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Will Rising Food Prices Make Loblaw Companies Ltd (TSX:L) a Buy?

It’s official: Canadians are about to take a hit at the grocery stores. According to three grocery chain CEOs, price hikes are expected in coming months as pressures from the U.S. lead to supply chain issues. Although we haven’t seen any massive increases just yet–a quick look at Statistics Canada actually showed a few decreases from September to October–the consensus is that “moderate” hikes are coming.

Enter Loblaw Companies Ltd (TSX:L). Loblaw is Canada’s largest food retailer by revenue, and therefore has massive exposure to (and influence over) the country’s food prices. Theoretically, increasing food prices could be good news for Loblaw–but only if they rise more than expenses. And with supplier demands being the big culprit behind impending increases, that may not be the case. But before we get ahead of ourselves, let’s take a look at these price hike claims, and whether they’re legitimate.

Reasons for food price hikes

The big culprit for rising food prices appears to be pressure from the U.S.

As you might know, Canada is currently in the midst of a mini “trade war” with the Trump administration, and food is one of the categories that have been hit. One of the big points of contention in the USMCA agreement is milk; previously a highly protected domestic product, it will be subject to U.S. competition under the new deal.

Theoretically, this should actually make milk cheaper to source, but the problem is that the federal government has slapped retaliatory tariffs on various U.S. food imports like coffee and salad dressing. This may have the short-term effect of increasing costs, but on the other hand, these tariffs may not last forever. As to whether Loblaw will end up making good on these price hikes, we’ll have to wait and see.

How Loblaw could benefit

There are some scenarios where Loblaw could benefit from rising food prices, but they put the company in a rather awkward position.

If grocery CEOs are sincere in saying that increased supply costs will “force” price hikes, then the hikes should just minimize losses, not actually increase earnings.

On the other hand, if they are exaggerating the effects of the trade war as an excuse to implement price hikes they already had planned, then earnings may go up. But this puts the grocery stores at odds with customers and may lead to problems with goodwill.

Also worth noting is that CEO Galen Weston said that the price hikes would be small, so the effect on earnings won’t be huge either way.

Is it a buy?

Loblaw has not being doing well in 2018.

Down 11% year-to-date, it suffered a particularly brutal 20% drop in November, which was around the same time that Q3 earnings came in at $106 million, down 88% from a year before, which raises the question of whether the market had the right idea when it sent Loblaw tumbling.

Although the Q3 earnings release noted that the company was negatively impacted by a one-time charge, operating income was also down 35%, which casts serious doubts on the company’s core business. Quite frankly, these look like fundamental problems that a few price hikes won’t overcome.

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Fool contributor Andrew Button has no position in any of the stocks mentioned.

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