Metro Inc

TSX:MRU

Earnings Call Transcript 2020-Q1

[Operator]

Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to the METRO INC. 2020 First Quarter Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]I would now like to turn the conference over to your speaker today, Sharon Kadoche, Senior Adviser, Investor Relations and Risk at METRO INC. Please go ahead.

[Sharon Kadoche, Senior Advisor of Investor Relations & Risks]

Thank you, Julie. Good afternoon, everyone, and thank you for joining us today. Our comments will focus on the financial results of our first quarter, which ended December 21, 2019. With me today is Mr. Eric La Flèche, President and Chief Executive Officer; and François Thibault, Executive VP and Chief Financial Officer. During the call, we will present our first quarter results and comment on its highlights. We will then be happy to take your questions. Before we begin, I would like to remind you that we will use in today's discussions different statements that could be construed as forward-looking information. In general, any statement which does not constitute a historical fact may be deemed as a forward-looking statement. Expressions such as expect, intend, are confident that, will and other similar expressions are generally indicative of forward-looking statements. The forward-looking statements are based upon certain assumptions regarding the Canadian food and pharmaceutical industries, the general economy and our annual budget as well as our 2019-2020 action plan.These forward-looking statements do not provide any guarantees as to the future performance of the company and are subject to potential risks, known and unknown as well as uncertainties that could cause the outcome to differ materially. A description of these risks, which could have an impact on these statements, could be found under the Risk Management section of our 2019 annual report. We believe these statements to be reasonable and pertinent at this time and represent our expectations. The company does not intend to update any forward-looking information, except as required by applicable law.I will now turn the call over to François.

[François Thibault, Executive VP, CFO & Treasurer]

Thank you, Sharon, and good afternoon, everyone. A few things before I go over our Q1 results. First, as you're aware, effective this quarter, we report results under the new standard IFRS 16, which effectively removed the distinction between operating leases and finance leases. Our press release and interim report provide information on new standards, but in a nutshell, $1.962 billion of assets are added on the balance sheet with a corresponding net amount in lease liabilities and retained earnings. On the P&L, the impact on net earnings is positive of $700,000, which is not material and less than $0.01 of EPS. This represents roughly the quarterly impact going forward. In December, when we presented new standard during a conference call, our forecast had indicated an impact that was closer to $0.01. I remind you that fiscal 2019 numbers have not been restated for IFRS 16.Secondly, we disposed of our MissFresh business for a net after-tax loss of $4.2 million. We have adjusted our numbers for this loss. And finally, we acquired the minority interest in Groupe Première Moisson for a cash consideration of $51.6 million.So turning to our results. Total sales reached $4.03 billion versus $3.98 billion last year, an increase of 1.3%. Excluding the impact of the new standard IFRS 16, which reclassifies rental sublease income, sales reached $4.04 billion or a 1% increase -- 1.6% increase, sorry. Same-store sales were up 1.4% for the quarter, and our internal basket inflation was about 2%. Our food same-store sales stands at 2% when adjusting for the Christmas shift. Our pharmacy same-store sales were 3.6%.During the quarter, we captured $50 million in cost synergies related to the Coutu acquisition compared to $11 million for the same quarter last year. This represents synergies of $65 million on an annualized basis, the same amount, same level that we disclosed in the previous quarter.Gross margin stood at 19.6% of sales or 19.9% when adjusting for the impact of IFRS 16 compared to 19.4% for the same period last year.Operating expenses as a percentage of sales came in at 10.6% versus 11.3% last year. Excluding the loss on the disposal of MissFresh for $7.5 million this quarter and the gain of $7.4 million on the divestiture of pharmacies in Q1 last year, the operating expense ratio was 10.4% of sales versus 11.5% last year. And when we exclude the impact of IFRS 16, the ratio stands at 11.7%.Adjusted EBITDA stood at $370.6 million. That's up $57.4 million and represented 9.2% of sales versus 7.9% for the corresponding quarter last year. Normalized for the IFRS 16 impact, adjusted EBITDA was up 4.7% and represented 8.1% of sales. The income tax expense for the quarter was $60.3 million versus $66.7 million last year, representing an effective tax rate of 26.2% and 24.7%, respectively. The company recognized a $3.3 million tax benefit during the first quarter of 2020 following the sale of MissFresh.Adjusted net earnings were $180.9 million compared to $172.2 million last year. That's up 5.1%. Adjusted net earnings per share were $0.71 versus $0.67 last year, an increase of 6%. The adoption of IFRS 16, as I mentioned at the beginning, had no material impact on this quarter's EPS.Under the normal course issuer bid program, we may repurchase up to 7 million shares between November 25, 2019, and November 24, 2020. As at January 17, 2020, the company repurchased 850,000 shares at an average share price of $55 for a total consideration of $46.7 million.Given our strong financial position and the fact that the Jean Coutu operations are well integrated, the Board of Directors has approved a change to our dividend policy, whereby we are increasing our payout ratio range from 20% to 30%, to 30% and 40% of the previous year's adjusted net earnings. The Board also declared a quarterly dividend of $0.225, a 12.5% increase over our previous quarter -- over our previous quarterly dividend. The annual dividend payment will represent about 31% of fiscal 2019 adjusted net earnings.That's it for me. I'll now turn it over to Eric.

