The big three Canadian grocers — Loblaw Companies Ltd. (TSX:L), Empire's Sobeys (TSX:EMP.A) and Metro Inc. (TSX:MRU) — are seeing an improving trend in their earnings margins while four European peers are watching them shrink and margins are flat at two comparable U.S. companies.
The Canadian grocers also operate with lower leverage, or borrowed money, than their international peers, Moody's said.
"While we do not rate any of the Canadian supermarkets, we are nevertheless asked for our views on the sector, especially given Loblaw’s July 15 announcement that it would acquire Shoppers Drug Mart Corp., Canada’s No. 1 pharmacy retailer, for $12.4 billion and Sobeys’ pending acquisition of Canada Safeway for $5.8 billion," Moody's said.
"Our main finding is that although the Canadians are smaller and less diverse, they have good margins and superior credit metrics."
It says Loblaw's leverage will rise following the Shoppers deal, which will be paid in cash and stock, but should come down within two years.
Comparable European supermarkets — which include Tesco PLC, Carrefour S.A., Koninklijke Ahold N.V. and Delhaize Group — are much larger and more geographically diverse than Canadian and U.S. grocery chains.
Moody's says scale is positive for credit quality because it gives the stores bargaining power when dealing with suppliers, and increases their ability to leverage costs.
But the exposure of European supermarkets to non-food products, such as clothing and consumer electronics, has left them vulnerable to economic conditions, which have been poor lately.
This has left European grocers lagging behind their American and Canadian counterparts in terms of same-store sales growth.
Economic improvement in North America has boosted same-store sales growth, especially at Kroger, which has maintained growth at three per cent — compared with 1.5 per cent at Sobeys, 1.1 per cent at Metro and less than 0.5 per cent at Loblaw.
Loblaw should see some improvement in its sales growth after its acquisition of Shoppers, Moody's says.
"The transformational acquisition is complementary to Loblaw and will expand its reach in health and wellness," the report says.
Moody's says Loblaw's profit margin has also lagged those of its Canadian peers, mainly because of competition from Wal-Mart and Costco in Ontario.
It estimates Metro is the leader among the Canadian grocers in terms of profit margin, at nine per cent of earnings before certain items, compared with 7.5 per cent at Sobeys and 7.0 per cent at Loblaw.
An expansion into Quebec by Walmart and Target could squeeze Metro's profit margins but Moody's adds that:
"We think the Canadian supermarkets’ margins are somewhat protected to the downside by ongoing cost reduction measures, tight inventory management, improving store offerings and an increased focus on loyalty programs."
"We expect the impact of rising competition to be manageable for the Canadians and that their aggregate margins will be better than those of the Europeans in the medium term."