light on this using two simplistic examples in Exhibit 2.] Loblaw gained market share in the Conventional channel this quarter, but lost some in the Discount channel to Walmart and Costco, though Loblaw already took steps to address this slippage early in Q3/22.

  We see inflation peaking in Q2/22, though remaining >7% in H2/22 (many vendors have reportedly asked for additional price increases), before slipping more rapidly over H1/23.

  TD Investment Conclusion

  Loblaw is well-positioned among the grocers, given its disproportionate exposure to pharmacy, the discount channel, and private label. Coupled with enhanced merchandising strategies and alternative profit streams (e.g., Media, Connected Health), we forecast EPS growth of 15% over the rest of 2022 (vs 9%/13%, normalized, for Metro/Empire). In the short term, we still see good relative performance for Loblaw, particularly after yesterday’s pullback and earnings raise. That said, as inflation moderates, we could see more investor funds move into the processors in search of greater risk/reward.