[Eric Richer La Fleche, President, CEO & Non]

Thank you, François, and good afternoon, everyone. The 2020 fiscal year is off to a good start with solid revenue and earnings growth in a very competitive environment in the first quarter. Food same-store sales were up 1.4% and up 2% when adjusting for the Christmas calendar shift, that's on top of 3.2% in the same quarter last year. Our average basket was up, while traffic and tonnage were slightly down due to the Christmas shift. Adjusting for the transfer of the holiday sales, overall tonnage and traffic were up slightly, so our Q1 results are in line with our expectations.Our internal food basket inflation was 2%, down from 2.8% in the previous quarter. We experienced produce deflation in the quarter as we cycled high produce inflation last year. Also fresh meat costs have been quite volatile over the past few months, and our teams did a very good job to deliver effective merchandising programs. The competitive environment was intense but not worse than recent quarters. We are pleased with our holiday sales, and most of that performance will be in our Q2 results.Pharmacy same-store sales grew by 3.6% with a 4.1% increase in prescription drugs and a 2.7% increase in front store sales, fueled in part by a strong performance in OTC and HABA. Prescription count grew by 2.5%. We are also pleased with our pharmacy sales during the holiday season.The integration with Jean Coutu is proceeding as planned, including the work in the Coutu warehouse to increase automated capacity as well as a deployment of the Coutu retail management systems across the Brunet network. The other priority in the short-term is the renewal of the Varennes collective bargaining agreement. As mentioned on the last call, we expect to start capturing the distribution synergies in the latter part of the year.E-commerce sales continued to grow, and our KPIs are improving every month. Although very modest as a percentage of total sales, e-com sales are largely incremental to the METRO banner as we gain share of wallet from existing customers and attract new customers. We will soon be adding a second hub store in Québec City, bringing the total to 8 stores for the province.In the quarter, CapEx totaled $76.7 million, an increase of $18 million compared to the same quarter last year. This reflects our increased investments in our Ontario supply chain project, which is progressing well.On the retail side, we opened 4 new stores, including 2 relocations, converted 2 METRO stores to food basics and expanded or remodeled 8 stores for a net square footage addition of 86,000 square feet or 0.4%.In conclusion, we are well positioned to reach our objectives this year and are confident in our ability to grow by focusing on our customers' needs, continuing to invest in our retail network and supply chain and, most of all, executing well every day. This, combined with the higher dividend and share buybacks, will continue to create value for our shareholders.We will now be happy to take your questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Karen Short with Barclays.

[Karen Fiona Short, Research Analyst]

Just a little color. I know you indicated that the competitive landscape was kind of consistent. But obviously, tonnage did slow meaningfully, sequentially. So wondering if you could just give a little bit more color on that specifically.

[Eric Richer La Fleche, President, CEO & Non]

Well, again, I said in the opening statement, it was intense, highly promotional, like it always is. But it wasn't really worse than in recent quarters. And in the fall, we always see aggressive promotional prices. It was again this fall. Around Thanksgiving it was, and leading into Christmas, it was also. But what we saw was not extraordinary or out of the -- what we're used to. So I would say the competitive environment was intense, but not worse than it was in the recent quarters. That's my answer.

