Loblaw Companies Limited (L C$33.

33, TSX)
Industry: Food Retail Loblaw Companies Limited, a subsidiary of George Weston Limited, is Canadas largest food distributor and a leading provider of drugstore, general merchandise and financial products and services. The company had revenues of over $31 Billion in 2011. Loblaw operates in two segments: Retail and Financial Services. The Retail segment consists primarily of food and also includes drugstore, apparel and other general merchandise. The Financial Services segment includes core banking, credit card and auto & home insurance services. Loblaws Brands are: Presidents Choice No Name Joe Fresh PC Financial Current Price 52-week Range Market Cap (millions) No: of Shares (millions) Dividend Yield Beta

12th April 2012

Recommendation: Hold
Market Data CAD 33.33 42.27-32.61 9378.5 281.37 2.18% 0.27

Investment Case
We maintain our hold rating on the stock with a target price of $38 based on our intrinsic valuation calculation using discounted cash flow. We arrive at our number assuming flat growth rate in top-line and believe that the scope of earning growth from margin improvement and operating efficiencies is limited. Some highlights and concerns from this quarters result are: Sales growth was up by 3.6% over previous year while the same store growth sale was up 2.5%. An extra selling day in 4Q11 vs. 4Q10 added 0.8-1.0% to same store sales growth in 4Q11. Loblaw reported a basic 4Q11 EPS of $0.62 compared with C$0.59 in 4Q10.Full year basic EPS was C$2.73 compared with C$2.43 a year ago. In the near term, management expects EPS in 2012 to be lower than in 2011 EV/EBITDA P/E Revenue EBITDA Net Earnings Basic EPS per share Same store sales growth

Financial highlights of 2011 Q4 Results

2011 Q4 7373 485 174 0.62 2.5% 2010 Q4 7119 471 165 0.59 (1.6%) Growth(YOY) 3.56% 2.97% 5.45% 5.08%

Valuations
2010A 7.1x 13.9x 2011A 6.8x 12.5x 2012E 6.9x 13.0x 2013E 6.5x 11.9x

Loblaw Outlook for 2012

IT/Supply Chain - Supply chain renewal is substantially complete, leading to a $20 million decrease in spending in 2012 relative to 2011 - IT spending is expected to increase by $90 million in 2012 relative to 2011, resulting in $70 million net incremental expenses in 2012 Capex Spending - Capex is estimated to total C$1.1b in 2012 - 60% of Capex will be directed to core retail business while balance towards supply chain and IT - In 2012, the company will focus on initiatives that build on its competitive position of its business and invest in opportunities to support long-term profitability Customer Proposition spending - Customer proposition initiatives will cost Loblaw $40 million in an effort to improve assortment, boost customer service and lower prices to help improve its competitive position and drive sales Store Network expansion - Net square footage additions in 2012 are expected to grow by approx. 1% to total 0.5m sq. ft.

Competition

Industry Outlook and Highlights

The size of food and beverage stores industry in Canada has grown from $70.3 billion in 2000 to over $110 billion at the end of 2010. Over the corresponding period the industry witnessed a CAGR growth of 4.15%. Annual CPI inflation has been the major driver of the industry growth and continues to strongly influence revenue growth. Given the high inflationary expectation going forward due to loose monetary policy across globe the food inflation is expected to be trending up going forward. Year Given the mature status of industry, margins have been hard to come by and firms have to be operationally effective to maintain margins. The most important cost drivers of the industry are as follows: All-Items Food Food from stores 2.0 2.3 2.3 2.2 2.7 2.7 2.3 3.5 3.9 0.3 4.9 5.5 1.8 1.4 1.0 2006

Canada CPI
2007 2008 2009 2010

Source: StatsCanada

For the period 2000 2010 the total expenses grew at a lower CAGR of 3.8% than the growth in revenues. This suggests that for operationally effective companies there should be a net improvement in the operating margins over the decade. Going forward the industry is expected to remain muted with margin pressures due to high competition.

