Financial Literacy Individual Case Study: Loblaw Companies Limited

8 June 2020

Loblaw Companies Limited is a publicly traded company in Canada. It is a retailer for grocery, pharmacy, health and beauty, apparel, general merchandise, financial services, and wireless mobile products and services. Their operations are divided between Retail and Financial Services and includes divisions of Market, Discount, PC Financial® services, Joe Fresh®, and Shoppers Drug Mart. It is controlled by George Weston Limited. Wittington Investments Limited is their ultimate parent.

This report is intended to support the Board with their duties of reviewing strategic direction, assigning responsibility and assessing performance of that direction to management, deciding on major policy decisions. Sobey’s[1] was selected as a competitor for comparison purposes. All calculations and financial documents are found in the Appendices. 

Loblaw Companies Limited 2019 Annual Report[2] was prepared in accordance with International Financial Reporting Standards (IFRS) and approved by the independent auditor KPMG LLP. 

Assets on the balance sheet represent purchased future benefits, an increase indicates growth. Loblaws reports assets at cost. Liability and Equity represents what a company owes. In Liabilities, the cost of borrowing is interest and in Equity, the cost of shareholders is Returns on Investment (ROI). The capital structure is heavily leveraged through long term debt and lease liabilities. Sobey’s finances more through shareholder equity than Loblaw while offering a greater ROI. We would want to know if our capital structure should be amended. The Debt to Equity ratio measures the leverage (debt) compared to equity. This is an indication of risk: greater risk with higher debt. This ratio is industry dependent. Loblaw D/E of 2.21 indicates greater risk than their more conservative competitor of 1.48 so investors would expect a greater ROI. While Loblaw has experienced an increase of ROI, this increase is less than that of their competitor. We would want to know why.  

Total assets are increasing and indicates growth. Productivity refers to the effectiveness and efficiency of asset utilization. The cost of additions to properties under construction was $601 million in 2019 and $506 million in 2018. Loblaw continues to grow with commitments for construction, expansion, renovations and purchases of $128 million in 2019 and $233 million in 2018. Loblaw values its capital assets at cost but uses FMV for right-of-use assets of investment properties. Although this growth is positive, we would want to know if the share buyback resulted in artificial sway towards liabilities and the effect of the new IFRS lease standards.

The Current Ratio is used to assess short term liquidity or solvency. Our numbers indicate that current assets are decreasing but we are still in a healthy position above 1. We would want to know why our competition is experiencing growth here. Because we are a company with significant inventory dealing in risky inventory the Quick Ratio should be assessed. As less than 1, this may indicate that Loblaw may not be able to satisfy its current liabilities in the short term. We would want to know why this number has fallen and how to remediate this.

Working Capital is a measure of short-term solvency or liquidity. Current Assets includes cash, accounts receivables, inventory, income tax recoverable, and prepaid expenses. Cash and short-term investments increased from the previous year but compared with total assets it is declining. This is the case with their competitor as well. We would want to know why liquidity is diminishing yet cash is increasing. We would also want to know the purpose for the funds and whether it was excessive.

Accounts receivable (A/R) is separated between general and credit card receivables. Days Sales Outstanding (DSO) is an estimate of the number of days customers take to pay. DSO for general receivables has dropped from 2018 but is still about 2.5 days over their competitor. When receivables including credit card receivables is considered, DSO jumps to 36.5 days as an increase from 2018. We would want to know how to minimize this risk especially as it relates to doubtful accounts. Because the credit card receivables are serviced by Eagle Credit Card Trust® PC Bank, a consolidated structured entity of Loblaw, we would want to know how to minimize this risk.

Inventory is anything purchased that is planned to be sold. Typically, this should change with sales. Loblaw includes costs such as transportation that are incurred to bring inventories to their retail outlets. Cost is measured at weighted average cost at their retail and distribution outlets (as is their competitor) while Shoppers Drug Mart measures at weighted average cost or on a first-in first-out basis. Loblaw included a write-down of $33 million in 2019 down from $37 million in 2018 and we would want to know how the company can address related efficiencies. 

