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Staying Close to Home

August 26, 2012 | About:
Gordon Pape

Gordon Pape

16 followers
In his classic investment book, "One Up on Wall Street," former Fidelity star manager Peter Lynch tells how he chanced upon one of the biggest coups of his career. His wife had returned home from a trip to the grocery store, all excited. There had been a special promotion going on — a new line of pantyhose known as L'eggs. She showed her husband the plastic egg-shaped package and he immediately recognized it as a winner — not just because of the design but because the manufacturer, Hanes, had taken the unorthodox step of selling stockings in supermarkets.

"Selling stockings in grocery stores was an immensely popular idea," he wrote. "You could have figured that out by seeing the number of women with plastic eggs in their grocery carts at the checkout counter."

But how many people made the connection between those eggs and a company listed on the New York Stock Exchange? Very few. Thanks to his wife, Peter Lynch was one of those few. After doing his due diligence into the manufacturer, he took a large position in the company in his Fidelity Magellan Fund. By the time Hanes was taken over later by Consolidated Foods, it had increased in value six times over (a "six-bagger" in his terminology).

"I'm convinced that Hanes would have been a 50-bagger if it hadn't been bought out," he lamented.

Over the years, I have been periodically reminded about the value of simply looking around you when searching for investment ideas. It happened again last week.

I was one of the speakers at an Education Day in Sudbury organized by Rocco Faiella, managing partner of the Faiella Financial Group. One of the other presenters was Brandon Snow, the dynamic young co-manager (with Alan Radlo) of the Cambridge Canadian Equity Corporate Class, which is part of the CI fund group.

During his presentation, Mr. Show raved about the performance and prospects of Metro Inc. (TSX: MRU, OTC: MTRAF). Now as it happens, I'm in our local Metro store a lot as I have been doing the family shopping since my wife had surgery which left her with mobility problems. It's small as supermarkets go but it is well-organized with an excellent bakery section, fresh produce and a decent deli counter. And, they offer Air Miles. However, I had never thought about Metro in investment terms until I listened to Mr. Snow's talk. That prompted me to take a closer look. Here's what I found.

The company traces its roots back to the late 1940s when a small group of food retailers banded together to act as a single buyer in acquiring products from wholesalers at better prices in order to compete with the major chains of the day. This led to the formation of Lasalle Stores, which became an important force in a highly competitive business.

Over the years, Lasalle grew through a series of mergers and acquisitions and changed its name to the Metro-Richelieu Group. In 1992, the company made a big move by taking over the 48-store Steinberg supermarket group, adding $600 million in annual sales.

The company was listed on the Toronto Stock Exchange in 1993 but because it was so Quebec-oriented the stock did not attract a lot of attention.

The big breakout came in 2005 when Metro invested $1.7 billion to buy out all the A&P Stores in Canada, thus giving it a national profile and a 24% share of the Ontario market. That deal also gave it Dominion Stores which had previously been owned by Conrad Black's Argus Corporation before being sold to A&P. All the stores have since been rebranded with the Metro name.

Today Metro employs 65,000 people and has annual sales of more than $11 billion. The company is a leader in the food and pharmaceutical sectors in Québec and Ontario. It operates a network of more than 600 food stores under several banners including Metro, Metro Plus, Super C, and Food Basics, as well as over 250 drugstores under the Brunet, The Pharmacy and Drug Basics banners.

During his presentation, Mr. Snow repeatedly referred to Metro as a "boring" company — but one that has done very well for its investors. A look at its chart shows steady upward momentum since the stock bottomed out at just over $20 during the 2008-09 crash. Over the past year the shares have moved from the $45 range to the current level and continue to trade above the 50- and 200-day moving averages.

The latest financial results for the fiscal 2012 third quarter, released August 9, were very good. Sales were up 3.8% year-over-year to just over $3.7 billion. Sale-store sales were ahead 1%.

Adjusted net earnings were $147.4 million compared to $127.1 million in the same period last year. On a per-share basis, this worked out to $1.46, fully diluted, an improvement of 18.7% over last year.

For the first 40 weeks of the fiscal year Metro reported sales of almost $9.1 billion, or 3.7% ahead of a year ago. Adjusted net earnings were $347.2 million ($3.41 per share), up from $308.3 million ($2.96 per share) in 2011.

The company has increased its dividend every year since 2003. The latest hike, at the start of this year, was 11.7% bringing the quarterly pay-out to $0.215 per share ($0.86 annually). Based on the current price, the yield is 1.5%.

Metro also has an active stock repurchase plan. Between September 11 of last year and July 27 this year, the company bought over 4.2 million shares for cancellation at an average cost of $50.99. The total expenditure was $216.2 million. As of June 30 there were 97.2 million shares outstanding with a market capitalization of $5.4 billion.

At the end of fiscal 2011, the company reported cash on hand of $255.5 million. Return on shareholders' equity totaled 15.4% in 2011. The balance sheet is sound with long-term debt corresponded to 28.5% of the combined total of long-term debt and shareholders' equity (long-term debt/total capital).

The company operates a relatively low-risk business. Even in the worst of times people have to eat and suppliers of staple foods usually fare better in a recession than the rest of the market.

The bottom line is that while groceries may be a boring business, this is a solid, profitable company that has rewarded shareholders well in recent years. I just wish I had remembered Peter Lynch's advice when I started shopping there a couple of years ago.

The stock closed on the TSX on Friday at $57.93. It also trades on the over-the-counter Pink Sheets in the U.S. where it finished the week at US$58.37.

About the author:

Gordon Pape
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 2.9/5 (7 votes)

Comments

22482494
22482494 - 2 years ago
Good article
MritikCapital
MritikCapital - 2 years ago
Hi Gordon,

Thanks for your article. I enjoy reading your thoughts.

Given that Wallmart and Target are going to expand into grocery in the next 5 years in Canada do you see Metro as being able to withstand the competition.

There is a high probability that fortunes of Canadian Grocers will go the same way as US Grocers over the last decade.

Cornelius Chan
Cornelius Chan - 2 years ago
I also had no idea of Metro. Thanks to this article I have another blue chip Canadian stock to track!

Please leave your comment:


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