Price increases of more than five per cent, indigestible: Loblaw CEO

Shoppers seem able to stomach a slight increase in food prices for now, but a larger jump–say five per cent –would cause “severe indigestion,” and could hit Loblaw's bottom line, says the food store giant's CEO.

Allan Leighton told analysts that the company's internal inflation gauge increased slightly in the first-quarter of 2011, compared to falling prices during the same quarter of 2010.

“(It was) a quarter in a wonky market, with little sales volume, plenty of aggressive commercial activity and some modest and pesky inflation,” Leighton said on a conference call with analysts to discuss Loblaw's  first-quarter results.

“Where goes inflation is the million-dollar question. Three per cent on food is digestible, five per cent or more would cause severe indigestion.”

Rising world prices of everything from meat and flour to sugar and gasoline have put upward pressure on food processors, grocers and most companies operating in the food business. But consumers are resisting price increases on store shelves so grocers are finding it hard to recoup their higher costs.

Loblaw, along with its rival big Canadian grocers, Metro and Sobeys parent Empire Co. Ltd., had complained about the impact of depressed food prices on its sales. But that changed this quarter, as Loblaw finally saw commodity price inflation work its way through the supply chain to its grocery baskets.

While Loblaw's inflation calculation was lower than the average 2.5 per cent inflation rate reported by Statistics Canada, it was the first time in several quarters that Canada's biggest grocer reported a jump–and that appears to have had a impact on Canadians shopping habits during the quarter.

The company's first-quarter profits rose nearly 23 per cent to $162 million from $132 million a year earlier, even though its sales fell. Revenues were down slightly to $6.87 billion from $6.91 billion, due to lower retail sales and revenue in its President's Choice financial services division.

The Toronto-based company said Wednesday its earnings were equal to 58 cents per share, higher than the 48 cents per share reported last year and above average expectations of 53 cents per share, according to analysts surveyed by Thomson Reuters.

Shares in Loblaw added 3.4 per cent or $1.36 to $41.41 Wednesday afternoon on the Toronto Stock Exchange.

Leighton expressed caution about the company's outlook as many uncertainties lie ahead.

Loblaw's profit margins will be squeezed as it tries to keep prices low to attract consumers in an increasingly competitive environment, while it watches purchasing prices rise as raw material costs rise on everything from coffee to beef to wheat. In addition, the company is spending $1 billion this year as it wraps up one of its biggest-ever store and technology upgrades.

“The balancing act between sales for vanity and profit for sanity is becoming more acute,” he said, adding that shoppers are also feeling a strain.

“Looking forward, trading conditions continue to be tough–consumer confidence is staid, disposable income is being spent on reducing household debt and fuel costs are biting heavily,” he said.

National grocery chains have increased promotions over the past year to attract cash-strapped consumers and as they face fierce competition, particularly in Ontario, from each other and retailers like Zellers and Shoppers Drug Mart who are increasing their food offerings.

U.S. retail king Wal-Mart also plans a major expansion of 40 new grocery stores in Canada this year, its rival Target plans to enter the Canadian market in 2012.

Leighton said he expects promotional activity to become even more aggressive as a way to shore up sales in this difficult environment.

“The market is much softer and people looking for ways for which they can get incremental sales,” he said.

However, he added, he is also seeing “more balancing going on than in the past because there needs to be” as inflation takes its toll.

Sales in Loblaw retail segment, which is comprised largely of food, but also includes its pharmacy, gas bar, general merchandise and Joe Fresh clothing line, fell by 0.5 per cent to $6.8 billion in the quarter. Same store sales were down 0.1 per cent.

While the results showed it was “business as usual” at Loblaw, Leighton noted that the company made changes of “real significance” as it advanced its reorganization to update its supply chain and merchandise management.

The company spent $43 million on its “store renewal process” during the quarter. About 60 per cent of the company's distribution centres are now operating on a new information technology network that updates how it tracks inventory through its supply chain, he said.