If you believe in the idea of a conglomerate discount, the answer to the question in the title is a simple one: Loblaw Companies Ltd. (TSX: L).
However, if you believe that Weston Foods, George Weston Limited’s (TSX: WN) bakery business, has a bright future, you might want to opt for the parent rather than the child.
And, of course, there is the third possibility, that you buy neither. Here’s why.
The parent
George Weston consists of three parts.
An operating business in Weston Foods, a bakery with over 6,000 employees at more than 40 facilities across North America. A controlling 49.5% ownership stake — 50.7% if you include W. Galen Weston’s personal investment — in Loblaw Companies, and lastly, it has cash, short-term investments, and a 6.1% stake in Choice Properties Real Estate Investment Trust to go along with the 82.4% interest Loblaw has in the REIT.
Its cash and short-term investments were $3.9 billion at the end of the first quarter, 63% higher than a year earlier. The market value of the 6.1% stake in Choice is $67.1 million, and the 49.5% stake in Loblaw is $12.2 billion.
Together, that brings the value of the company’s holdings to $16.2 billion without taking into account Weston Foods, which generated a paltry $10 million in operating income in the first quarter from $517 million in revenue.
The bakery division is looking to grow by selling customers fancier bread.
“We are innovating in indulgent product,” Weston Foods president Luc Mongeau said on a conference call discussing George Weston’s latest quarterly results. “There is a strong demand for product that delivers greater indulgence, and we are benefiting and growing in these areas with our portfolio.”
Weston Foods has undertaken a three-year transformation that will see its business restructured to simplify operations and deliver cost savings to the business while also becoming more competitive.
“Weston Foods’s business performance has been impacted by challenging inflationary pressures and cost relating to the transformation program,” CEO Galen G. Weston said.
Certainly, it doesn’t help that both Weston Foods and Loblaw are in the middle of extricating themselves from the bread price-fixing scandal which has gripped the country since the news broke in January.
George Weston has an enterprise value of $23.4 billion, or 5.9 times EBITDA. By comparison, Loblaw has an enterprise value of $34.0 billion, or 8.5 times EBITDA.
Despite the headwinds Weston Foods currently faces, I’d rather pay 5.9 times EBITDA for an investment, all things being equal. From this perspective at least, Weston is the better buy.
The child
Loblaw’s grocery stores are the engine that drives the entire Weston empire. Without it and Shoppers Drug Mart, we probably wouldn’t be having this discussion.
As we make our way through 2018, all of Canada’s major grocery store chains seem to be experiencing some kind of pain, not the least of which is an intense competition that’s cutting into profits.
At Metro, Inc. (TSX: MRU), you’ve got a company in the final stages of closing its transformational $4.5 billion acquisition of Jean Coutu Group PJC Inc., Quebec’s leading pharmacy. That integration is going to take a while.
Over at Sobeys, owned by Empire Company Limited (TSX: EMP.A), it’s in the middle of Project Sunrise, CEO Michael Medline’s attempt to make the grocery store chain a national presence both in terms of its store locations but also in the way it’s operated. Early results are promising.
Finally, Loblaw is spending a lot of energy in 2018, not to mention capital, accelerating its e-commerce business by expanding its PC Express service (order online, pick up at the store) to more than 700 locations across the country, up from 200 last year. Add to that a home delivery service available in 16 Canadian cities by the end of the year, and you’ve got the makings of pretty good success story come 2019.
Of the three grocery store businesses, Loblaw probably has the least amount of work ahead of it.
In 2017, Loblaw generated free cash flow of $1.48 billion, which gives it an FCF yield of 4.4%. By comparison, George Weston generated free cash flow of $1.4 billion in 2017 for an FCF yield of 6%, 160 basis points higher.
Given they both have dividend yields of 1.8% at the moment, if you are in the mood for owning Canada’s largest grocery store operator, I’d do it through the parent.
