How Sobeys' purchase of Safeway will impact distribution infrastructure

Is there a business case for facility consolidation?

In June, Sobeys' parent company, Empire Company Limited, reached a deal to buy 213 Safeway grocery stores in Western Canada for $5.8 billion.

As part of this deal, Sobeys will obtain four primary distribution centres, a related wholesale business and 12 manufacturing facilities.

Sobeys already has some distribution infrastructure in Western Canada so let's understand this situation further.

It goes without saying that anytime there is an acquisition of this magnitude where there is an overlap of facilities within the same market areas, it is realistic to expect distribution infrastructure consolidation to take place to obtain efficiencies.

In general, grocery distribution efficiency increases as throughput volume increases as long as the capacity of a building is not exceeded. When throughput and/or storage capacity is exceeded, then there can be a sharp decline in warehouse productivity which ends up yielding a higher cost per case for distribution services due to additional overtime and manpower requirements.

What's the distribution infrastructure in Western Canada for both firms? Are there synergies for consolidation?

The most recent information shows that Safeway Canada operates from four main distribution centres totalling 2.08 million square feet in Canada.

In Winnipeg, Safeway operates from two distribution centres.

There's a 427,000-square-foot facility in the west end of Winnipeg on King Edward Street that ships dry grocery, tobacco, supplies, perishables and produce to corporate and independent stores in Manitoba, Saskatchewan, Ontario.

This is an older building that Safeway set up in 1962. The facility is on a site that has limited expansion capability.

There is also a 35,000-square-foot freezer facility on Empress Street in the West end of Winnipeg.  This facility distributes frozen food and frozen meat.

In Calgary, Safeway operates distribution from four locations totaling 791,000 square feet.

The dry grocery/fresh bakery are distributed from a 352,000 square foot facility campus on 42nd St. S.E. southwest of city centre.

Paper/cereal/supplies/bulk foods meanwhile are distributed from an adjacent 72,000 square foot facility on Manitou Rd., while frozen food/frozen meat/perishables/fresh meat/produce are distributed from a recently expanded 256,000 square foot facility run by Lucerne Foods (a Division of Canada Safeway Ltd.) on 56th Ave. S.E.

GM/HBC/tobacco/repack are distributed from an estimated 111,000 square foot facility on 48th St. S.E. in the southeast part of the city.

In Edmonton, Safeway operates distribution from two locations. There's a 442,000-square-foot facility in Edmonton on Yellowhead Trail at the junction of the St. Albert Trail on the northwest side of town.  This facility distributes grocery, perishables, and produce to corporate and independent customers in B.C., Saskatchewan and Alberta and has limited expansion capability.

Frozen food is distributed care of Trenton Cold Storage from a 210,000 square foot facility on 66th St. N.W.

In Vancouver, Safeway operates from three distribution locations, all of which are operated by third-party logistics companies.

Grocery is distributed to about 70 stores care of Cold Logic ULC which operates a 200,000-square-foot facility on 200 St., Langley, B.C.

Produce and perishables are distributed care of Cold Logic ULC from a 132,000 square foot facility on 188 St., Surrey, B.C., while frozen food and frozen meat are distributed care of Versacold from a 80,000-square-foot facility on Derwent Way, Delta, B.C.

The most recent information that we have is that Sobeys operates from five distribution centres across Western Canada totaling 1.29 million square feet in Canada.

There's a 321,000-square-foot Sobeys West IGA full-line distribution centre on Inkster Blvd in Winnipeg on the northwest side of the city just a few kilometers away from the Safeway building.

This is a 30-year-old building that was recently expanded from 200,000 sq. ft. in order to supply Target stores with food merchandise.  Further facility expansion does not appear to be an option.

The 208,000-square-foot Calgary grocery/perishables distribution centre on 30th Street S.E. was last renovated in 2012.

There's also a 512,000-square-foot Edmonton grocery/perishables/produce distribution centre on 156 St. N.W.

And the 152,000-square-foot Thrifty Foods refrigerated distribution centre in Victoria, B.C., near the airport near Mills Road that was opened in 2011.  This facility services corporate and independent stores on Vancouver Island and the lower mainland.

Lastly, a 93,100-square-foot Thrifty Foods dry distribution centre/office complex in Central Saanich, B.C., on the north side of Victoria, BC.

The Overlap in Distribution Infrastructure

The most obvious overlap in distribution infrastructure exists in the cities of Winnipeg, Calgary and Edmonton.

My predictions: In Winnipeg, the two main distribution centers are older full-line facilities.  The consolidation of these two buildings will not yield significant transportation savings thus the business case for consolidation will be predicated on savings made available by reducing fixed overhead expense and through warehouse labour efficiency improvements.

There is insufficient volume to justify an automated distribution centre similar to the Sobeys Vaughan facility.

Any type of consolidation here would most likely require a new site and building since both of the existing sites appear to be land-locked.

The Safeway freezer is a smaller facility and there may be an opportunity to consolidate this facility. The investment cost is high relative to the returns so consolidation is not a slam dunk decision for this market – don't bet on it.

In Calgary, the situation is different from Winnipeg since this is a high growth market.

Here it likely makes economic sense to consolidate perishables distribution into the newly expanded Safeway distribution centre since the Sobeys facility is smaller and more limited. Similarly, the Sobeys dry grocery distribution operation is a good candidate for consolidation into the Safeway infrastructure.

In Edmonton, the total warehouse space being operated between the two firms is over 950,000 square feet, which is significant.

The Sobeys distribution centre is positioned on a larger plot of land which appears to have room for expansion. If consolidation is economically justified then we would expect the Sobeys location to be the more logical choice.  It may also be feasible to take the outsourced frozen food distribution operation in-house as another opportunity.

Now keep in mind that distribution infrastructure consolidation and expansion decisions require extensive analysis since they are not taken lightly.  Often times, the one-time expenses and business disruption associated with a consolidation opportunity can be very costly and these factors alone can be show stoppers.

Without the ability to capture real outbound transportation savings, the business case for facility consolidation is always more challenging.  Since this is the case in the three locations we discuss, it will be interesting to see if we have read the tea leaves correctly.

Lastly, it will also be interesting to see if Sobeys decided to invest into another automated distribution center given the higher throughput volumes made available through this acquisition.

Sobeys is a smart company that is willing to take risks. It would not surprise me to hear that Calgary or Edmonton will be the next site for an automated Sobeys full-case dry grocery distribution centre.

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