Loblaw Buying Canada Safeway No Pipe Dream in Spinoff
Loblaw plans to put more than C$7 billion ($7.1 billion) of property into a real estate investment trust that will be sold through an initial public offering by mid-2013. While Loblaw will still own more than 80 percent of the REIT, it may receive C$670 million from the deal, according to Toronto-Dominion Bank.
Buying Safeway Inc. (SWY)’s Canadian unit is logical as Loblaw faces more competition from Wal-Mart Stores Inc. (WMT) and Target Corp. (TGT), said Veritas Investment Research Corp. Safeway, a grocer that got 15 percent of its $44 billion of sales in 2011 from Canada, is undervalued after falling 14 percent last year, Bank of Montreal said. Safeway trades at the cheapest price relative to revenue and earnings among North American food retailers larger than $1 billion, according to data compiled by Bloomberg. Edward Jones & Co. said closely held Overwaitea Food Group, the western Canadian chain, is another option for Loblaw.
“The REIT will free up a lot of cash that the company could inject into an acquisition,” Kathleen Wong, a Toronto-based analyst at Veritas, said in a telephone interview. Loblaw “said the priority of the cash is going to grow the business, but we speculate that if Canada’s Safeway or Overwaitea are for sale, maybe Loblaw will be interested.”
Julija Hunter, a Loblaw spokeswoman, declined to comment on how the company would spend the proceeds from the REIT sale. Teena Massingill, a spokeswoman for Safeway, declined to comment on whether it would entertain an offer from Loblaw for the Canadian division. Safeway announced yesterday that Chairman and Chief Executive Officer Steve Burd will retire in May. An Overwaitea representative declined to comment on Loblaw.
Today, shares of Safeway fell 1 cent to $18.34, while Loblaw’s stock declined 0.9 percent to C$41.64.
Loblaw said Dec. 6 that it will transfer about 35 million square feet (3.3 million square meters) of property to a REIT that it will take public this year.
“The REIT will have a mandate to explore opportunities outside of Loblaw as part of its growth strategy,” Sarah Davis, Loblaw’s chief financial officer, said on a conference call with analysts last month. “We don’t plan on sitting on the money for five years or an extended period of time.”
Loblaw would raise C$670 million by selling 20 percent of the REIT, according to Michael Van Aelst, a Montreal-based analyst with Toronto-Dominion. It could use the money to buy Safeway Canada as U.S. discount retailers expand in the country, boosting competition for traditional supermarkets, according to Veritas, Raymond James Financial Inc. and Edward Jones.
Wal-Mart, the world’s biggest retailer, will double its Canada grocery sales by 2016 from the 2011 level, Veritas’s Wong estimates. Target spent C$1.83 billion in 2011 to buy store leases from Toronto-based Hudson’s Bay Co.’s Zellers unit. Wal-Mart of Bentonville, Arkansas, planned to add 4,000 workers in the country last year, while Minneapolis-based Target will hire as many as 27,000 people there in 2013.
Buying Safeway Canada, a unit of the $4.4 billion publicly traded company that’s headquartered in Pleasanton, California, would give Loblaw more than 200 stores that generated $6.7 billion of revenue in 2011, data compiled by Bloomberg show.
“Safeway is the one name that keeps popping up because that’s the one most people feel is available in the marketplace and makes the most sense,” Brian Yarbrough, a St. Louis-based analyst at Edward Jones, said in a phone interview. “From a geographic standpoint, it makes sense” for Loblaw, he said. “It’s an opportunity to gain some quick market share, which is tough to come by up in Canada right now.”
Safeway Canada has been shielded from some of the new competition because of its rewards program for customers, which awards airline miles for spending money at its stores, said Karen Short, a New York-based analyst at BMO. Loblaw said in February that it’s planning to start a new loyalty program in 2013, the Globe and Mail reported at the time.
Unlike some other grocery chains, “Safeway’s not broken,” Short said in a phone interview. “It has great assets, great locations, great brand equity, a very strong loyalty program. They have a lot of things that are valuable, and the stock has done nothing. They pretty much look cheap on any metric.”
Safeway shares closed yesterday at $18.35. At that price, Safeway had a cheaper valuation based on sales, earnings and free cash flow than every other food retailer in North America larger than $1 billion, data compiled by Bloomberg show. Its price-sales ratio of 0.1 compares with the industry median of 0.4, the data show.
In April, options traders bet that Safeway was a takeover candidate as calls priced 10 percent above its stock price rose to the highest level on record versus comparable put contracts.
While a takeover makes sense, it may be difficult to convince Safeway to sell its stores, and doing so could require too high of a price, according to Raymond James’s Kenric Tyghe.
“There’s no question around the merits strategically or otherwise of a Safeway acquisition,” the Toronto-based analyst said in a phone interview. “The question is, because the merits are attractive as they are, would the incumbents overpay? The chance of prying it out of their hands is very, very remote.”
Loblaw could instead use the IPO proceeds to pay off debt maturing in the next few years. It has a C$200 million note coming due in November and C$450 million of bonds that mature next year, data compiled by Bloomberg show.
Maintaining its investment-grade credit rating is another factor Loblaw should consider if pursuing an acquisition, said Marc Goldfried, a Toronto-based money manager at Aegon Capital Management Inc., which oversees C$8.5 billion including Loblaw shares.
“Otherwise, they’re going to take themselves out of the debt financing market,” he said in a phone interview. Loblaw’s debt is rated BBB by Standard & Poor’s, two rungs above junk. Loblaw said Dec. 6 that the REIT spinoff isn’t expected to affect its credit rating.
Still, Loblaw’s best defense against Wal-Mart and Target is to gain scale, which an acquisition would give, said Raymond James’s Tyghe.
“In a market that is so competitive, every little basis point of market share is worth its weight in gold,” he said.
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