Loblaw’s Q1 2023 Results Show Why Shoppers Drug Mart Acquisition Remains a Big Winner 

From the looks of Loblaw Companies’ (CA:L) first-quarter 2023 results reported on May 3, nearly a decade after it acquired Shoppers Drug Mart, the deal continues to pay big dividends for the grocery store chain.

And while investors pushed L stock down more than 3% on Wednesday — that, as the Canada’s TSX Composite Index was off 0.3% — shareholders ought to still be very happy about the results. The year-to-date moves show Loblaw shares up 4.1% while the TSX index is 5.3% higher.

The past two years of inflationary price increases have challenged a significant portion of the Canadian population. Grocery shoppers have focused their anger on the country’s five major grocery store chains, which account for 75% of Canada’s grocery sales.

In the big picture, Loblaw reported revenue of $13.0 billion in Q1 2023, 6.0% higher than a year earlier. (All figures in Canadian dollars, unless otherwise noted.)

Strong Drugs

On the bottom line, its adjusted net earnings were $505 million, 10.0% higher than in Q1 2022. In addition, due to fewer shares outstanding, its earnings per share increased 14.0% in the quarter to $1.55.

The company has two segments: Food Retail (Loblaws, Provigo, Real Canadian Superstore, etc.) and Drug Retail (Shoppers Drug Mart, Pharmaprix).

In the first quarter, the food retail segment had same-store sales growth of 3.1% over last year, with total sales of $9.01 billion. Meanwhile, its drug retail segment’s same-store sales were $3.72 billion, 7.4% higher than in Q1 2022.

Although the food retail segment did just fine in the quarter — the timing of New Year’s Day reduced same-store sales by 1.1% — the drug retail segment shined in the quarter.

“Drug Retail sales were led by continued strength in higher margin beauty and cough and cold products. Drug Retail sales growth rates were further magnified by lapping Omicron related lockdowns last year,” stated its Q1 2023 press release.

“ … Total Retail gross margin increased due to higher sales growth in more profitable front-store sales in drug stores, offsetting a slight decline in Food Retail gross margin as costs continued to increase faster than prices.”

Transformational Acquisition

Loblaw first announced the $12.4 billion cash-and-stock acquisition of Shoppers Drug Mart in July 2013, closing the transaction eight months later in March 2014. It acquired Shoppers for several reasons, the biggest being it gave the company a leading share of the Canadian food and drug retail industry.

To be sure, few were surprised by the deal. “We think the deal was a long time coming … Shoppers Drug Mart was a sitting duck,” Barry Schwartz, a portfolio manager at Baskin Financial Services, told Reuters at the time.

Meanwhile, Loblaw execs spoke rhapsodically about the deal and what they expected from it.

“This transformational partnership changes the retail landscape in Canada. With scale and capability, we will be able to accelerate our momentum and strengthen our position in the increasingly competitive marketplace,” said Galen G. Weston, executive chairman of Loblaw, at the time.

“This combination creates a compelling new blueprint for the future, positioning us to capitalize on important trends in society, from the emphasis on health, wellness and nutrition, to the imperatives of value and convenience.”

When Loblaw acquired Shoppers Drug Mart, the drugstore chain had annual revenue of $10.78 billion, 39% gross margins, and $881 million (8.2% margin) in operating income. In 2022, Shoppers had $16.09 billion in revenue. So while the company doesn’t break out the drug retail segment’s gross margin or operating income, it’s fair to say Shoppers has maintained its gross and operating margins over the past nine years, if not increasing them.

Based on an 8.2% operating margin, its operating income in 2022 was approximately $1.42 billion, or 44% of the retail segment’s overall operating income.

So, drug retail generated 29% of the retail segment’s $55.49 billion in revenue in 2022 but 44% of its operating income, while food retail generated 56% of the operating income from 71% of the revenue.

Put another way, for every $11.33 in revenue generated, its drug retail business had $1 in operating profits, compared to $21.41 in food retail revenue, or 89% higher.

Key Component

In May 2022, Shoppers acquired Lifemark Health Group, a Canadian provider of health and wellness services such as physiotherapy, massage therapy, chiropractic, mental health, and other rehabilitation services.

The company paid $845 million for Lifemark. In Q1 2023, Lifemark’s revenues were $118 million, or about 5% of Shoppers’ overall revenue. So while it might not be a big part of Shoppers today, it is expected to be a key component in the drug retail segment’s growth in the next decade.

Investors might think of food when they hear the name Loblaw, but it is drug retail that delivers the company’s real profitability and growth. The Q1 2023 numbers say so.

This article originally appeared on Fintel

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