Buy Loblaw for rising profits and dividends

Key stock Loblaw Companies earned more last year. It’s expected to earn significantly more this year and next. This gives the company the means to reinvest in its businesses and reward its shareholders. It remains a buy for gains and modest, but rising, dividends.

Greater Toronto Area-based Loblaw Companies (TSX─L) earned more in 2015 and is expected to earn more this year and next. We expect it to continue to raise its dividend and buy back its shares. The company remains a buy for further long-term share price gains as well as modest, but growing, dividends.

In the 52 weeks to January 2, Loblaw earned adjusted earnings of $1.422 billion, or $3.46 a share. This was up by 13.1 per cent from adjusted earnings of $1.165 billion, or $3.06 a share, the year before. This excludes the extra week in that year.

Executive chairman and president Galen Weston said “we delivered positive same-store sales and stable [profit] margins, achieved growth in operating earnings, and our strong balance sheet allowed us to return capital to our shareholders.”

In 2015, Loblaw’s retail sales rose by 8.6 per cent, to $44.469 billion. Its food same-store sales rose by 1.9 per cent. Meanwhile, drug retail same-store sales climbed by 4.3 per cent. Growing same-store sales are a positive indicator for retailers.

Same-store sales rose in both chains

In 2015, Loblaw’s financial services earnings before income taxes slipped by 4.5 per cent, to $106 million. This segment’s revenue increased. But its costs increased even more. These costs included providing free groceries under a loyalty program.

In 2015, Loblaw’s Choice Properties real estate investment trust did better. Both its revenue and earnings went up. The acquisition of properties from the company should further raise revenue and earnings.

Loblaw plans to make $1.3 billion of capital investments this year. Of this, $1 billion will go to its retail operations. That’s by far the company’s core business. It can afford to reinvest in its businesses.

On January 2, Loblaw held cash and short-term securities of $1.082 billion. Subtract this from total debt of $11.704 billion and its net debt was $10.622 billion. This was 3.5 times last year’s cash flow of $3.004 billion (excluding changes in non-cash working capital and credit card receivables). Loblaw’s predictable business makes this ratio acceptable. Also, the cash flow exceeded last year’s net capital investment of $1.205 billion and dividend payments of $416 million. Loblaw used its excess cash flow to repay debt and buy back shares.

In 2016, Loblaw is expected to earn $3.93 a share. This would represent earnings per share growth of 13.6 per cent. Based on this earnings estimate, the shares trade at a forward price-to-earnings, or P/E, ratio of 17.5 times. This seems acceptable given the company’s ongoing earnings and dividend growth.

Loblaw’s P/E ratio is acceptable

In 2017 Loblaw’s earnings are expected to grow by 10.2 per cent, to $4.33 a share. Based on this estimate, the shares trade at a better forward P/E ratio of 15.9 times.

This year, Loblaw plans to maintain “a stable trading environment that targets positive same-store sales and stable gross margin; surfacing efficiencies; delivering synergies as a result of its acquisition of Shoppers Drug Mart; and returning capital to shareholders.” We also expect the company to continue to raise its dividends.

Raising the dividend

Loblaw has raised its dividend. It pays a dollar a share, for a modest yield of about 1.5 per cent.

2016 is the fourth year in a row that Loblaw has increased its dividend. Before that it paid 84 cents a share for a number of difficult years.

Loblaw has excess cash flow. That’s why we expect it to continue to raise its dividend. If it does so in 2017, we expect it to become a full-fledged ‘dividend aristocrat’.

 

The Investment Reporter, MPL Communications Inc.
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