Days Inventory On Hand (DIOH) is an estimate of how long it takes to sell inventory. As this is directly related with efficiency, the increase over 2018 as well as in the difference with their competitor would warrant further investigation. 

Discontinued operations are business units sold in current year. There was a reorganization in 2018 where Choice Properties Real Estate Investment Trust was discontinued. Future closures for distribution centres in Laval and Ottawa are planned to be relocated in Cornwall. This will involve restructuring costs over the next two years. We would want to know the strategic purpose of these reorganizations and their implications on future cash flows. 

Loblaw features two reportable operating segments: Retail and Financial Services. Evaluations about productivity are based on adjusted EBITDA and adjusted EBIT. Productivity appears positive with numbers in both income and cash flow increasing for both segments. We would want to know what items were excluded from operating income in the calculation for adjusted EBITDA. We would also want to know the details related to the amortizations of intangible assets acquired with Shoppers Drug Mart. 

Capital Assets are used for daily operations and refer to resources owned and employed in excess of a year. Capital Asset Turnover is an indicator of efficiency and is increasing for Loblaw. Depreciation is straight-lined over the estimated useful life of an asset. There were no write downs for 2019 or 2018. We would want to know the consequences on future cash flows and risks involved with the IFRS lease standards changes and why Loblaw is continuing to report under International Accounting Standard (“IAS”) 17 and self-determining classification of risk.

Intangible Assets are long-lived resources that are void of physical form. Goodwill represents the excess of the cost of the FMV of acquisitions. Impairments are write-downs of intangible property where the Recoverable Amount (Present Value of the Future Cash Flows) is less than the Carrying Amount (Net Book Value) as assessed on a cash generating unit (CGU) basis. We would want to know why there was a net gain of $12 million in 2019 for assets held for sale with an impairment charge of $8 million in 2019 and $3 million in 2018. A major item is the $342 million associated with the acquisition of CREIT in 2018 and three investment properties that were disposed to Choice Properties for $59 million with a recognized gain of $7 million in 2019 and $6 million in 2018. We would have questions about the future risk related to the subsequent leaseback, and soon thereafter, reorganization of approximately 61.6% effective interest in Choice Properties to Weston. We would want to know what happened with the flip-flop approach to this entity and the risk going forward. 

Accounts Payable refers to the amounts the company owes on its purchases.

Days Payable (DPO) is an estimate of how long the company takes to pay its suppliers. Here we see a slight drop from last year but is significantly higher than for their competitor. As this can affect supplier relationships, especially considering the commodity risks associated with the current COVID-19 crisis, we would want to know how to most efficiently approach this issue. 

The Cash Conversion Cycle (CCC) compares the time it takes to receive cash and spend cash. It includes the process and storage to receive inventory minus the payable terms to make payments plus shipping product and invoicing involved with receiving payment. As this number is increasing, we would want to know what operational strategies could help with its efficiency. 

Long Term Debt refers to debts or loans due in excess of a year. From the Long Term Debt Ratio we can see that long term debt is increasing but not as fast as for our competitor. Most of the long term debt is not due in the near future and is mostly at reasonable interest rates. We would want to know if our stability could change given the possible instability of the economy and interest rates over the next while. 

Contingencies include potential liabilities dependent on a future event. This is recorded when liability is probable and reasonably estimated. Disclosure is required when liability is reasonably possible. The report lists claims against the company including several class action suits for sizable amounts. We would want to know why several of them are included, meeting the threshold of “reasonably possible” but yet contingencies have not been reserved as not being “probable”.

Shareholders invest by buying shares or leaving earnings in the company as Retained Earnings. Shareholders expect an ROI. Dividends are paid when a company is starting to mature and does not need the money to grow. Return on Equity (ROE) represents how much profit the company earns for every dollar of shareholder investment. Loblaw purchased 13.6 million shares under a common share repurchase program in 2019. This increased the dividend and helped to generate $1.2 billion in free cash flow. We would want to know the purpose for this liquidity and whether ROE could be maintained or increased going forward? We would also have questions about the cost of capital as represented by the Weighted Average Cost of Capital (WACC) and whether the investment in assets will cover this. More common share dividends were declared in 2019 compared with 2018. We would want to know if this is related to the buy back and the implications are for shareholders. Fewer shares have been issued and outstanding in 2019 compared with 2018 and we would have questions about the purpose of this direction.

