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Don’t Forget the Cranberry Sauce: Pharmacy Deal Adds Gravy to a Grocery Chain

Posted Oct 6, 2017, 01:38 PM | By Edward Golding

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If you’ll be shopping to make Thanksgiving dinner this weekend, your favourite grocery store might be the scene of an epic food fight.

Canada’s Big Three food retailers have been waging an ongoing battle to win customers and market share, as they face aggressive, large and transformative competitors like Walmart and Amazon—which recently picked up Whole Foods, as I’ve previously written about.

Now one of the Big Three, Montreal-based Metro Inc., is shoring up its pantry with an announcement this week to acquire Quebec pharmacy giant Jean Coutu Group, the province’s dominant drugstore chain that also owns generic drug maker Pro Doc Ltée. The purchase price is an estimated $4.5 billion.

MD portfolios keep Metro in the basket

We view this move with interest, since Metro is a holding in several MD portfolios and pools. The combined business will have a network of more than 1,300 stores in Canada. Post-merger, Metro says it expects to generate approximately $16 billion in revenue, $1.3 billion in earnings1, and $500 million in free cash flow, including $75 million in expected synergies within three years.

The deal would allow Metro and Jean Coutu to increase product offerings and outlets and strengthen its position against its bigger traditional rivals: Loblaw Companies Ltd. and Empire Company Ltd. (Sobeys).

While Metro paid a steep price for the Jean Coutu assets, we believe this is a necessary and positive move to navigate some of the risks faced by all brick-and-mortar retailers—both grocery and pharmacy—from growing global and online competition. It follows similar tie-ups, including the acquisition of Shoppers Drug Mart by Toronto-based Loblaw Companies in 2013 and San Francisco-based McKesson Corp.’s $3 billion takeover of Rexall Health last year.

As of October 4, Metro was an overweight position relative to the benchmark in MD Equity Fund, MDPIM Canadian Equity Pool and MDPIM Dividend Pool as the company generates some of the highest net margins and returns on equity in the industry.

Talking turkey on groceries and other consumer staples

It can take years to know for sure whether a particular merger or acquisition is the right decision for a company, as the consequences play out over time. But, at this stage, this consolidation looks like a good move to give this Quebec-based grocery icon a bigger foothold in food, pharmacy and healthcare staples.

Meanwhile, I expect all grocers will stand to benefit this weekend from the Thanksgiving bump in sales in what is one of the busiest shopping weeks of the year, as many of us are fortunate to celebrate time with family and friends.

Apparently, more than 30% of Canadian households (4.2 million) can be expected to purchase turkey or turkey products for this holiday weekend feast2. Cranberry sauce? Got it!

1 Earnings before interest, tax, depreciation and amortization

2 Turkey Farmer’s of Canada, Annual and seasonal consumption statistics 2016.

Edward Golding

Edward Golding, CFA, MBA, is a Portfolio Manager with the Investment Management team at MD Financial Management. He oversees the Canadian, Dividend and U.S. equity mutual funds and investment pools at the firm.