The development of Wal-Marts Supercentre format in Canada looks set to put pressure on the rest of the grocery industry

The development of Wal-Mart's Supercentre format in Canada looks set to put pressure on the rest of the grocery industry

Recovery in the Canadian retail sector is set to become increasingly complex during 2011, with the economy remaining on unsteady ground and while Quebec and Ontario become battle grounds as Wal-Mart Stores expands its grocery presence.

Analysts are paining a mixed picture of Canada's economic prospects in 2011. The Conference Board of Canada says economic growth is set to "remain sluggish" and that economic growth has lost "much of its vigour as households and governments have become over extended". It is forecasting GDP to grow by 2% in 2011, down from the 2.8% recorded in 2010.

Against that, TNS has recorded "glimmers of optimism" in the economy in its January results. The research group said its Monthly Consumer Confidence Index showed a "slight but significant gain of 2.3 points in January" to 98.4, with Canadians feeling "slightly better about the present economic situation", as well as their "economic prospects for the next six months".

Meanwhile, TD Newcrest analyst Michael van Aelst says there are signs that a period of falling food prices is coming to an end. In a preview note ahead of Loblaw's annual and fourth-quarter results, which are due on 24 February, van Aelst claims the last three months of the year should have marked an end to a deflationary environment that has "plagued the supermarket industry for most of 2010". He argues that food inflation is set to appear in the first quarter of 2011 as the "strong Canadian dollar offset to rising prices on imports diminishes as suppliers start to pass on higher operating and commodity costs".

The recent performance of Canada's major retailers has been mixed. In their latest results, both Metro Inc and Sobeys recorded flat same-store sales, while Loblaw saw its same-store sales fall over the third quarter.

In Metro's most recent results, president Eric LaFleche said that adjusted net earnings grew despite food deflation due to "increased competitive activity". Meanwhile, Sobeys' second-quarter profits were hit by costs relating to store closures in Quebec.

Competition is already rife in Ontario, with Van Aelst attributing the weakness in Metro Inc's most recent first-quarter results to the "intensely competitive" market in the province. He said the "quarter was highlighted by aggressive promotional activity in Ontario stoked by the roll-out of Sobeys' FreshCo banner, new space added by Wal-Mart as it converts more stores to the Supercentre format" as well as a lack of inflation.

Meanwhile, the analyst signalled the potential for intense competition in Quebec, during 2011, saying that Wal-Mart's planned entry into Canada's second-largest province is set to increase promotional activity, as the "added square footage leads to a fiercer battle for market share".

He adds that most of the activity is likely to play out in the discount channel, as he expects Loblaw to "raise its game" in Quebec to recover from "several years of under-performance".

While Wal-Mart is set to increase competitive pressure, Canada's grocery industry is still likely to have some winners in 2011.

Van Aelst upgraded his rating of Loblaw to buy earlier this week, on the back of anticipated "significant margin upside and food inflation poised to return in the first quarter of 2011". The analyst explains that, although Loblaw has the greatest share of the discount channel in Quebec, the lowest percentage of its revenues are generated in the province. The impact of Wal-Mart's Supercentres entering Quebec on Loblaw will be "manageable", van Aelst argues.

However, the future does not look as rosy for Metro Inc, as van Aelst sees fewer opportunities to expand gross margins. "As feared the opportunities for Metro to expand gross margins has moderated greatly after years of successful efficiency programmes," he says. Van Aelst adds that Metro needs food inflation to protect margins from the impacts of drug reform in Ontario and Quebec, as well as the high levels of competition in Ontario.

For the retailers looking hoping for an improvement in the economic landscape to drive up prices and bolster profit, the shaky economic outlook, combined with a competitive landscape that looks set to heat up, will not be providing anyone with the reassurance they're looking for.