Weston Foods: Reports Second Quarter 2018 Results

Toronto / CA. (gwl) George Weston Limited (GWL) announced its consolidated unaudited results for the 12 weeks ended June 16, 2018. GWL’s 2018 Second Quarter Report to Shareholders has been filed with SEDAR and is available at sedar.com and in the Investor Centre section of the Company’s website at weston.ca.

Galen Weston, Chairman and Chief Executive Officer, George Weston Limited, commented that «Loblaw’s base businesses continued to deliver solid results in an extremely competitive environment, and is rapidly advancing its e-Commerce and loyalty offerings across Canada. Weston Foods had a challenging quarter, but we are also starting to see the benefits of our transformation program. We are focused on delivering results and continue the roll out of our transformation program».

2018 Second Quarter Highlights (unaudited)

(CAD millions except where otherwise indicated) 12 Weeks Ended 24 Weeks Ended
For the periods ended as indicated Jun. 16, 2018 Jun. 17, 2017(3) Change Jun. 16, 2018 Jun. 17, 2017(3) Change
Sales CAD 11,245 CAD 11,436 (1.7)% CAD 21,989 CAD 22,239 (1.1)%
Operating income CAD 589 CAD 640 (8.0)% CAD 1,091 CAD 1,153 (5.4)%
Adjusted Ebitda(1) CAD 1,073 CAD 1,038 3.4% CAD 1,991 CAD 1,965 1.3%
Adjusted Ebitda margin(1) 9.5% 9.1% 9.1% 8.8%
Net earnings attributable to shareholders
of the Company CAD 38 CAD 170 (77.6)% CAD 228 CAD 288 (20.8)%
Net earnings available to common shareholders
of the Company CAD 28 CAD 160 (82.5)% CAD 208 CAD 268 (22.4)%
Adjusted net earnings available to common
shareholders of the Company(1) CAD 210 CAD 216 (2.8)% CAD 388 CAD 400 (3.0)%
Diluted net earnings per common share (CAD) CAD 0.21 CAD 1.23 (82.9)% CAD 1.61 CAD 2.08 (22.6)%
Adjusted diluted net earnings per common share(1) (CAD) CAD 1.63 CAD 1.67 (2.4)% CAD 3.01 CAD 3.10 (2.9)%

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Consolidated Results of Operations

Net earnings available to common shareholders of the Company in the second quarter of 2018 were CAD 28 million (CAD 0.21 per common share), a decrease of CAD 132 million (CAD 1.02 per common share) compared to the same period in 2017. The decrease included the decline in the underlying operating performance of CAD 6 million (CAD 0.04 per common share) and the unfavourable year-over-year net impact of adjusting items totalling CAD 126 million (CAD 0.98 per common share), as described below.

  • The decline in underlying operating performance of CAD 6 million (CAD 0.04 per common share) was primarily due to:
    • the unfavourable underlying operating performance of Weston Foods;
    • the unfavourable underlying operating performance of Loblaw Companies Limited’s Retail segment, which as previously announced, the year-over-year performance was expected to be negatively impacted by minimum wage increases, incremental healthcare reform, and the disposition of Loblaw’s gas bar operations in the third quarter of 2017; and
    • the unfavourable impact of an increase in depreciation and amortization, as described below;

partially offset by,

    • the favourable underlying operating performance of Loblaw’s Financial Services segment.

In the second quarter of 2018, Loblaw’s Choice Properties segment completed the acquisition of Canadian Real Estate Investment Trust (CREIT). The impact of the acquisition of CREIT to net earnings available to common shareholders of the Company for the second quarter of 2018 was nominal, as set out in «Loblaw Segment Results» section of the MD+A in the Quarterly Report.