[Karen Fiona Short, Research Analyst]

Okay. And then just on the pharmacy side. Obviously, the pharmacy comps were strong on a 1- and 2-year basis. And while the front-end was strong, I mean it did decelerate sequentially fairly meaningfully. Any thoughts as to why that would have happened?

[Eric Richer La Fleche, President, CEO & Non]

Well, we're very happy with our front store sales in pharmacy. The 2.7% number is for the quarter ending, again, on December 21. There is a transfer of sales in that business also. We didn't point out exactly the amount. But yes, I would tell you that the sales trend in the front store is maintained, and we're doing fine in the front store on trend as we were.

[Karen Fiona Short, Research Analyst]

Okay. And then last question for me. On the payout ratio, just curious if you could just go -- run through the philosophy on increasing the ratio from a Board perspective?

[Eric Richer La Fleche, President, CEO & Non]

So our previous policy was 20% to 30%, target, 25%. We were at the 30% number as of this year. Following the acquisition of Coutu, which is going well, and the cash flow profile generation of the Coutu assets, the company I think has evolved to a position where we can pay out a higher percentage of our previous year's earnings as a dividend. So that's why the policy was changed from a range of 20% to 30% to a range of 30% to 40%. And the increase that we are giving for this year, 12.5%, will bring the payout ratio to almost 31%, right?

[François Thibault, Executive VP, CFO & Treasurer]

Yes.

[Eric Richer La Fleche, President, CEO & Non]

31%. So that's the rationale.

[Operator]

Your next question comes from the line of Irene Nattel with RBC Capital Markets.

[Irene Ora Nattel]

Eric, I was just wondering if, continuing the discussion around consumer behavior, competitive environment, what you're seeing, if you're seeing anything around consumer trade down, increasing penetration on promotions or just the shift in traffic from conventional to discount?

[Eric Richer La Fleche, President, CEO & Non]

So there hasn't been -- or we haven't seen a noticeable shift. The number of discount stores continues to grow. We have converted 2 -- as I said in my opening remarks, 2 METROs were converted in Ontario. So that long-term trend to discount, especially in Ontario, continues but not at an accelerated pace. We haven't seen consumers trading down in that respect.That said, at METRO, we think we're really well positioned with both formats, 3 if you add Adonis, on the food side, with conventional, full-service, discount, well represented in both provinces to capture whatever market environment is before us. But as we speak today, the conventional business is doing well.

[Irene Ora Nattel]

That's great. And certainly, when you talk about the adjustment for the Christmas -- for the shift in Christmas, when you kind of do the math, it makes sense. But should we assume that you get all of that back in Q2? I think this morning at the AGM, you mentioned that really best way to -- will be to look at Q1 and Q2, when you're pleased with the overall holiday sales. Can you provide a little bit more color there?

[Eric Richer La Fleche, President, CEO & Non]

Well, it's exactly what you just said. Yes, we are pleased with our holiday sales in both food and pharmacy. That will help our Q2 for sure. We are comping good numbers in Q2, by the way, last year, but we're happy with our Christmas sales. There is a transfer clearly from Q1 to Q2. And you'll have to add up Q1 and Q2 in due time to see the overall performance, and we're confident that we'll be okay.

[Irene Ora Nattel]

That's very helpful. And just switching gears for a moment, if I might. On the NCIB, are there any plans to accelerate the pace of repurchase as we move through the year?

[François Thibault, Executive VP, CFO & Treasurer]

I think -- Irene, it's François. I think the pace that we've done so far, 850,000 shares I think is a good pace. We have authority to do 7 million. We'll see obviously what market conditions are, but we have no change in our capital allocation. CapEx, dividend and excess cash will be used to do share buybacks, keeping a financial leverage of adjusted debt to EBITDA of 2.5. So absolutely no change going forward on that allocation of capital. So yes, I think the pace that we've seen so far is a good pace for the year.

[Irene Ora Nattel]

Okay. So as we think about sort of in aggregate, François, we should assume that you're going to try and keep leverage as close to that level as possible?

