Inflation has dropped considerably from last year, but is still double the Bank of Canada’s target. The central bank needs inflation to drop to 2%, but the latest figures indicate an annual rate of 4.4%.
At this rate, your money could lose half its value within 16 years. Put another way, you need to earn a return of at least 4.4% right now to preserve purchasing power. I believe Canada’s most dominant grocery store chain Loblaw Companies (TSX: L) could be the ultimate inflation hedge in this environment. Here’s a closer look.
Food inflation
Food is a key element of the cost of living and this segment of your monthly bill has sky-rocketed in recent months. Over the past year, food costs have gone up by 8.9%. Over the past three years, the average grocery bill has jumped by a whopping 21%.
Some items have jumped faster than that headline number. Edible oils, excluding olive oil, have soared 19.3% over the past 12 months alone. Bread, eggs, cheese, and butter were all up 11.8% over the same period, while pasta was up 14.2%.
Simply put, the price of nearly every essential item on the grocery store shelf is increasing.
Loblaw, one of the largest chains of grocery stores in Canada, has successfully managed to pass most of these cost increases to ordinary consumers. This is reflected in their earnings statements. The company registered a gross profit margin of 31.3% in the first quarter of 2023. The gross margin was 31.1% in the same quarter of 2022.
Loblaw also declared an adjusted EBITDA margin of 10.9% this quarter, compared to 10.7% in the same quarter of last year.
In other words, margins are extremely stable, which indicates tremendous pricing power. The grocery store giant can raise prices when costs go up so that its profits are preserved. That makes Loblaw an inflation hedge.
Stock valuation
Loblaw’s immense pricing power and inflation hedge status is also reflected in the stock price. The stock is up 4.5% over the past 12 months. Meanwhile, the dividend yield is roughly 1.54%. That means the total return was nearly in line with the inflation rate over the past year.
At the moment, the stock trades at a price-to-earnings ratio of 20, which implies an earnings yield of 5%. Management expects earnings per share to grow “in the low double digits” over the next year, according to their latest earnings report.
Bottom line
Loblaw has demonstrated immense pricing power. The company has successfully passed on all the additional costs of food and pharmaceuticals to its customers. That’s helped it preserve profit margins over the past year. Now, the company expects to grow sales while retaining its margins while the stock trades at a favourable multiple.
If you’re looking for an inflation hedge, Loblaws stock could be an ideal fit. Keep an eye on it.