  • The unfavourable year-over-year net impact of adjusting items totalling CAD 126 million (CAD 0.98 per common share) was primarily due to:
    • the fair value adjustment of the Trust Unit liability of CAD 86 million (CAD 0.68 per common share);
    • the unfavourable impact of acquisition and other costs related to Choice Properties’ acquisition of CREIT of CAD 51 million(CAD 0.39 per common share); and
    • the fair value adjustment of the forward sale agreement for 9.6 million Loblaw common shares of CAD 15 million (CAD 0.12 per common share);

partially offset by,

    • the foreign currency translation of CAD 14 million (CAD 0.12 per common share);
    • the fair value adjustment of derivatives of CAD 6 million (CAD 0.05 per common share); and
    • the favourable impact of the reversal of provisions related to the Loblaw Card Program of CAD 4 million (CAD 0.03 per common share).
  • Net earnings available to common shareholders of the Company also included the positive contribution from the increase in the Company’s ownership interest in Loblaw, as a result of Loblaw’s share repurchases for cancellation.

Adjusted net earnings available to common shareholders of the Company(1) decreased by CAD 6 million (CAD 0.04 per common share) to CAD 210 million (CAD 1.63 per common share) in the second quarter of 2018 compared to the same period in 2017. Adjusted diluted net earnings per common share(1) also included the positive contribution from the increase in the Company’s ownership interest in Loblaw (CAD 0.09 per common share). Normalized for the disposition of Loblaw’s gas bar operations, adjusted net earnings available to common shareholders of the Company(1) were relatively flat (increased by CAD 0.01 per common share, or 0.6 percent) compared to the same period in 2017.

Reportable Operating Segments

The Company has two reportable operating segments, Loblaw and Weston Foods. The Company also holds cash, short term investments and a direct interest in Choice Properties of approximately 3.8 percent (2017 – 6.0 percent). Loblaw has three reportable operating segments: Retail, Financial Services and Choice Properties. Loblaw provides Canadians with grocery, pharmacy, health and beauty, apparel, general merchandise, financial services, and wireless mobile products and services. Loblaw also holds approximately 61.7 percent (2017 – 82.5 percent) effective interest in Choice Properties, which owns, manages and develops a high quality portfolio of commercial retail, industrial, office and residential properties across Canada. During the second quarter of 2018, Choice Properties completed the acquisition of CREIT. The Company’s effective interest reflects the issuance of 182,836,481 new Trust Units to Trust Unitholders other than the Company in connection with the acquisition of CREIT.

Weston Foods is a leading North American bakery that offers packaged bread and rolls in Canada as well as frozen and artisan bread and rolls, cakes, donuts, pies, biscuits and alternatives throughout Canada and the U.S.

Weston Foods Segment Results (unaudited)

(CAD millions except where otherwise indicated) 12 Weeks Ended 24 Weeks Ended
For the periods ended as indicated Jun. 16, 2018 Jun. 17, 2017 Change Jun. 16, 2018 Jun. 17, 2017 Change
Sales CAD 468 CAD 509 (8.1)% CAD 985 CAD 1,048 (6.0)%
Operating income CAD 21 CAD 24 (12.5)% CAD 31 CAD 47 (34.0)%
Adjusted Ebitda(1) CAD 48 CAD 54 (11.1)% CAD 92 CAD 115 (20.0)%
Adjusted Ebitda margin(1) 10.3% 10.6% 9.3% 11.0%
Depreciation and amortization(i) CAD 28 CAD 25 12.0% CAD 59 CAD 49 20.4%

Depreciation and amortization includes CAD 4 million year-to-date of accelerated depreciation related to restructuring and other related costs recorded in the first quarter of 2018.

Sales Weston Foods sales in the second quarter of 2018 were CAD 468 million, a decrease of CAD 41 million, or 8.1 percent, compared to the same period in 2017. Sales included the unfavourable impact of foreign currency translation of approximately 2.4 percent. Excluding the unfavourable impact of foreign currency translation, sales decreased by 5.7 percent mainly due to a decrease in volume, including the impact of product rationalization, and the negative impact of changes in sales mix.

Operating Income Weston Foods operating income in the second quarter of 2018 was CAD 21 million, a decrease of CAD 3 million, or 12.5 percent, compared to the same period in 2017. The decrease was primarily due to the decline in underlying operating performance of CAD 9 million, partially offset by the favourable year-over-year net impact of adjusting items totalling CAD 6 million, as described below:

  • the fair value adjustment of derivatives of CAD 6 million; and
  • the impact of restructuring and other related costs of CAD 3 million,

partially offset by,

  • the unfavourable year-over-year impact of the net proceeds from insurance claims of CAD 3 million.

