TORONTO - Loblaw Companies Ltd. (TSX:L) plans to unveil about 700 Joe Fresh stores in the U.S. next year as Canada's largest grocery chain works to ramp up sales of its hip fashion line to help bolster earnings that dropped by 19 per cent in its most recent quarter.

Loblaw's Joe Fresh clothing brand announced Wednesday it has formed a partnership with U.S. retailer J.C. Penney Co. (NYSE: JCP) to open 700 stores in the U.S. in 2013 that will run for four years.

The move comes amid a massive overhaul of Loblaw's information technology and supply chain software system that is set to cost the company billions. The capital intensive roll out, along with a hyper-competitive grocery market in Canada, has eaten into its bottom line.

Loblaw reported second-quarter net earnings of $159 million, or 56 cents per diluted share, down almost 19 per cent from the $197 million earned in the same period in 2011. That missed analysts' calls for earnings of 62 cents per share by five cents.

Shares fell 1.5 per cent or 47 cents to close at $31.45 on the Toronto Stock Exchange.

"While I'm not happy that earnings are down, we are on plan," said Loblaw president Vicente Trius on a conference call Wednesday.

He noted that the market remained tough in the second quarter as grocers competed fiercely for customers who are keeping a close eye on their wallets.

"With continuing concerns for the global economy, consumer confidence slipped for the quarter," he said.

Revenue came in at $7.37 billion for the period ended June 16, an increase of 1.3 per cent from the $7.28 billion over the second quarter of 2011. Retail sales and same-stores sales grew 1.1 per cent and 0.2 per cent respectively.

The U.S. expansion of the Joe Fresh stores, set to open next April, coincides with the final stages of Loblaw's continued investment in the infrastructure overhaul.

Still, Trius said he is not concerned that the expansion will add to the company's expenses.

"It is an opportunity to leverage our brand across almost 700 stores...(with) limited financial risk and it has no capital. It's a wholesale arrangement but where we control the brand and it is actually accretive from the start," said Loblaw president Vicente Trius on a call Wednesday to discuss lower second-quarter earnings.

"No cost of capital and very low incremental expense. You might need a few people to manage, you know, but it's very very simple."

BMO analyst Peter Sklar seemed to agree, saying the deal "is largely a wholesale arrangement with limited risk for Loblaw."

The chain first pushed into the competitive U.S. landscape last year with a flagship store in Manhattan and already has six in the U.S. in addition to 300 stores in Canada.

The brand has been generating a lot of buzz among the fashonista crowd for its on-trend but budget-friendly pieces, but during its most recent quarter saw flat sales compared to a year ago.

"We feel positive about our start-up in the U.S. with our stores in Manhattan and let's say that we are right on target with our expectations," Trius said.

Adjusted earnings per share were in line with analysts' estimates of 60 cents but below BMO analysts' estimate of 67 cents, said Sklar in a research note.

Sklar attributes the earnings miss to higher expenses, which Loblaw management explained was due to foreign exchange losses and marketing costs related to their acquisition of Zellers prescription files. But he was also impressed with underlying trends at the chain.

"Thematically, we found that the second quarter offered more of the same. Loblaw continues to experience declining gross margin trends and at the same time is unable to gain any meaningful traction on food tonnage," he wrote.

Loblaw warned that full-year earnings will be lower than in 2011, as its operations aren't growing at a rate fast enough to cover the IT and supply chain investment.

"We remain confident that our ongoing investments in infrastructure, including the completion of our IT implementation, will enable efficiencies and expense leverage to drive future earnings growth," said chairman Galen Weston Jr.

Loblaw, a subsidiary of George Weston Ltd. (TSX:WN), operates more than 1,000 stores across Canada under numerous banners, including Great Canadian Super Store, Provigo, No Frills and Atlantic Superstore.

The company employs 138,000 full- and part-time workers.

The company is also converting some of its Ontario stores from a conventional format to a discount format.

Canada's grocery companies are in stiff competition against each other as well as other types of retailers that offer food items, including U.S.-based department store chain Walmart and Toronto-based Shoppers Drug Mart (TSX:SC).

The Sobeys grocery chain owned by Empire Co. Ltd. (TSX:EMP.A) of Stellarton, N.S., has joined forces with U.S. department store operator Target, which will also offer food in its Canadian stores when they open.

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