Net earnings has increased for both Loblaw and their competitor. We would want to confirm whether this is related to the changes in lease standards. Significant factors affecting Net Earnings incudes the repurchase of shares, dispositions of gas bar operations, tax payment charge related to a legal matter, the wind-down of PC Financial® banking services; restructuring related to the Loblaw Card Program; the card loyalty PC Optimum Program; minimum wage increases; and incremental healthcare reform. 

The Profit Margin (PM) shows the profitability of the business. Changes in PM are caused by inefficiencies and price. The PM for both Loblaw and its competitor indicates that they are (red) businesses engaged in operational excellence who strive to reduce price by reducing cost. Gross Margin (GM) represents sales after the cost of goods sold (COGS). This measures production costs as related to sales as a measure of efficiency. The numbers indicate that while both Loblaw and its competitor are fairly stable, Loblaw is much higher with a slight increase over last year. Although this is positive, we would want to know how to increase this even further.

The Price to Earnings (PE) Ratio indicates that the price shareholders are willing to pay for every dollar of profit is declining. As this is an expectation about the future, we would want to know why the market thinks the future is dimming. 

Revenues are recognized when earned. Loblaw recognizes revenue on delivery of inventory and matches this with the related administrative and management services. Loblaw offers a customer loyalty awards program where the revenue is deferred when earned based on the FMV of the award. EBITDA Margin, showing operating profit to revenue, indicates growth compared to their competitor. We would want to know what this cash profit was from.  

Cost of sales refers to the direct costs recorded when revenue earned. Direct Expenses are reported when they are used to help earn their matched revenue. Cost of sales is increasing with sales. Gross margin as an estimate of profitability is also increasing. We would want to review operating strategies to improve efficiencies even more.

Selling, General & Administrative Expenses refer to the indirect expenses of a business and are reported when incurred. SG&A expenses are increasing and this is consistent with sales. They are however decreasing compared with our competitor and we would want to know why. 

Restructuring refers to the (estimated) costs relating to the severance or shut down of a business or business unit. As mentioned above, we would have questions related to the 2018 reorganization of Choice Properties as well as around the move to Cornwall. Specifically, we would want to know their effect on strategy, future cash flows, and efficiencies.

Operating income shows earnings Before Income Taxes and Interest Expenses (EBIT) represents the operating performance of the business and is used to measure management performance. This shows how much profit operations made that were within management control. Loblaw shows an increase over last year and is ahead of their competitor here. Comparing this increase with sales we see that sales drags behind EBIT growth. While this appears positive, this includes the revenue from discontinued operations. We would want to have a more realistic picture of revenue and costs going forward. Even when broken down by segment, both Retail and Financial Services is improving. Because employee costs are significant, we would want to understand the implications of public health regulation in the area of employees and labour. Operating Margin, as an estimate of profitability, shows in increase for both Loblaw and its competitor. We would want to know what Loblaw is doing different from others to maintain this advantage.

Operating cash flow is represented by Earnings Before Income Taxes, Interest Expense, Depreciation Expense and Amortization Expense (EBITDA). This adds depreciation on cash flow and expenses onto EBIT. This is an estimate of productivity and would be affected by amortization of intangibles, impairments, restructuring, pensions, Loblaw Card Program, PC Financial wind-down, and spin-outs of Choice Properties. While this estimate is rising for Loblaw, it lags behind their competition. We would want to know why. Because Loblaw projects an estimated growth rate of 2% over the long term, we would want to know details related to this projection and how this may have to be adjusted given the current pandemic.


[1] Empire Company Limited, 2019. Fresh Thinking. 2019 Annual Report. online: <https://corporate.sobeys.com/wp-content/uploads/2020/05/2019-Empire-AR-SEDAR.pdf>

[2]  Loblaw Companies Limited, 2019. Live Life Well. 2019 Annual Report. online: <http://www.annualreports.com/HostedData/AnnualReports/PDF/TSX_L_2019.pdf>