Canada’s second-largest grocer Sobeys has swooped to buy the local business of US supermarket giant Safeway. Sobeys has paid a full price for Safeway’s Canadian arm but, writes Dean Best, the market was broadly positive and agreed with the company’s optimism. For Safeway, however, the sale does leave some questions.
The future of Safeway Inc’s Canadian operations had been the subject of speculation for some time – but much of the talk of a possible takeover highlighted Loblaw and Metro Inc as potential suitors. Sobeys hardly got a mention.
However, this week, Canada’s number two grocer announced it had struck a deal to buy Safeway’s stores in the country. Sobeys will pay a cash price of C$5.8bn for assets including 213 grocery outlets, 12 manufacturing plants and four distribution centres.
For analysts covering Safeway, it was deemed a very good price for the US grocery giant’s business north of the border. Shares in Safeway jumped in the aftermath of Wednesday’s announcement, although some on Wall Street were quick to point to the ongoing challenges the retailer faces in the US.
However, shares in Sobeys’ parent, Canadian group Empire Co., also shot up on news of the deal. Broadly, the acquisition of the Canada Safeway business was seen as a good move for Sobeys.
“We believe Empire would benefit from increased critical mass, a broad array of synergy opportunities, and the acquisition of a high-quality portfolio of retail locations in western Canada, which is the fastest growing part of the country,” Jim Durran, a Canadian retail and consumer analyst at Barclays Capital, said.
Executives at Empire and Sobeys were upbeat about the deal. “This acquisition represents a unique and highly strategic opportuinity for Sobeys to leverage its existing base and creating a new platform for growth,” Paul Sobey, Empire’s president and CEO, said on a conference call to discuss the results.
The acquisition will bolster Sobeys’ position as Canada’s number two grocer and draw it closer to market leader Loblaw. Durran estimates Sobeys’ market share will reach 24%, compared to Loblaw’s 31%. However, it is Safeway’s presence in western Canada that appealed to Sobeys; the deal will make the retailer the largest grocer in the western provinces of British Columbia and, it said, the “fast-growing” Alberta. Barclays Capital believes Sobeys may have to offload some stores in Alberta to assuage competition concerns (Empire and Sobeys’ management declined to comment on what they expected to the anti-trust reaction to be) but, even with those disposals, the retailer will be far ahead of its nearest competitor in the province, Loblaw.
Alberta has been one of the Canadian provinces in which other US retailers have entered in recent years. Canada’s grocery market has been a target for Wal-Mart Stores, Target Corp. and Costco, with all three retailers opening stores north of the border. In Alberta itself, Wal-Mart has 40 of its supercentres, while Costco has 14 of its wholesale outlets. Both networks would not come close to the combined Sobeys/Safeway estate in the province (on a pro-forma basis, before any required disposals, Sobeys would have 234 stores) but there is no doubt the entry of retailers like Wal-Mart has racheted up the competitive pressure across Canada – and prompted this piece of consolidation in the market.
Mr Sobey noted the deal would “significantly enhance” Sobeys’ scale, which in turn gives the retailer a chance to save costs to help bolster margins, particularly in a competitive market where organic growth is hard to come by. Sobeys has already earmarked C$200m of synergies it believes it can generate once the takeover of the Safeway stores closes – in areas such as distribution, IT and procurement. Of course, a retail customer of greater scale and buying power could cause furrowed brows among some suppliers, although, if you are an existing supplier to Sobeys, the prospect of the retailer having more stores could provide an opportunity.
Sobeys president and CEO Marc Poulin told analysts the retailer expects to “leverage significant purchasing power in food”. He said Sobeys would “integrate” the private-label portfolios of both retailers, which would lead to “efficiencies” in procurement, packaging and formulation.
Half of the C$200m of synergies are expected to be generated in the first year after the deal and it is these cost-savings, alongside a sale-and-leaseback programme of Safeway’s Canadian real estate assets, C$1bn in “non-core” asset sales (Empire and Sobeys would not identify which assets could be offloaded) and an equity issue that will fund the deal. While one US analyst noted the “whopping” 11.3x adjusted EBITDA multiple set out in Sobeys’ offer, the Canadian retailer’s management sought to point out the “effective” multiple would be 7.4x after items like the sale-and-leasebacks and cost synergies. The takeover of Safeway’s Canadian arm would, Empire and Sobeys said, be “immediately accretive”.
Further south, Safeway’s management were quick to point to the value Sobeys’ had placed on its Canadian business. “This was an extremely attractive offer and that it offered a substantial premium to the market multiples for US retailers,” Safeway CEO and president Robert Edwards said. He admitted Safeway had not run an auction process for the assets. “This was an unsolicited offer,” he said. However, he added: “We believe that this transaction maximised the value of our Canadian assets.”
However, while Wall Street acknowledged Sobeys had paid a full price for Safeway’s Canadian business, some argued the stores north of the border were the retailer’s crown jewels. Barclays Capital analyst Meredith Adler said the Canadian business was Safeway’s “best retail asset”, a view echoed by Janney Montgomery Scott’s Jonathan Feeney. That said, Feeney said the “whopping” adjusted EBITDA multiple for Safeway’s Canadian business – which he noted was twice the value put on the whole company – explained why Safeway plumped for a sale to Sobeys and not pursue other alternatives. “While this transaction removes Safeway’s best assets, given the opportunity to now buy back as much as 30% of the equity at its much lower valuation makes this a smart sale,” he said.
Nevertheless, there is concern about Safeway’s US business. Analysts estimated Safeway’s Canadian arm accounted for between 40-50% of its profits. Ajay Jain, an analyst at Cantor Fitzgerald in New York, said Safeway was “burning off the furniture to save what’s left of the house”, noting the disposal of the Canadian business followed the recent IPO of Safeway’s gift card business Blackhawk (although the retailer still holds a majority stake in the unit).
“We have felt for some time that any steps by Safeway to monetize Blackhawk and the Canadian businesses would serve to expose the US operations in a much more negative light. We think that reality has taken shape now that Safeway has spun off its main growth vehicle – Blackhawk – and sold its largest and most stable earnings stream – Canada,” Jain said.
Safeway said it plans to pay down debt and buy back shares with the bulk of the proceeds from the Sobeys transaction. “Some of the proceeds may be used to invest in growth opportunities,” it said. However, could the money be better served tyring to withstand the competitive pressures in the US grocery sector?
“The US competitive landscape remains dynamic, as traditional competitors – e.g. Albertsons, Supervalu Inc – talk price cutting and the mass and club channels continue to expand their perishable footprint — not to mention Safeway is among the most vulnerable if Amazon’s grocery rollout has traction, given its exposure to high density urban centers,” Feeney said.
With the sale to Sobeys, the speculation over Safeway’s Canadian business is done and dusted. Now the spotlight will shift to how it revitalises its US operations.