A tougher 2H compare (L.CN)
Loblaw reported Q2 EPS of C$1.94 vs. consensus expectations of C$1.91. Food retail SSS increased by 6.1%. Management said food inflation was in line with the CPI. Drug retail SSS increased by 5.7% with front-end growth of 5.0% driven by cosmetics and health & beauty and pharmacy growth of 6.3%. OTC growth remained strong but was off peak levels. Digital sales grew 13.9%.
Retail gross margins contracted 30bps due to double-digit supplier cost increases that were not fully passed on to customers and higher shrink. In Q1, gross margins expanded 20bps YOY driven by front-end drug store margins. Management said suppliers raised prices by $1B this year, double what would be expected in a normal year. In Q2, the average price for meat and produce increased MSD% while the center of store price increases were up DD%. SG&A expenses leveraged 60bps. Adjusted EBITDA margins expanded by 40bps.
Management reaffirmed the previously issued guidance of retail earnings outpacing sales growth and EPS growth of LDD%. The company repurchased C$511M of shares during the quarter. Grocery inflation has been a larger political issue in Canada than in the U.S. which may be putting some pressure on management to not price as aggressively. Loblaw will be facing more difficult SSS comparisons in the 2H, (+6% and 7.5% more difficult in Q3 and Q4 respectively in food retail). The combination of decelerating SSS and gross margins contracting is behind our short positioning.
Growth slowing, appetite for acquisitions (RKT.LN, PRGO)
Reckitt reported 1H EPS of 173p, slightly above consensus expectations of 168.7p. Revenue and margins were narrowly above expectations. Q2 LFL sales grew 4.1% with price/mix growth of 8.4% offset by volume declines of 4.3%. Volumes were little changed sequentially with Q1 -4.5%. By segment operating profit was above expectations in the health and nutrition segments while hygiene was below.
- Hygiene LFL sales grew 5.5%. Lysol returned to growth, +HSD% in Q2.
- Health LFL sales grew 4.9%. OTC, intimate wellness, and parts of Dettol were strong. The OTC business grew ~20% in the 1H with product shortages from the flu season. Management believes retail inventory levels for cough/cold products are “in a good place” and in Q4 the business will face “high comparatives.”
- Nutrition LFL sales decreased by 0.9%. Enfamil remained the market share leader in the U.S. with non-WIC share just below 50%.
Gross margins expanded by 130bps driven by price increases, mix benefits, and productivity improvements offsetting inflationary pressures. Brand investments increased by 60bps. Adjusted operating margins contracted 180bps against unusually high margins last year that had one-time items.
Management continues to target LFL revenue growth of 3-5% growth for the year. Adjusted operating margins are now expected to expand slightly compared to flattish previously. Management’s guidance implies a more difficult 2H in which EPS growth will be challenging. Management expects leverage to be below 2x by year end. Management said surplus cash will be returned to shareholders, but they are always looking for good quality assets. RKT results bode well for Perrigo. There are several strategics including RKT that have the balance sheet and appetite for acquisitions within consumer health care. 2024 may be the year of M&A for consumer health care.
Lidl yellow light (GO)
Lidl named its fifth CEO for its U.S. division since the chain opened in the U.S. in 2015. Michal Lagunionek, who was named CEO of Lidl U.S. in 2021, will return to Europe after a short sabbatical. Lidl recently closed 11 stores on the East Coast recently. In February, Lidl U.S. laid off ~200 employees at the corporate headquarters. Lidl has about 170 stores in the U.S. and plans to open more.
Although the formats are similar, Aldi has seen much more success in the U.S. with more than 2,200 locations. Aldi also entered the U.S. market four decades before Lidl. Returning from competing in the U.S. grocery sector probably does require a sabbatical. The competitive environment is difficult enough for U.S. supermarkets without Lidl being a meaningful threat. Hard discounting, closeout, and private label are gaining shoppers who are looking for savings.