Sales and earnings estimates

Given the high inflationary expectation we assume the industry growth rate to continue in the range of 2.5% 4%. However, the last 10 year CAGR sales growth rate for Loblaw is 3.39% which has declined to 1.59% in last 5 years. Given The stagnant same sales growth of the company over last 5 years Limited room to increase number of stores by opening new store thereby limiting increase in total retail square feet Decrease in the tonnage sold

We believe the company misses the catalyst to grow its topline significantly over the industry growth rate. Infact, if the company is unable to significantly increase its Sales/Sq. Ft. we expect it to grow in-line with or below the overall inflation rate. Our assumptions for projections are as follows Revenue Growth CAPEX EBITDA Margin Effective tax rate 2.5% 1000 6.6% 27.2%

CAD Millions Total Revenue EBITDA D&A EBIT Interest EBT Taxes Net Income Change in W/C CAPEX FCF 2011A 31250 2083 699 1384 327 1057 288 769 683 987 105 2012E 32031 2114 716 1398 333 1065 290 775 190 1000 670 2013E 32832 2167 734 1433 316 1117 304 813 200 1000 695 2014E 33652 2221 752 1469 310 1159 315 844 230 1000 710 2015E 34494 2276 771 1505 305 1200 327 873 230 1000 725

Discounted Cash Flow Valuation

For our DCF analysis, we assume a terminal growth rate of 2.5% and WACC of 6.4%. By looking at historical data, we predict Loblaws working capital for the next five years. Given significant investments on the infrastructur e program, we use managements guided capital expenditures in our model. For the sake of simplicity, depreciation and amortization expenses are calculated as a percentage of total revenue. Our DCF analysis results in an estimated enterprise value of $16367 million, implying a per share equity value of $38. The assumptions used in our model are as follows: Revenue Growth WACC CAPEX Outstanding Shares 2.5% 6.4% 1000 281.3

2012 FCF PV Enterprise Value Net Debt Equity Value Price/Share 660 620 16367 5715 10652 38

2013 685 644

2014 700 581

2015 715 558

Terminal Value 17897 13964

Relative Valuation
Name 5 Year Average P/E 14.99 14.45 18.73 13.52 11.51 12.29 12.55 13.33 13.90 P/E(TTM) 12.21 15.27 17.24 15.57 10.91 13.99 13.25 13.44 13.91 5 Year Average P/CF 5.72 10.68 15.85 7.79 3.98 9.49 5.35 8.64 8.74 P/S 0.33 0.87 1.23 0.25 0.53 0.45 0.26 0.49 0.63 5 Year Average P/S 0.35 0.84 1.39 0.27 0.54 0.42 0.24 0.48 0.63 EV/EBITDA 6.95 8.65 10.26 8.63 8.73 8.74 8.30 8.56

Loblaw Shoppers Drug Mart Saputo Inc. Alimentation Couche-Tard Canadian Tire CorpMetro Inc A Empire Co Ltd A Median Average

Loblaw is trading at lower valuations compared to median industry multiples. The lower multiples reflect markets uncertainty about its growth, expansions plan and risks associated with its IT strategy. In our view, being a mature company the core business of Loblaw should trade close to its international peers such as Tesco. Given, the significant value of real estate in its books a slight premium is justified. Hence, we use P/E and EBITDA multiple of 13 and 7.5 to arrive at our target price of CAD 36 and CAD 36.5. These numbers are closely in line with our DCF intrinsic value.

Investment Summary
Our target price of CAD 38 is based on our DCF intrinsic value calculation. The earnings are expected to fall though most of 2012.We thus find it difficult to use aggressive growth numbers or assign higher multiples to Loblaw given the uncertainty associated because of the following: Lack of avenues for topline growth i.e. volume growth Significant challenges in implementation of IT Infrastructure in 2013 and 2014 Impact of drug regulatory changes on pharmacy operations Pressure on margins from expenditure to acquire customers from financial business Uncertainty of strategy going forward given the leadership of new President Limited upside potential in margin expansion from IT system implementation and operational efficiencies Companys key operational parameters do not inspire confidence of high growth going forward