[François Thibault, Executive VP, CFO & Treasurer]

Yes. That's our -- the 2.5 is maintained as a target financial leverage.

[Operator]

Your next question comes from the line of Mark Petrie with CIBC.

[Mark Robert Petrie]

Eric, just on the tonnage topic, you guys have delivered tonnage growth for effectively 4 years. And even with the calendar shift, it's flat. So by no means an overly concerning result, but definitely a departure from the run rate. So how do you sort of interpret that result? And when you break down the drivers and levers, what stands out to you in terms of the performance of the business?

[Eric Richer La Fleche, President, CEO & Non]

Well, it's one quarter. The tonnage is essentially flat on a comparable basis. We were comping strong numbers. The market is competitive, as I said. So nobody is giving us a free ride, and we have to fight for every dollar. That said, the tonnage is fine like produce where we experienced a bit of a deflation. Our tonnage is really strong in produce. So I think we will continue to develop effective merchandising programs, and I'm confident that our tonnage will be fine. This is the result for one quarter.

[Mark Robert Petrie]

Yes. Okay. And in terms of the balance between sales and gross margin, I mean another solid -- very solid gross margin performance in the quarter. I know you don't split out food or pharmacy, but can you give us some of the -- a sense of the biggest drivers of that margin expansion? I mean was it the same carryover from Q4 in terms of synergies, mix and private label?

[Eric Richer La Fleche, President, CEO & Non]

Yes. So synergies, there is a bit of an uptick in synergies Q1 over Q1 last year. But I would say, most of the driver there is good effective merchandising, more weight on the fresh side and good shrink management. So it's a lot of small stuff by each banner and store operations to deliver a decent gross margin number. So don't get the impression that we walked away from sales. And we think we're effective in our merchandising, and we're happy with the result.

[Mark Robert Petrie]

Okay. And then just the last question. I just wanted to ask sort of longer-term about the results that you've seen from all the remodels that you've completed over the last number of years. Obviously, that's an ongoing project, and it's an evolution. But could you just talk about the impact that you see, sales lift, paybacks and how that has evolved over time? And as the stores mature, does the performance sort of progress as you would expect?

[Eric Richer La Fleche, President, CEO & Non]

In general, yes, we're happy with the results of our investments. Most investments meet the targets that we set for returns. We typically get a good lift in the first year, and we continue to see a lift in the next couple of years that's above the average. So that hasn't changed. The cost of the projects has gone up. That's for sure. So the return comes off a little bit. But overall, it meets our hurdle rates or more. I'm quite happy with the performance in both conventional discount on the food side and also pharmacy. So we're disciplined with our investments. We look at every project, project-by-project, and we challenge the pro formas, and we challenge the investment, and we try to make the returns that we have been used to. So it's more challenging with higher cost of projects, but we'll manage.

[Mark Robert Petrie]

Okay. And just to sort of clarify, separate -- or excluding the higher cost of -- upfront cost of the investment, the sales performance or uplift is consistently on track with your expectations, versus what it would've been 5 years ago?

[Eric Richer La Fleche, President, CEO & Non]

Nobody is batting for 1,000, but in general, yes, we're happy with our returns.

[Operator]

Your next question comes from the line of Michael Van Aelst with TD Securities.

[Michael Van Aelst, Research Analyst]

So first off, just on the inflation, CPI in your provinces was around 3.6% in the quarter and your inflation was 2%. That's a bigger gap than what we've seen in recent quarters. Are you seeing more trade down? Or is that a mix difference? Or what do you think accounts for that? And if you had a crystal ball, where do you think your basket inflation would be for the year?

[Eric Richer La Fleche, President, CEO & Non]

Well, we don't have a crystal ball, so I'm not going to go there. But the number we report on inflation is the number that we have based on what we sell at store level. So it's dollars for item, department-by-department, and this is the number that we saw in the quarter. So yes, maybe it's a slightly bigger gap to CPI. We typically see a gap to CPI. I'm not sure it's that significant. Again, there's no change in the methodology, and it's the same way of reporting it. So crystal ball, 2% is the number we can live with and, hopefully, it'll stay in that neighborhood. We'll have to see.

