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The retailing landscape for the country's grocers is set for a drastic makeover, as the entry of major U.S. retailers into the Canadian grocery market heightens competition and threatens profit margins.
"The Canadian grocery industry has been living through a half-decade paradise that is likely to end soon," Perry Caiccoa at CIBC World Markets said in a note to clients. "The rare combination of negligible square footage growth and a rising Canadian dollar has had the effect of keeping competitive pressure to a minimum while padding gross profits."
"With square footage growth about to begin climbing again in Canada and with the year-over-year Canadian dollar gains disappearing, the entire industry is about to head into a very difficult time period."
But Caicco says one company will stand out among its peers: Metro (MRU.A-T). He believes Metro's strong position in key markets, notably Quebec, and solid management team will help it weather the coming storm.
"The biggest key to Metro's success is the location of its asset base: 60 percent of its stores are in the lucrative Quebec market, where Wal-Mart's food foray is minor and Target won't be arriving until 2014. Another 15 percent are in the protected Greater Toronto Area," he said. "These markets are lucrative because new competitors are unwilling, unable or hesitant to place assets there, severely limiting competitive square footage growth."
"Quebec is the highest-priced market in Canada and, as a result, the most lucrative. Returns on investment are superior to any other province."
And while Metro has little growth in its core operations, its taste for acquisitions will help pad its earnings.
"Shareholders can reasonably trust that every couple of years, Metro will step up and acquire some business or group of stores in order to keep its EBITDA and earnings growth rate at some reasonable pace," he said.
Unlike Metro, Loblaws (L-T) has struggled for years to update its technology and increase profit margins. Caicco believes the competitive pressures of Wal-Mart and Target will be felt more fully by Loblaw's, rather than Metro.
"Certainly, under a new President, the issues at Loblaw should gradually abate, but it is to Metro's great benefit that its largest competitor is in such bad condition," he said.
"Longer term -- 2013 to 2014 -- numerous Canadian grocers could have issues as an explosion of square footage hits the market and strategic responses are crafted. But in the meantime, we see very little downside in Metro," Caiccoa concludes.
Caiccoa has a $53 price target and a 'market weight' rating on Metro.