Loblaw Companies (TSE: L) is a food and pharmacy company that also offers financial services. We are neutral on the stock.
Measuring Loblaw’s Efficiency
Loblaw Companies needs to hold onto a lot of inventory to keep the business running. Therefore, the speed at which a company can move inventory and convert it into cash is essential in predicting its success.
To measure its efficiency, we will use the cash conversion cycle, which shows how many days it takes to convert inventory into cash. It is calculated as follows:
CCC = Days Inventory Outstanding + Days Sales Outstanding – Days Payables Outstanding
Loblaw Companies’ cash conversion cycle is 27 days, meaning it takes the company 27 days for it to convert its inventory into cash. In the past several years, this number has remained relatively flat, indicating that the company’s efficiency has not been impacted by competitors.
In addition to the cash conversion cycle, let’s also take a look at Loblaw Companies’ gross margin trends. Ideally, we would like to see a company’s margins expand each year. This is, of course, unless gross margins are already very high, in which case it is acceptable for them to remain flat.
In Loblaw Companies’ case, we can see that gross margins have expanded in the past several years. This is ideal because it allows the company to increase free cash flow or reinvest a larger percentage of revenue into growth initiatives.
Growth Catalysts
Loblaw is in a very interesting position at the moment. Given that the company operates many grocery chains along with pharmacies, it is well protected from rising inflation. People might cut 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 in order to tame it. Fortunately, this will likely translate into higher interest income for Loblaw.
As a result, the company will benefit from the rising inflation while its financial segment awaits higher interest rates.
Dividend
Loblaw Companies currently has a 1.29% dividend yield, which is below the sector average of 1.5%. When taking a look at its LTM free cash flow figure of $3.98 billion, its $479-million dividend payment looks safe.
Taking a look at its historical dividend payments, we can see that its yield has ranged from 1.56% to 2.7% up until 2021.
At 1.29%, the yield is near the low end of its range, implying that the stock price is trading at a premium relative to the yields investors have seen in the past.
Wall Street’s Take
Turning to Wall Street, Loblaw Companies has a Moderate Buy consensus rating, based on three Buys, two Holds, and zero Sells assigned in the past three months. The average Loblaw Companies 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 the 12.6% upside analysts are expecting.
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