[Michael Van Aelst, Research Analyst]

Okay. And then I want to look at some of the costs because there are some big movements in some of your OpEx line items. You had wages and benefits down 2%, for example. But then your other was up 9% and your rent, excluding -- if you adjust for IFRS, it looked like it was up something, I think, 6% or 7%, if I remember correctly. So can you talk about what's going on there? Like, wages and benefits being down 2%, is that a head count reduction? Or is that bonus accruals being lower?

[Eric Richer La Fleche, President, CEO & Non]

I'll ask François to take this.

[François Thibault, Executive VP, CFO & Treasurer]

I think it's good productivity numbers. The employee benefits expense has gone up, as you see, by $3 million. That's mostly a reflection of lower interest rates, which increased the pension expense in our results. On the rent, yes, you're right, adjusting for the IFRS 16, it's higher. It's mostly utilities cost in Ontario. So we've had significant increases in utility, energy expense in Ontario. And on the other line is the usual suspects, higher transportation costs, the investments that we're making in e-com for the GTA, some IT with the projects we're having. So as we said, we're going to start cycling the higher transportation costs in Q2. So everything else being equal, we should cycle that. But these are the main items that explains the differences.

[Michael Van Aelst, Research Analyst]

And duplicate overhead costs, where do they stand now? And where do we see those? When you're talking about like the merging of the DCs and trying to ramp up Varennes and prepare it?

[François Thibault, Executive VP, CFO & Treasurer]

They would all be -- they would be in there. They will be in the SG&A -- mostly in the SG&A.

[Michael Van Aelst, Research Analyst]

The other Varennes, I guess?

[Eric Richer La Fleche, President, CEO & Non]

So there's no huge duplicate overhead costs relating to the DC projects in Toronto. Yes, we have some consultants in...

[François Thibault, Executive VP, CFO & Treasurer]

You talked about Varennes?

[Michael Van Aelst, Research Analyst]

Yes, Varennes.

[Eric Richer La Fleche, President, CEO & Non]

Oh, sorry about that.

[François Thibault, Executive VP, CFO & Treasurer]

Yes. So there is -- so it's all there in -- between -- it's all there in the transportation expense, in the wages. So that's -- as we said, that's the last bucket of synergies that we will realize once we merge the DC and the transportation later this year, but it's all in those numbers. Yes.

[Michael Van Aelst, Research Analyst]

And just finally then, on your balance sheet, there are some big increases in accounts receivable and inventories on a year-over-year basis. Can you explain what's happening there?

[François Thibault, Executive VP, CFO & Treasurer]

You're talking -- not accounting for IFRS 16?

[Michael Van Aelst, Research Analyst]

Well, I don't know how big of an impact there is on accounts receivable or inventories.

[François Thibault, Executive VP, CFO & Treasurer]

Well, there's a big long-term accounts receivable increase due to the IFRS 16 of $629 million long term and $87 million on short term.

[Michael Van Aelst, Research Analyst]

Yes. No, I'm talking more about the -- I think it's just your normal inventories.

[François Thibault, Executive VP, CFO & Treasurer]

But it's in line. It's a growth of business ahead of the Christmas season. And you look at the trend between the accounts receivable, inventory and the payables are in line.

[Operator]

Your next question comes from the line of Patricia Baker with Scotiabank.

[Patricia A. Baker, Analyst]

Actually, all of my questions have been answered. So I'll just let someone else get on the line.

[Operator]

Your next question comes from the line of Vishal Shreedhar with National Bank Financial.

[Ryan Li, Associate]

This is Ryan for Vishal. Most of my questions have been asked. Just one last one. Just with the MissFresh divestiture, what was the reasoning behind that? Was there a -- when you picked it up versus now, was there a difference in view of where the market was going, changes in where METRO viewed this business model, whether it was viable or not? Able to comment on that?

[Eric Richer La Fleche, President, CEO & Non]

Well, yes, a quick comment. MissFresh was a small startup. We thought there was more potential in the meal kit business for us than we saw, especially at store level. And then the subscription e-com model, that's not a model that we're willing to continue. We thought we were not the best owner going forward for that business. So it didn't meet our objectives. We thought that with the METRO customer ecosystem, we could leverage that to gain some sales on the meal kits. It was challenging. There was no real advantage with that. So better someone else than us.

