The defensive nature of shares in Canada’s major grocery-store chains and various initiatives have led to recent success for Stellarton, N.S.-based Empire Co. Ltd., which owns Sobeys Inc.; Brampton Ont.-based Loblaw Cos. Ltd.; and Montreal-based Metro Inc. In fact, these three companies are expected to do even better, making their stocks well worth considering for your clients.

Loblaw has refocused after the problems it faced in 2006, when it tried to compete head-on with Walmart Canada, which is owned by Wal-Mart Stores Inc. of Bentonville, Ark. Loblaw is now in the process of putting in new supply chain management systems, which are expected to increase productivity significantly.

Metro, the current leader on the efficiency front, has improved the attractiveness of its stores and still has more potential in this area.

As for Empire’s Sobeys brand, it is entering the important discount market, in which Loblaw and Metro are already players.

Long-term prospects are good for all three companies, but Metro is considered the safest stock in the near term. There’s a risk of hiccups with Loblaw’s new systems and uncertainty about the successfulness of Sobeys new discount stores.

The current economic environment is a positive one for grocery-store stocks in general, as investors like defensive stocks in a sluggish economy, says David Andrews, director of investment management and research with Toronto-based Richardson GMP Ltd.

Another positive sign is rising food prices, including those for wheat, sugar and coffee. This should help grocery stores’ margins, which had been squeezed by the drop in food prices in the past few years.

Furthermore, Walmart Canada hasn’t been the threat grocery stores had feared. Walmart was counting on the attraction of one-stop shopping at its superstores, which offer a full range of groceries, but the strong sales it expected haven’t materialized. This is mainly because Canadian grocery stores are well run and offer an attractive shopping experience, says Martin Hubbes, executive vice president and chief investment officer with AGF Investments Inc. in Toronto: “It’s easier for Wal-Mart in the U.S., where grocery stores are poorly run.”

In contrast, Bill Chisholm, a research analyst with MacDougall MacDougall & MacTier Inc. in Toronto, doesn’t discount competition from Walmart Canada, but he feels the Big Three Canadian grocery chains are up to the task.

Here’s a closer look at the three:

> Empire Co. Ltd. Sobeys, which accounts for about 90% of Empire’s operating income, lost out to Metro in its attempt to buy A&P Canada Co. in 2005 — a major disappointment for Empire, as the acquisition would have increased its presence in Ontario substantially.

Sobeys has more corporate and franchised stores across Canada than Loblaw — at 1,300 vs 1,029 — but only about half the square footage (28.2 million square feet vs 50.6 million sq. ft.), indicating much smaller store sizes. As a result, Sobeys’ productivity isn’t as strong as either Loblaw’s or Metro’s. (Metro is concentrated in Ontario and Quebec, and has 655 stores and 19.6 million sq. ft.)

A potential problem for Sobeys’ expansion efforts, says Chisholm, is that developers often prefer Loblaw or Metro in their malls because of greater brand recognition.

Sobeys entered the discount market this past May with its FreshCo. stores, and its smaller locations will gradually be rebranded with that name. This is a move that equities analysts laud because of the importance consumers put on fresh produce and good, ready-to-eat prepared foods. Chisholm’s only caveat about this strategy is that if a Sobeys and a FreshCo. are located close to each other, FreshCo. sales could cannibalize Sobeys’ sales.

In a Sept. 22 report, Chisholm had a “buy” recommendation and a 12-month target price of $63 for Empire’s 34.2 million outstanding Class A non-voting shares, which closed at $55.06 per share on Sept. 30. The 34.3 million Class B voting shares are 88% controlled by the Sobey family. Chisholm thinks Empire’s stock could have the most upside potential among the Big Three in the long term because Sobeys has the least efficient chain and, as a result, has the most room for improvement.@page_break@Empire’s net income was $293.8 million for the 12 months ended July 31, vs $278.7 million in the same period a year earlier. Revenue was $15.6 billion, vs $15.2 billion.

> Loblaw Cos. Ltd. Analysts say Loblaw has regained its focus. It is no longer pushing non-food goods, with which it was trying to compete aggressively with Walmart Canada, although it still offers some of these products. In particular, Loblaw has had significant success with its Joe Fresh clothing line, which is offered in or near Loblaws stores. Another move, announced in early October, is a major expansion of Loblaw’s prepaid cellphone offerings.

Loblaw is also focusing on catering to ethnic groups. In 2009, it bought Richmond, B.C.-based T&T Supermarket Inc., whose 18 stores in British Columbia, Alberta and Ontario offer Asian foods and ingredients — with an emphasis on fresh and ready-to-consume meals.

Pricing of Loblaw’s very successful President’s Choice-branded food items, which had gotten out of line, is now at an appropriate level. And while Chisholm believes the President’s Choice financial services brand “hasn’t been a gold mine” — it has one million credit cardholders — Loblaw believes it can triple or quadruple the number of cardholders.

Chisholm and analysts with TD Newcrest (a unit of TD Securities Inc. ) and UBS Securities Canada Inc. (all companies are based in Toronto) all have buys on Loblaw. Chisholm’s target price for the stock is $47; UBS’s is $48. The 284 million outstanding shares were trading at $40.77 on Sept. 30.

An Aug. 18 TD Newcrest report took Loblaw off its “Action List Buy” list after a run-up in Loblaw’s share price of almost 30%. However, the report still gave a “buy” rating on the stock, with a 12-month price target of $51. The report notes that temporary problems with the new systems and/or labour strife — as current negotiations with its unions are not going well — could cause earnings volatility over the next year. However, much like other analysts, those at TD Newcrest believe higher productivity will increase earnings once the new systems are up and running.

Real estate is an important part of Loblaw’s valuation, worth about $32 a share, says Marie-Eve Savard, an associate, portfolio manager and research analyst with Standard Life Investments Inc. in Montreal. In contrast, Metro’s real estate valuation is worth only $2 a share and Empire’s is $1.50 a share.

Loblaw’s net income was $671 million in the year ended June 19, vs $649 million in the same period a year earlier. Sales were $31 billion, vs $31.2 billion.

> Metro Inc. purchased A&P Canada Co. in 2005. Andrews says the A&P integration was one of the smoothest he’s seen and very comfortable for customers, as no major changes were made in the stores, items offered or flyers.

Hubbes likes Metro’s very focused management team and notes that as a smaller chain, Metro can expand more easily. It has improved its stores, but still has more to do to bring it up to Loblaw’s standards. Hubbes adds that Metro’s industry-leading productivity is also very attractive. He usually prefers the company to Loblaw, as he finds the latter too pricey in comparison.

In an Aug. 12 report, Chisholm had a “buy” rating on Metro, with a target price of $50 vs the $44.64 per share that the 107 million outstanding shares closed at on Sept. 30.

A UBS report issued on the same day rated the stock “neutral,” with a target price of $47.

An important factor for Metro is that it owns 28% of the multiple voting shares and 4.3% of the subordinate voting shares of Quebec-based convenience-store chain Alimentation Couche-Tard Inc., which Chisholm says is very successful and growing strongly.

Metro’s net income was $382.8 million in the year ended July 3, vs $342.5 million in the same period the year prior. Sales were $11.3 billion, vs $11.1 billion. IE