Adjusted Ebitda(1) Weston Foods adjusted Ebitda(1) in the second quarter of 2018 was CAD 48 million, a decrease of CAD 6 million, or 11.1 percent, compared to the same period in 2017. The decrease was driven by the decline in sales and higher input and distribution costs, partially offset by productivity improvements and benefits realized from the transformation program, net of costs.

Weston Foods adjusted Ebitda margin(1) in the second quarter of 2018 decreased to 10.3 percent compared to 10.6 percent in the same period in 2017. The decline in adjusted Ebitda margin(1) in the second quarter of 2018 was driven by the factors as described above.

Depreciation and Amortization  Weston Foods depreciation and amortization in the second quarter of 2018 was CAD 28 million, an increase of CAD 3 million, or 12.0 percent compared to the same period in 2017 due to investments in capital.

Weston Foods Other Business Matters

Restructuring and other related costs  Weston Foods continuously evaluates strategic and cost reduction initiatives related to its manufacturing assets, distribution networks and administrative infrastructure with the objective of ensuring a low cost operating structure. In the second quarter of 2018, Weston Foods recorded restructuring and other related costs of CAD 2 million (2017 – CAD 5 million), which were primarily related to the reorganization costs from the transformation program and the previously announced closure of an unprofitable manufacturing facility in the U.S. that was completed in the first quarter of 2018. Restructuring and other related costs recorded in the second quarter of 2018 was CAD 2 million of severance and exit costs.

Loblaw Segment Results (unaudited)

(CAD millions except where otherwise indicated) 12 Weeks Ended 24 Weeks Ended
For the periods ended as indicated Jun. 16, 2018 Jun. 17, 2017(3) Change Jun. 16, 2018 Jun. 17, 2017(3) Change
Sales CAD 10,923 CAD 11,080 (1.4)% CAD 21,290 CAD 21,484 (0.9)%
Operating income CAD 559 CAD 625 (10.6)% CAD 1,037 CAD 1,118 (7.2)%
Adjusted Ebitda(1) CAD 1,025 CAD 984 4.2% CAD 1,899 CAD 1,850 2.6%
Adjusted Ebitda margin(1) 9.4% 8.9% 8.9% 8.6%
Depreciation and amortization(i) CAD 372 CAD 360 3.3% CAD 741 CAD 720 2.9%

Depreciation and amortization in the second quarter of 2018 includes CAD 119 million (2017 – CAD 121 million) of amortization of intangible assets acquired with Shoppers Drug Mart Corporation.

As previously announced, Loblaw’s year-over-year financial performance was negatively impacted by minimum wage increases and incremental healthcare reform. In addition, the disposition of Loblaw’s gas bar operations, in the third quarter of 2017, had a negative year-over-year impact on financial performance.

In addition, sales, operating income and adjusted Ebitda(1) in the second quarter of 2018 included the impacts of Choice Properties’ acquisition of CREIT, as described below, and the consolidation of franchises as set out in «Loblaw Other Business Matters».

In the second quarter of 2018, Choice Properties completed the acquisition of CREIT. The impact of the CREIT acquisition on consolidated results was an increase in revenue of CAD 69 million, adjusted Ebitda(1) of approximately CAD 48 million and net interest expense and other financing charges of CAD 48 million in the second quarter of 2018. The acquisition had a nominal impact on adjusted net earnings available to common shareholders of the Company(1).

Sales Loblaw sales in the second quarter of 2018 were CAD 10,923 million, a decrease of CAD 157 million, or 1.4 percent, compared to the same period in 2017. The decrease was primarily driven by Retail, partially offset by Choice Properties net of consolidation and eliminations, driven by the acquisition of CREIT. Retail sales decreased by CAD 271 million, or 2.5 percent, compared to the same period in 2017 and included food retail sales of CAD 7,676 million (2017 – CAD 7,988 million) and drug retail sales of CAD 2,924 million (2017 – CAD 2,883 million).