[Operator]

Your next question comes from the line of Chris Li with Desjardins.

[Christopher Li, Research Analyst]

Just a few quick ones for me, hopefully. Just first, your comment about the labor productivity improvements. I'm just wondering, is that capturing some of the early benefits that you're seeing from the self-checkouts and electronic shelf labels?

[Eric Richer La Fleche, President, CEO & Non]

Yes. I think it's a contributing factor. It is still early days for self-checkouts and shelf labels, but it's certainly meeting our objectives at this stage in terms of usage by customers and hours saved. More work to do, work in progress, but it's delivering and will deliver the savings that we are hoping for. And it's slightly contributing to the wage and benefit improvement.

[Christopher Li, Research Analyst]

Okay. And I should probably know this as well. The self-checkout, is that predominantly just within the METRO conventional stores? Or are they also in the Jean Coutu store as well?

[Eric Richer La Fleche, President, CEO & Non]

For now, it's all on the food side, not on the pharmacy side. And we have it in METRO stores, and we have it also in discount stores. Mostly METRO, I would say.

[Christopher Li, Research Analyst]

And is pharmacy a potential for rollout in the future?

[Eric Richer La Fleche, President, CEO & Non]

Some, some potential. I've seen it at competitors. So it really depends location-by-location. When the customer count is very high, it could be helpful. So it's something we will look at, but nothing to announce yet.

[Christopher Li, Research Analyst]

Okay. And you mentioned also you're building an extra -- another hub store in Québec from 7 to 8. What would that coverage be going forward once you have that store up and running for e-commerce?

[Eric Richer La Fleche, President, CEO & Non]

So our strategy is to target urban centers, not the whole province for now for obvious reasons, and Québec City is a larger urban area. So we were operating with one store, and it's reaching or will soon reach capacity. So we decided to open a second store. And that's an advantage of this hub store model. You expand when demand is there, and you can add at a reasonable cost some more capacity. So that's why we're opening that second store in the next few weeks.

[Christopher Li, Research Analyst]

And then in Ontario, you have 2 stores, I believe, right now. What's the plan for the next 12 months in Ontario?

[Eric Richer La Fleche, President, CEO & Non]

Well, for competitive reasons, we're going to keep our plans to ourselves. The 2 stores are ramping up. Sales are growing. Operational metrics are improving every month. So more work to do. It's more competitive out there in Ontario as in other domains. So pleased with our progress, but work in progress.

[Christopher Li, Research Analyst]

Okay. And then maybe switching quickly to just the drug reforms. Any particular events that your team is keeping a close eye on for this year? I'm thinking in particular on things like potential reduction in branded drug prices or any potential changes to dispensing fees, any of that nature.

[Eric Richer La Fleche, President, CEO & Non]

So yes, we, of course, keep a close eye on all of that. We are not expecting major reforms to hit us in the near future. We're keeping a close eye, but it's not on our radar in the short term.

[Christopher Li, Research Analyst]

Okay. And then maybe one quick one for François. Just your leverage target of 2.5x, I just want to make sure I understand. Is that -- so if you based on now Q1 with IFRS 16 fully baked in, as you calculate that leverage, is that 2.5x as of Q1? Or is that your target?

[François Thibault, Executive VP, CFO & Treasurer]

That's -- so it's measured on the pre-IFRS impact, okay? So taking the existing debt and using the methodology by S&P, so capitalizing the leases as per the S&P method, so no change on that. We'll see as the year progresses, whether we convert that ratio to a post-IFRS, and we'll use the equivalent. But I want to make sure that we get further ahead in the year before we adjust for any leverage. So for now, it's the same methodology that we've been using in the past.

[Operator]

There are no further questions at this time. I will turn the call back over to the presenters for closing remarks.

[Sharon Kadoche, Senior Advisor of Investor Relations & Risks]

Thank you all for your interest in METRO, and we will speak again soon to discuss our second quarter results on April 22. Thank you.

[Operator]

This concludes today's conference call. You may now disconnect.