Could inflation help grocery stocks survive the minimum wage apocalypse?


There may be a silver lining for Canadian grocery stocks staring down the barrel of minimum wage hikes, as added labour costs could help increase prices, boost inflation and contribute to stronger returns for investors.

That’s according to research from National Bank Financial, which “observed that the shares of the Canadian grocers perform better in environments with medium-to-high food inflation,” wrote analyst Vishal Shreedhar on Tuesday.

Despite 10 consecutive months of deflation for the food retail industry, National predicted that positive inflation is set to return, partly because of price hikes that will be needed to pay for rising wages.

Statistics Canada reported Friday that the consumer price index rose 1.2 per cent in July compared to the same month last year, and that food prices increased 0.6 per cent over the same period and 0.3 per cent from June to July.

“We believe that the grocery space, in aggregate, is at an inflection point where deflation should turn into inflation over the coming months,” noted Shreedhar. “This will be supportive of same store sales growth and the optics of growth (we don’t see a meaningful change in (earnings per share) growth over the medium term).”

The prediction of inflation-related benefits for grocery stocks comes as governments in Alberta and Ontario, as well as the fledgling NDP-Green government in British Columbia, have announced plans to hike their minimum wages to $15 an hour over the coming years. This has raised concerns that the added costs will hit Canadian retailers hard, as they employ many minimum-wage workers, with companies examining ways to offset the increased expenses, which may include possible job cuts.

Metro Inc. reported its latest results this week, with management saying the minimum wage increases in Ontario would add costs of between $45 million and $50 million in 2018. The Montreal-based company also “largely” attributed a year-over-year decrease in same-store sales to deflation. 

Metro’s returns, however, have jumped during times of medium and high inflation, along with those of other grocers, National’s research showed. Since January 2000, high inflation periods (above 3 per cent) coincided with an increase in Metro’s average year-over-year returns of 33.2 per cent. Returns for Loblaw Companies Ltd.’s increased by 7.7 per cent, and Empire Company Ltd.’s by 10.6 per cent.

During medium inflation periods, (0.5 per cent to 3 per cent), Loblaw average year-over-year returns increased by 5 per cent, Metro’s by 12.6 per cent, and Empire’s by 13.6 per cent. 

Loblaw has seen 3.6 per cent growth in its year-over-year returns during low inflation periods (0.5 per cent or lower), National’s figures show. Meanwhile, Metro reported a 1.7 per cent increase and Empire a 1.6 per cent decrease in returns during the same periods.

As of Friday’s close, Loblaw shares were down about 4.2 per cent since the start of 2017, while Metro stock was up around 4.1 per cent on the year and Empire had gained approximately 38.1 per cent.

Still, National warned a stronger dollar and increased competition could offset gains. Grocers may not be able to implement all their mitigation measures in time either, the bank said.

National’s research also showed that Ontario increasing its minimum wage in 2014, to $11.00 from $10.25, was followed by stronger food inflation than the rest of Canada.

“In addition, we believe that the grocers will start testing out higher prices in advance of the minimum wage increases being implemented,” added Shreedhar. “As a result, we expect upward price pressure over the coming months as the grocers evaluate strategies.”

A Wednesday research note from Raymond James maintained an outperform rating on Metro, and said they remain buyers of the stock. One of their reasons was “the 2018E wage inflation fears’ impact on earnings power currently priced into the grocery group overstates the reality.”

RBC Capital Markets noted a possible benefit for Metro would be a “potential return to slight inflation as retailers pass some of the cost increases.”

Desjardins Capital Markets noted this week that the stronger loonie could offset some of the increased labour costs as well. “The combination of the U.S. grocery industry returning to inflation in July (after 19 months of deflation) and the sharp recent increase in the value of the Canadian dollar may assist the Canadian grocery industry in compensating for the upcoming increase in the minimum wage in Ontario.”

CIBC economist Andrew Grantham wrote Friday the 1.2-per-cent increase in the CPI was in line with expectations and still below the Bank of Canada’s two per cent target.

“Food prices edged up again, and are now becoming a support to inflation on a year-over-year basis as well,” noted Grantham. 

gzochodne@postmedia.com
Twitter: @geoffzochodne