This is a guest contribution by Harvi Sadhra, CEO and Founder of Hashtag Investing. Hashtag investing is an exclusive community for stock investors to get real-time feedback and discover compelling stocks and strategies any time.
In the wake of the coronavirus outbreak, investors started panic selling, wiping out trillions of dollars from the stock market. Canada’s stock market reported its worst crash since the 2008 financial crisis. Between February 20 and March 20, the S&P/TSX Composite Index fell a whopping 34%. This has left a lot of Canadian investors wanting to learn how to buy stocks, and what stocks to buy.
Consumer Staple stocks were the least affected, falling 16% during this sell-off, noted Bloomberg Quint.
Among the 230 companies in the TSX Composite Index, only grocery chain Metro’s (MRU) stock reported a gain of 3.6% during this period. Among other outperformers were Loblaw Companies (L) and Empire (EMP-A-T) which fell 4.5% and 8.6%, respectively. These are the top three Canadian food retailers.
Food and grocery are defensive stocks that are immune to economic downturn and this holds true even in the coronavirus pandemic. In this article, we will look at the top two grocery retail stocks that can protect you from the market crash and even pay dividends.
Grocery stocks immune to coronavirus and downturn
Amidst the spread of COVID-19, governments worldwide are taking emergency measures like locking down cities and closing non-essential services. Canada announced a lockdown last week, reported The Globe and Mail. Essential services like hospitals, power and utility companies, grocery and pharmacy stores are to remain open even during a lockdown.
Unlike other retailers, grocery stores and pharmacies are still in full operation and they would be the last to close. Loblaw Companies and Metro are the biggest beneficiaries of this lockdown as they have exposure to both grocery and pharmacy.
Loblaw Companies (TSX:L)
Loblaw Companies is Canada’s largest food retail chain with 23.6% market share, according to Gain Report. It has over 1,000 grocery stores and 1,300 drug stores nationwide covering 90% of Canadians.
It has banners like the Market, Real Canadian Superstore, Fortinos, Valumart, Freshmart, Provigo, Shoppers Drug Mart, Joe Fresh, and President’s Choice under its umbrella.
In Q4 2019, Loblaw’s revenue rose 3.3% YoY (year-over-year) to $11.59 billion. Food retail sales rose 2.7% while the drug retail sales rose 4.2% on a YoY basis. Its retail business adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) margin rose to 10% in Q4 2019 from 7.8% a year ago. Its adjusted EPS (earnings per share) rose 5.8% to $1.09.
Metro is Canada’s third largest food retail chain with 9% market share, according to Gain Report. It has over 950 grocery stores and 650 drug stores nationwide. It has banners like Super C and Food Basics, under its umbrella. Metro’s revenue rose 1.3% YoY in fiscal Q1 2020.Its adjusted EPS rose 6% to $0.71.
Coronavirus opportunities for Canadian food retailers
As restaurants have closed in the lockdown, more people are eating at home, thereby increasing demand for groceries, and increasing popularity for TSX stocks that focus on groceries.
Desjardins analyst Chris Li estimates that shift to grocery-store food will increase big three Canadian food retailers’ sales by 1% and EPS by 2%-4% this year, reported BNN Bloomberg. The growing demand is creating opportunity but panic buying has left grocers struggling.
Coronavirus brings business challenges for grocers
Amidst the long shutdowns, people are panic buying toilet paper, hand sanitizer, soap, food, and other supplies, leaving store shelves clean. Big food and tissue companies are adjusting their manufacturing process to meet the growing demand.
Many grocery chain CEOs are reassuring the public that there will be no shortage of food and essentials and the shelves will continuously be restocked, according to another article from The Globe and Mail.
Online shopping, which formed a very small percentage of grocery sales until now, is suddenly seeing an uptick. In the past few weeks, Loblaws click-and-collect grocery pickup service PC Express saw more than 100% increase in online orders. Loblaws home delivery service Instacart reported a 150% jump in order volume across North America.
According to The Globe and Mail article, many large companies like Metro, Loblaws, Walmart Canada, and Fresh City Farms are struggling to deliver all orders.
While these retailers expand their delivery capacity, they have appealed to customers to leave the e-commerce service for the more vulnerable group (senior citizens and people with disabilities) and the ones who are experiencing symptoms.
Investors retreat to grocery stocks
As the world grapples with the coronavirus pandemic, central banks are adopting monetary easing. The Bank of Canada cut its benchmark rate by 50 basis points. Rate cuts are attracting investors towards dividend stocks. Moreover, investors nearing their retirement, who cannot afford a short-term downside, are retreating to defensive stocks like grocery stocks.
Top three Canadian grocery stocks have rebounded; stocks of Loblaws, Metro, and Sobeys parent Empire, rose 15%, 11%, and 16.5% this week ending March 27, while the TSX Composite Index rose 14%.
What is attracting investors towards Loblaw and Metro?
One major quality of defensive stocks is they grow steadily and are not as volatile as the market. Metro is steadier with a beta of 0.17 whereas Loblaw is more volatile with a beta of 0.37.
One example of their defensive nature was visible in the October 2018 – September 2019 period when Metro and Loblaw stocks rose 45% and 39%, outperforming the TSX Composite Index which rose 4.7%.
However in the subsequent decline between October 2019 and March 2020, the TSX Composite Index fell 24% whereas Metro and Loblaw fell 3% and 10%.
On the volatility front, Metro is a better stock than Loblaws. Metro also operates at almost double the profit margin than Loblaw because of which the former has higher return on equity.
At present, Metro and Loblaw have a dividend yield of 1.6% and 1.9%, respectively. This makes them a better investment option at a time of interest rate cuts.
Loblaws has a median price target of $76, representing a 12% upside. Metro is trading at its median price target of $57, indicating that analysts see upside potential in Loblaws. In these turbulent times, grocery stock will benefit investors through moderate capital appreciation and dividends.
The above two stocks are likely to outperform in the short term. However, when the markets recover, these stocks may likely underperform other high growth stocks as they are less volatile.