Excluding the consolidation of franchises, Retail sales decreased by CAD 370 million, or 3.5 percent, primarily driven by the following factors:

  • the impact of the disposition of gas bar operations of CAD 376 million; and
  • the impact of incremental healthcare reform on drug retail;

partially offset by,

  • food retail same-store sales growth was 0.8 percent for the quarter after excluding gas bar operations. Including gas bar operations, food retail same-store sales growth was 0.8 percent. The timing of Easter had a nominal impact on food retail same-store sales growth in the second quarter of 2018. In the second quarter of 2017, food retail sales were relatively flat excluding the favourable impact of Easter. Loblaw’s food retail average quarterly internal food price index was marginally lower than the average quarterly national food price inflation of 0.1 percent as measured by «The Consumer Price Index for Food Purchased from Stores» (CPI). CPI does not necessarily reflect the effect of inflation on the specific mix of goods sold in Loblaw stores;
  • drug retail same-store sales growth was 1.7 percent, including pharmacy same-store sales growth of 0.3 percent and front store same-store sales growth of 3.0 percent; and
  • in the last 12 months, Retail net square footage increased by 0.1 million square feet, or 0.1 percent.

The redemption of Loblaw Cards resulted in the delivery of approximately CAD 36 million of free products to customers in the second quarter of 2018, which was provided for in the fourth quarter of 2017. The redemptions did not benefit sales or Loblaw’s financial performance and Loblaw’s management does not believe it had a significant impact on food retail same-store sales.

Operating Income  Loblaw operating income in the second quarter of 2018 was CAD 559 million, a decrease of CAD 66 million, or 10.6 percent compared to the same period in 2017. The decrease in operating income included the improvements in underlying operating performance of CAD 27 million, which was more than offset by the unfavourable year-over-year net impact of certain adjusting items totalling CAD 93 million, as described below:

  • the improvement in underlying operating performance of CAD 27 million was primarily due to Choice Properties net of consolidation and eliminations driven by the acquisition of CREIT, and Financial Services. The improvement was partially offset by Retail which included the unfavourable impact of the disposition of gas bar operations. Retail’s year-over-year second quarter performance was negatively impacted by minimum wage increases and incremental healthcare reform. The decline in underlying operating performance also included the favourable year-over-year contribution from the consolidation of franchises in the second quarter of 2018; and
  • the unfavourable year-over-year net impact of certain adjusting items totalling CAD 93 million was primarily due to the following:
    • the impact of acquisition and other costs related to Choice Properties’ acquisition of CREIT of CAD 108 million; and
    • the change in the fair value adjustment to investment properties of CAD 10 million;

partially offset by,

    • the impact of the reversal of provisions related to the Loblaw Card Program of CAD 11 million;
    • the fair value adjustment of derivatives of CAD 5 million; and
    • the favourable impact of income earned, net of certain costs incurred, from the wind-down of PC Financial banking services of CAD 3 million.

Adjusted Ebitda(1) Loblaw adjusted Ebitda(1) in the second quarter of 2018 was CAD 1,025 million, an increase of CAD 41 million, or 4.2 percent compared to the same period in 2017. The increase was driven by Choice Properties net of consolidation and eliminations driven by the acquisition of CREIT, and Financial Services, partially offset by Retail. Retail adjusted Ebitda(1) decreased CAD 19 million driven by an increase in Retail selling, general and administrative expenses (SG+A), partially offset by an increase in Retail gross profit. The decrease in Retail adjusted Ebitda(1) included the unfavourable impact of the disposition of Loblaw’s gas bar operations of approximately CAD 20 million and the favourable contribution from the consolidation of franchises of CAD 13 million.

