Loblaw Companies: Beneficiaries of Inflation and Rising Rates

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Ioblaw Companies (EAST: L) is a food and pharmaceutical company that also offers financial services. We are neutral on the title.

Measuring Loblaw’s effectiveness

Loblaw Companies must keep a lot of inventory to keep the business running smoothly. Therefore, the speed at which a company can move its inventory and convert it into cash is critical in predicting its success.

To measure its effectiveness, we will use the cash conversion cycle, which indicates the number of days it takes to convert inventory into cash. It is calculated as follows:

CCC = Current Inventory Days + Current Sale Days – Current Payment Days

The Loblaw Companies’ cash conversion cycle is 27 days, which means it takes the company 27 days to convert inventory to cash. In recent years, this number has remained relatively stable, indicating that the company’s efficiency has not been affected by competitors.

In addition to the cash conversion cycle, let’s also look at gross margin trends for the Loblaw Companies. Ideally, we would like to see a company’s margins increase every year. This, of course, unless gross margins are already very high, in which case it is acceptable that they remain stable.

In the case of the Loblaw Companies, we can see that gross margins have increased over the past few years. This is ideal because it allows the company to increase its free cash flow or reinvest a larger percentage of its income in growth initiatives.

Growth catalysts

Loblaw is in a very interesting position right now. Since the company operates many grocery store chains as well as pharmacies, it is well protected against rising inflation. People could reduce their spending on non-essential items, but they will still need to buy food and water.

However, the interesting part is that the company also offers financial services under the President’s Choice Financial brand. If inflation persists, the central bank will have to raise rates to bring it under control. Fortunately, this will likely translate into higher interest income for Loblaw.

As a result, the company will benefit from rising inflation while its financial segment awaits higher interest rates.

Dividend

The Loblaw Companies currently have a dividend yield of 1.29%, which is below the industry average of 1.5%. When looking at its LTM free cash flow figure of $3.98 billion, its dividend payout of $479 million looks safe.

Looking at its historical dividend payouts, we can see that its yield has ranged from 1.56% to 2.7% through 2021.

At 1.29%, the yield is near the bottom of its range, implying that the stock price is trading at a premium to returns investors have seen in the past.

The Taking of Wall Street

On Wall Street, Loblaw Companies has a Moderate Buy consensus rating, based on three buys, two holds and no sells assigned over the past three months. The Loblaw Companies’ average price target of C$111.21 implies 12.6% upside potential.

Final Thoughts

Loblaw is uniquely positioned to benefit from both rising inflation and rising interest rates. We remain neutral for now because we want to see if we can get a better margin of safety than analysts’ 12.6% upside.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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