At the big chains, duking it out for every last square foot

Walmart Stores Inc.’s 1994 entry into Canada had many relegating the country’s homegrown retailers to also-ran status. How, the pundits asked, could they compete against what was even then a juggernaut?

But perhaps Walmart isn’t invincible. The chain’s U.S. operations are struggling, with some pointing to rival Target Corp.’s rise as the reason. But the latter is also having trouble.

As these two American giants continue to ramp up their food offerings in Canada, some analysts say there is the risk of too much new space being devoted to groceries at a time when sales are almost flat.

Walmart Canada added nearly $700 million in food sales in the last year alone, and the additional footage in its grocery aisles is brand new while Target’s food space more than replaces that of the now-departed and unlamented Zellers banner.

“We continue to believe that grocery square footage is growing well in excess of demographic growth in Canada,” BMO Capital Markets’ analyst Peter Sklar wrote in a note Aug. 14.

CIBC analyst Perry Caicco has projected Canadian grocery market growth of $1.6 billion in 2013. But almost all of that will be absorbed by about 4.3 million square feet of retail space being added this year. As a result, as little as $100 million will be fought over by existing stores, making the grocery market, in effect, a “zero-sum game,” Caicco says.

Part of the Canadian chain response has been to get bigger.

All three incumbent chains–Loblaw, Sobeys and Metro–have staked out turf with different formats to cover the price spectrum. Smaller players, such as Overwaitea Foods and Longo’s, increasingly occupy the more sophisticated or ethnic space.

But the big three have also done a lot more. Sobeys was swallowed by its parent company, Empire Inc., which is generally more profitable on a margin basis on its real estate and investments than food retailing. It also continued its aggressive rollout of FreshCo stores in Ontario, has backstopped Target’s foray into food and then, in June, acquired Canada Safeway and its 213 stores for $5.8 billion.

A few weeks later, Loblaw, after years of stagnating while trying to implement a billion-dollar back-end software system, made a bold move to acquire Shoppers Drug Mart Corp., the largest drugstore chain in the country, for $12.4 billion.

And Metro in August announced it was partnering with Target to brand the latter’s 18 pharmacies in Quebec under Metro’s Brunet drugstore banner.

The result is the three biggest chains rely ever less on food retailing for profit.

Empire and Loblaw, as well as its parent, George Weston Ltd., look more like mini-conglomerates these days, with their hands in several related businesses. Once the Loblaw-Shoppers merger is complete, Caicco says Loblaw’s grocery business will only be 37% of the company’s worth, with Shoppers worth 43%, its real estate worth 17% and financial services three per cent.

“Growth in food retailing will be different moving forward,” says Sylvain Charlebois, food industry observer and associate dean of the University of Guelph’s College of Management and Economics.

“Target and Walmart are indeed playing the square-footage game, which is consistent with their business model. On the other hand, the focus for the newly formed Loblaw-Shoppers marriage will be to provide healthier foods to urban dwellers buying downtown-based condos across the country,” Charlebois says.

Metro would seem the most vulnerable of the big three grocers at the moment, since it’s the most food-oriented. The rise of FreshCo in Ontario and Walmart in Quebec are eating into its two traditional strongholds.

Same-store sales dropped 0.9% in Metro’s most recent quarter, its first such decline in four-and-a-half years, and one driven by a decline in traffic. Metro also announced a $40-million makeover in Ontario including switching some conventional stores to discount Food Basics.

There has been speculation that Metro would buy Jean Coutu, the Quebec-based drugstore chain. But both companies have shot down the idea for now.

Nevertheless, the convergence of grocery, pharmacy, department and discount stores continues and, says Ken Hardy, emeritus professor of marketing at the Ivey Business School at Western University, it’s not just a way to differentiate product and service offerings.

Food retail is a slow-growth industry at the best of times, and has notoriously low net income. Pharma has better margins as does apparel, if well managed.

On the other hand, the square footage space race could end as early as 2015, Caicco notes. That would presumably be after Target has finished its initial 200-store rollout and Walmart has run out of discount stores to convert into its full-grocery Supercentre format.

In the meantime, the big three may have to invest further (lower prices, for example) to entice customers to shop, TD Securities analysts noted in a July 25 report.

Canada’s grocers could initiate strategies that are less dependent on increasing space, says Stewart Samuel, program director at IGD Services (Canada). In the U.K., he notes, supermarket giant Tesco has a new focus on opening retail destinations rather than mere big boxes. Tesco’s first such effort opened in early August in Watford, England.

The store has a restaurant, coffee shop, bakery and a standalone clothing section that supposedly makes shoppers feel like they’re in a proper fashion store. U.K. supermarkets are also moving “toward a ‘little and often’ style of grocery shopping,” says Samuel, and expanding online efforts rather than building big suburban stores.

“In Canada, we’re not yet seeing the same diversity around multi-formats: hypers, supermarkets, small supermarkets and convenience stores. But that will come over time as retailers look to new catchments and shopper groups where hypermarkets are unlikely to be the best solution,” Samuel says.

Hardy points to one big factor in the Canadian chains’ favour: real estate. Older chains hold many of the better locations, which is important in sales and company valuation, especially if the chain owns most of its sites, like Loblaw.

Loblaw’s takeover of Shoppers also gives it hundreds more prime locations, including downtown stores across small-town Canada, which “will give Loblaw a key edge in managing socio-demographic shifts,” Charlebois says. That may be the industry’s best defence to big-box expansion.