  • Retail gross profit percentage was 29.5 percent, an increase of 140 basis points compared to the same period in 2017. Excluding the consolidation of franchises, Retail gross profit decreased by CAD 7 million. Retail gross profit percentage, excluding the consolidation of franchises, was 27.9 percent, an increase of 90 basis points compared to the second quarter of 2017. The increase in Retail gross profit percentage was primarily due to the favourable impact from the disposition of gas bar operations of approximately 70 basis points. Margins were positively impacted by food retail and negatively impacted by healthcare reform.
  • Retail SG+A as a percentage of sales was 20.9 percent, an unfavourable increase of 140 basis points compared to the second quarter of 2017. Excluding the consolidation of franchises, Retail SG+A increased by CAD 25 million. SG+A as a percentage of sales, excluding the consolidation of franchises, was 19.3 percent, an unfavourable increase of 90 basis points compared to the second quarter of 2017, mainly driven by:
    • the unfavourable impact from the disposition of gas bar operations of approximately 60 basis points;
    • higher store costs driven by minimum wage increases; and
    • the unfavourable impact of foreign exchange;

partially offset by,

    • previously announced cost saving initiatives.

Loblaw adjusted Ebitda(1) included an increase in Choice Properties adjusted Ebitda(1), net of consolidations and eliminations, of CAD 50 million, primarily due to the contribution from the investment properties included in the acquisition of CREIT, as well as the expansion of the portfolio through other acquisitions and development of properties and an increase in base rent and operating cost recoveries from existing properties; and an increase in Financial Services adjusted Ebitda(1) of CAD 10 million, primarily driven by higher year-over-year interchange income due to an industry-wide reduction in interchange rates imposed on MasterCard International Incorporated® issuers affecting the first half of 2017 and growth in credit card receivables.

Depreciation and Amortization  Loblaw’s depreciation and amortization was CAD 372 million in the second quarter of 2018, an increase of CAD 12 million, or 3.3 percent compared to the same period in 2017, primarily driven by the consolidation of franchises and an increase in information technology (IT) assets. Depreciation and amortization in the second quarter of 2018 included CAD 119 million (2017 – CAD 121 million) of amortization of intangible assets related to the acquisition of Shoppers Drug Mart.

Outlook

In the second half of 2018, Weston Foods expects:

  • Sales will trend in a similar fashion to the first half of 2018, when compared to last year. Sales are expected to be negatively impacted by volume declines, including the loss of sales from key customers and product rationalization;
  • Adjusted Ebitda(1) will trend in similar fashion to the first half of 2018, when compared to last year. Adjusted Ebitda(1) will be impacted by sales trends as described above, headwinds from higher input and distribution costs in an inflationary environment and minimum wage increases, partially offset by improvements from the transformation program and productivity;
  • Investment in capital expenditures of approximately CAD 230 million for 2018, related to growth, regulatory and maintenance; and
  • Depreciation will increase.

Loblaw is focused on its strategic framework, delivering best in food and health and beauty, using data driven insights underpinned by process and efficiency excellence. This framework is supported by Loblaw’s financial plan of maintaining a stable trading environment that targets positive same-store sales and stable gross margin, creating efficiencies to deliver operating leverage, investing for the future and returning capital to shareholders.

Headwinds from minimum wage increases and healthcare reform will negatively impact Loblaw’s financial performance in 2018. The first half of the year was characterized by incremental cost headwinds and a very competitive retail market. In the second half, management expects cost pressures to increase, including from the newly imposed surtax on certain U.S. imports. Management continues to focus on overcoming these headwinds.

In 2018, on a full-year comparative basis, normalized for the disposition of Loblaw’s gas bar business and the impact of the CREIT acquisition, Loblaw expects to:

  • deliver positive same-store sales and stable gross margin in its Retail segment in a highly competitive market;
  • deliver essentially flat adjusted net earnings(1) growth with positive adjusted earnings per share(1) growth based on our share buyback program;
  • invest approximately CAD 1.3 billion in capital expenditures, including CAD 1.0 billion in its Retail segment; and
  • return capital to shareholders by allocating a significant portion of free cash flow(1) to share repurchases.

For 2018, the Company expects adjusted net earnings(1) to be lower when compared to prior year due to the results of Weston Foods and Loblaw, as described above.