Metro’s Path to Success in a Competitive Market

By Chirag Gandhi

Metro Inc under shareholder pressure as the market consolidates

In an era of consolidation in the grocery and drugstore industries, two Canadian giants are looking to team up. Metro Inc is poised to finalize the acquisition of Jean-Coutu (PJC) for $24.50 per share in a 75% cash deal worth of $4.5B. This latest news is not surprising amidst the successful acquisition of Shopper’s Drug Mart (Pharmaprix in Quebec) by Loblaw Co (L) for $12.4B in July 2013. The Canadian grocery chain market is in a consolidation phase and currently dominated by the “Big Three.” Early this year, Queen’s University reported the market share of the Big Three as follows:  Loblaw had a market cap of $28.01B, followed by Metro Inc (MRU) at $9.50B and Empire Company (EMP), owner of the Sobeys and Safeway chains, at $4.53B. Ever since Loblaw’s acquisition of Shopper’s Drug Mart, shareholders of Metro have put pressure on management to expand in order to compete with Loblaw, even with falling margins on food and merchandise. In 2013, Metro Inc came close to acquiring Safeway in Western Canada but fell short to Empire Company which dissatisfied their shareholders.

Metro’s Acquisition would change the landscape in eastern Canada

Jean-Coutu is a highly respected and recognized brand name in the Quebec market. Thus, its acquisition would successfully assert Metro’s dominance in Quebec by adding to their pre-existing labels like the Selections brand and SuperC stores. Jean-Coutu recently complained that the Quebec government has been ignoring their ideas regarding drug price reforms, which were suggested in light of major uncertainties in the industry. This is indicative of the immense struggles faced by grocers and drugstores in finding the help they need to take on bigger competitors and countering changes by the provinces (recently Quebec) regarding the new generic drug regulations. This acquisition is advantageous in the sense that it will allow both types of stores to take advantage of economies of scale and increase the margin on consumer products and drugs. Peter Chapman, a former Loblaw executive, believes that the acquisition will “add higher-margin products of cosmetics and drugs to Metro's core low-margin groceries.” Overall, Metro’s management believes that future growth can be achieved by following in Loblaw’s footsteps to acquire a major drugstore in an attempt to diversify products and increase margins.

A Friendly Deal For All Parties Involved?

It is no surprise that Metro Inc has been highly interested in acquiring a major drugstore to compete against Loblaw and Empire. However, their patience and perseverance have paid off as the Coutu group (majority shareholder) is willing to sign on to this deal.  On the other side, Brian Madden, portfolio manager with Goodreid Investment Counsel, believes the deal is “expensive in comparison with Loblaw's takeover of Shoppers.” Yet, the acquisition will lead to $100M in cost savings per year by eliminating redundancy in distribution, procurement and staff.  Quebec Finance Minister Carlos Leitao highlights the friendliness of the acquisition to reporters by stating that "it's good for Quebec consumers to have a strong Quebec group," seeing as both companies will remain open in Quebec, resulting in lower prices and more accessibility for consumers.

The Bottom Line

Metro has rewarded its shareholders with a dividend (currently 65 cents per share annually) that has grown at varying paces since 1999. In previous reports, management has said that it will retain excess capital until a major investment opportunity arises, and will show no hesitation in implementing share buybacks. The Jean-Coutu acquisition process has been well-received amongst shareholders, which has helped Metro’s stock to increase by 10%, from $40.09, to a peak of $44.03 in a matter of hours after the announcement. Although this acquisition is rumoured to add approximately $2.8B in debt on Metro’s balance sheet, investors believe that it will add higher-margin products to Metro's core low-margin consumables and yield cost savings from economies of scale. This acquisition brings Metro one step closer to becoming the top grocery chain in Canada, and affirms that consolidation will continue in the Canadian grocery chain landscape.