The news that Empire Company (TSX:EMP.A), the owner of Sobeys, is paying $800 million to buy Ottawa-based Farm Boy, a higher-end regional grocery-store chain currently invading Southern Ontario, put me in a state of shock.
How could CEO Michael Medline pull the trigger on such a big deal when Sobeys is still very much in turnaround mode?
The answer is quite simple: he had too. If Sobeys doesn’t make a preemptive strike, someone else likely would have made an offer before too long.
A move right out of the Canadian Tire (TSX:CTC:A) playbook
Back in January 2017, when Medline was first hired by Empire, I suggested that despite the executive’s brilliant acquisition of Sport Chek in 2011 — putting U.S. sporting goods retailers plans for Canada on hold — his lack of operational know-how as it relates to the grocery industry could be a risk for shareholders.
Note: I said could be. So far, Medline’s managed to do a better-than-decent job of righting the ship; it’s about halfway through Project Sunrise, which it launched in Q4 2017.
When Medline pushed for Canadian Tire to pull the trigger on the Forzani deal, not only did it make sense from the aspect on cementing its hold on the sporting goods market in Canada, but it also effectively blocked U.S. retailers such as Dick’s Sporting Goods from gaining a foothold in this market.
That’s called killing two birds with one stone.
He’s done it again
I first came across Farm Boy about five years ago while shopping for groceries in Kingston, Ontario on my way to a week-long vacation in Prince Edward County.
I was immediately fascinated by the store’s design and inventory. It wasn’t loaded cheek-by-jowl with toilet paper and other non-perishable items. Instead, it had lots of fresh fruits and vegetables and other quality products — both brand name and private label — that completely differentiated it from other grocery store chains including Sobeys.
I hoped and prayed for it to come to Toronto, which it finally did, but only after I’d moved to Halifax, where Sobeys owns Pete’s, a much smaller version of Farm Boy.
Now, Sobeys owns majority control of two unique grocery store formats.
On the one hand, it’s hard to understand why the company would spend $800 million, or 14.1 times its 2020 EBITDA, when it’s still trying to transform Sobeys into a national grocery store chain.
However, on the other hand, Medline’s acquired arguably one of the best-run smaller grocery store chains in North America. Its brand is second to none, providing Empire with a long runway of growth over the next 5-10 years.
An independent operation
Having learned its lesson with Safeway, it’s wisely keeping Farm Boy separated from the Sobeys’ ecosystem except when it comes to e-commerce. There, they will share resources, which only makes sense.
“We do not want to ruin the magic of Farm Boy by trying to integrate them,” Medline told analysts.“We love what Farm Boy is doing. It has the best brand… we want to see it grow.”
To that end, Sobeys would like to double the number of stores over the next five years to 52 locations (14 in Ottawa) and $1 billion in annual revenue.
As long as it doesn’t play with the successful formula that Co-CEOs Jean-Louis Bellemare and Jeff York have built over the last few years, Medline’s got another transformative deal on his hands.
The bottom line on Empire Stock
In July, I recommended that investors interested in Empire stock consider buying a half position and waiting for it to correct before buying some more.
In the three months since, it has lost about 7% of its value.
Given the Farm Boy news, you ought to be buying anywhere below $25 — the potential is that great.
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Fool contributor Will Ashworth has no position in any stocks mentioned.