Thursday, March 16, 2017

Empire Ltd & Metro Inc - 22 Years of Dividend Growth

Working through the Canadian Dividend All-Star list, I noticed that two of the companies with 22-year streaks of raising dividends operate grocery stores. Therefore, it seems logical to review Empire Company Ltd ("Empire") and Metro Inc ("Metro") together.

Company Overviews

Empire has more than 1,500 grocery stores across Canada opertaing under the Sobey's, Safeway, IGA, Foodland, FreshCo. and Thrifty Food brands and 350 gas stations. The company also holds a 41.5% equity interest in Crombie REIT which is a publicly traded grocery and store anchored shopping center Real Estate Investment Trust. Empire also has an equity interest in Genstar, a residential property developer in Canada and the United States. 

Metro operates or supplies a network of over 940 grocery stores across Canada under banners including Metro, Metro Plus, Super C, Food Basics, Adonis and Premiere Moisson. The company also operates 260 drugstores under the Brunet, Metro Pharmacy and Drug Basics banners. 

Dividends

Empire's last dividend increase of 2.5% occurred in June 2016. The company's stock currently has a dividend yield of ~2.3%. The net loss of $3.00 per share for the last twelve months leads to a negative payout ratio. The 3, 5, and 10 year dividend growth rates are impressive at 6.7%, 7.4%, and 7.7% respectively. 

Metro increased their dividend by 16.1% in January 2017 leading to a dividend yield of ~1.6%. The earnings payout ratio is 27%, in-line with the company's dividend policy of paying out 20-30% of the previous year's earnings before extraordinary items. The 3, 5, and 10 year dividend growth rates are high at 18.9%, 17.6%, and 15% respectively. 
% annual average growth planned through 2021
Valuations

Given Empire's negative net earnings in the past 12-months, it makes more sense to focus on the EV/EBITA multiple for them. The company currently has an EV/EBITDA mulitple of 7.3X which is in the middle of their 5-year range of their 5.2X - 9.5X. 

Metro currently has a trailing P/E of 16.6x which is in the middle-to-upper end of the 5-year range of 10X - 19X. Looking at EV/EBITDA of 10.7X leads to a similar conclusion when comparing to the company's 8X - 12X 5-year range. 

Catalysts

In addition to the higher initial dividend yield, here are a couple additional reasons why you would consider adding Empire to your portfolio as opposed to Metro. 

1. Turnaround Potential
- With a new CEO named in January 2017, and a new Chairman of the Board named in October 2016, Empire appears to be heading in a different strategic direction. It is also encouraging to note that a large portion of their net loss over the past 15-months was due to goodwill impairment charges, as the company's past mistakes were written off under previous management. 
2. Real Estate Holdings
- Empire's 41.5% equity interest in Crombie REIT is worth approximately CAD $500M. The Crombie investment along with that in Genstar could provide Empire with additional liquidity and leverage if it was required in the future. 

Here are two reasons why you might consider sacrificing the initial higher yield associated with Empire's shares in order to instead invest in Metro.

1. Less Volatility due to Operational Effectiveness
Compared to Empire's stock price which has swung between $14.74 and $22.72 in the past year, Metro's stock price has been more consistent within a range of $38.00 - $48.19. One big reason for Metro's lower volatility is the superior operational effectiveness as is evidenced by same-store-sales rising 3.6% in FY16 vs a 0.2% same-store-sales decrease at Empire.
2. Formalized Dividend Policy
Not only does Metro's formal dividend policy clearly state their target payout ratio, it also provides comfort to potential investors that management views the payout as a priority. Empire's lack of a formal dividend policy could be a potential red flag if the company continues to experience operational and financial challenges that call into question management's commitment to their dividend.

Drawbacks

In addition to some of the drawbacks of investing in either Empire and Metro identified above, the Canadian grocery market is very competitive and saturated as outlined below.

1. Traditional & Non-Traditional Competitors
Compared to Empire's $24B and Metro's $13B in annual sales, their largest competitor, Loblaw's earned a total of $46B in revenue last year. In many communities, Empire and Metro have to respond to any price cut that Loblaws implements in order to remain competitive. Beyond Loblaws, Empire and Metro must also compete for sales against Wal-mart (400+ locations in Canada), Amazon (in select cities), and other grocery chains/coops across the country.
2. Saturation of Grocery Stores
I've mentioned a couple of times on this blog that I live across the street from a Metro store which happens to have a Brunet drug store in front of it. If I expand the radius around my house to 5 kilometers on Google maps, there is a Super C (Metro's discount chain), A&P (Empire's full-price brand), Maxi (Loblaw's discount chain), Provigo (Loblaw's full-price brand in Quebec), and one large family operated grocer. It's important to note that I don't live in a major city (population ~55,000) where grocery stores are often even more prevalent.

Conclusions

Despite the fierce competition and saturation of grocery stores in Canada, I can understand why an investor would choose to add a defensive position in a grocery chain to their portfolio. Between Empire and Metro, it might be worth sacrificing a little current dividend yield in order to benefit from faster dividend growth and less earnings/stock volatility. If you would rather invest in the market leader, it would be worth looking into Loblaws Companies Ltd. (TSE: L) who have a five-year dividend growth streak of their own and a current dividend yield of ~1.5%.


Would you consider adding shares of  Empire or Metro to your portfolio?

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