TORONTO - Loblaw Companies Ltd. (TSX:L) is warning that its margins are taking a hit as it cuts prices to stay competitive - and that these price wars will likely continue into the holiday season.
"I think this Christmas period will be pretty fierce in terms of competition," Allan Leighton, president and deputy chairman of Canada's largest grocery store chain, said Tuesday on a conference call with financial analysts.
The grocery industry is becoming increasingly cut-throat as slowing inflation lowers the prices of most food items and retailers respond by slashing prices.
Loblaw, which reported an increase in third-quarter earnings, said the price of its products isn't keeping pace with inflation.
The slowdown hurt revenue, a trend Loblaw expects to worsen in the fourth quarter.
"We believe inflation, or lack of it, will be a factor for at least the next six months, restricting revenue growth," Leighton said.
"With that in mind, we have invested in price in the quarter at a cost to gross margin."
Leighton added that he expects there will be further price reductions in time for the holiday season at Loblaw's several banners, which include No Frills, Zehrs, Fortinos and Real Canadian Superstore - good news for consumers but a trend that will make the fourth quarter a difficult one for the company.
"Our outlook for the rest of the year has not changed. We believe sales revenue and margins will be challenged. Inflation will disappear, competition will intensify, and volume growth and volume market share will be key," Leighton said.
Edward Jones analyst Brian Yarbrough said Leighton is probably correct to assume declining inflation will continue to impact Loblaw for the next six months, although this could change if the economy rebounds more quickly than expected.
"If the economy starts to strengthen and people start paying full price for things and they don't have to discount as much, that helps pricing," Yarbrough said.
"And if the economy starts coming back and a lot of these commodity prices start moving back up, you'll expect the manufacturers to start pushing price increases through again."
In addition to losing revenue due to lower prices, Loblaw will continue to lay out millions in capital expenditures in the fourth quarter under a program to renovate its stores and upgrade its information technology and supply chain infrastructure.
Chief financial officer Robert Vaux said the investment in information technology cost the company about $25 million in the quarter and impacted earnings by about six cents per share.
In total, Loblaw expects to spend approximately $1 billion on capital expenditure in 2009, which will include more than 200 store renovations, almost 100 of which were completed during the third quarter. It expects to spend $70 million to complete its renovation program in the fourth quarter.
The program also hurt Loblaw's revenues, as stores in the midst of renovations have approximately 10 to 15 per cent less space to dedicate to core general merchandise, the company said.
However, Yarbrough said keeping stores up to date is key to maintaining customer loyalty.
"The issue with (Loblaw) has been for probably 10 years straight up until 2006, all they did was add new stores and grow square footage and they didn't put money into systems and they didn't put money into some of their older stores," he said.
"It's kind of amazing how the consumer will respond to a newer, updated, fresher store. I think that's a big driver."
Loblaw said Tuesday it earned $189 million or 69 cents per share for the quarter ended October 10. That was up from year-ago profit of $157 million or 57 cents per share as the grocery chain benefited from cost containment and improved supply chain efficiencies.
Revenues totalled $9.47 billion for the quarter, flat compared to $9.49 billion last year.
On average, analysts were expecting earnings of 62 cents per share before items and revenue of $9.62 billion, according to estimates compiled by Thomson Reuters.
The better-than-expected earnings boosted Loblaw's share price by $1.50 or 4.9 per cent to $31.90 in Tuesday trading on the Toronto Stock Exchange.
The company said same-store sales fell 0.6 per cent in the quarter, adding that the Thanksgiving holiday sales helped boost figures.
Loblaw added that its sales were negatively impacted by the sale of its food service business in the fourth quarter of 2008. It said sales growth in its food and drugstore segment was "modest," growth in apparel was "moderate" while gas bar sales and other general merchandise "declined significantly."
The company said its recent acquisition of T&T Supermarket Inc. just before the quarter's end has not significantly impacted earnings, but is expected to boost figures in the future.