NEW KID IN TOWN

The arrival of Wal-Mart supercenters in Canada is probably more widely anticipated by the competition than consumers themselves.Reports of supercenters being built north of the border have been circulating for the last couple of years, but their actual arrival is now only months away, with the first three stores scheduled to open in Ontario this fall, probably in October.One of the stores in London,

The arrival of Wal-Mart supercenters in Canada is probably more widely anticipated by the competition than consumers themselves.

Reports of supercenters being built north of the border have been circulating for the last couple of years, but their actual arrival is now only months away, with the first three stores scheduled to open in Ontario this fall, probably in October.

One of the stores in London, Ontario, is an existing 130,000-square-foot Wal-Mart discount store that will be expanded to 200,000 square feet, according to a company spokesman. A second store, in Ancaster, near Hamilton, is also an existing Wal-Mart that is being increased from 110,000 square feet to 155,000 square feet, while the third in the Toronto suburb of Stouffville is a greenfield project of 200,000 square feet.

The competition has had plenty of advance warning that these behemoths were coming, and has been preparing for their arrival for some time.

For example, Loblaw Cos., Toronto, Canada's largest supermarket operator, has been expanding its general merchandise offering for the last few years in addition to introducing its Real Canadian Superstores to Ontario three years ago from western Canada.

The chain launched a new line of fashion items called Joe Fresh Style in March. The line was placed in 40 Loblaw Superstores but will eventually be available in all 80.

And in April, the com-pany hired a seasoned veteran from Canadian Tire, one of Canada's largest general merchandise retailers, to head its own general merchandise business.

While Loblaw will continue to expand its general merchandise offering, the biggest challenge for the company over the next three years will, ironically, be food, according to one analyst.

The success of the general merchandise business will be linked to the success of the food business, said Perry Caicco of CIBC World Markets, Toronto. That's because the general merchandise side of the store will not be a destination for a long time, despite strong marketing and new products.

Caicco added that with the exception of Loblaw's Blue Menu healthy food line introduced last year, the grocer has not been very innovative in its food offerings, particularly in fresh food where product selection and innovation in prepared foods, deli, bakery, produce and meat "has, in our opinion, not been as robust as in the past."

Meanwhile, all of Loblaw's conventional competitors are very food focused, noted the analyst. He pointed out that Metro is rejuvenating its Dominion chain with a renewed concentration on superior food offerings and is in decent shape geographically since the bulk of its stores are in Quebec, which isn't being targeted by Wal-Mart so far. And Sobeys keeps rolling out food-centric square footage in all markets.

"Even Safeway, with its new lifestyle formats in western Canada, is improving its food offerings, while Wal-Mart is entering the food business in a serious way later this year. In this environment, Loblaw cannot afford to slip behind on its most important business."

Competition for Wal-Mart in London, Ontario, is fierce, where there are two A&Ps, a Sobeys, a Price Chopper and two Loblaws fighting with Wal-Mart within a five-mile radius, according to Rick Pennycooke, president of Lakeshore Group, a Toronto-based retail development consultant.

With only two stores in the Toronto area, Whole Foods Market is not much of a factor in Canada.

Countering Wal-Mart

"Wal-Mart will be competing with any food retailer in the same trading area," said Bill Chisholm, an analyst with brokerage MacDougall, MacDougall & MacTier, Toronto. "The main appeal will be price, so one could say it will be more capacity in the already large discount segment."

He said the most visible response is Loblaw's expansion of its Real Canadian Superstore program. He added that the Ontario market has become more "price competitive this summer as all chains have been sharpening their prices so as not to give Wal-Mart supercenters a clear price advantage."

Chisholm said Loblaw, Metro and Sobeys, Canada's three largest chains, continue to invest in new stores and additional space, with most of Loblaw's and Metro's expansion taking place in their discount formats, while Sobeys continues to expand its Price Chopper chain.

"But it is also expanding the Sobeys banner in smaller upscale locations in the Toronto area with focus on high-quality fresh products," he said.

In addition to preparing for the arrival of Wal-Mart's supercenters, Metro has been busy digesting the acquisition last July of A&P's 236 Canadian stores in Ontario under the A&P, Dominion, Food Basics, The Barn and Ultra Food & Drug banners for $1.5 billion (U.S.). The U.S. parent still has a toehold in Canada through the 15% stake it has retained in Metro.

A&P had annual sales of $3.96 billion and more than 32,000 employees in Canada, boosting Metro's network to 579 stores, over 60,000 employees and sales of close to $10 billion.

Positive Synergies

The acquisition has been so far so good, according to Caicco, with results being solid, as predicted. The estimated cost savings over two years from integration have been raised to $58 million from $54 million.

"The next step is for Metro to begin much-needed renovations and updating the Dominion stores," he said. Dominion was A&P's more upscale banner in Toronto.

Chisholm concurred, saying the acquisition has been very successful as the planned synergies are being realized, although no major changes are visible in the stores.

As for the distribution problems Loblaw encountered last summer, Chisholm said they were mainly "self-inflicted" and are being sorted out.

"The bigger question is its ability to become a successful general merchandiser," he said. "This may prove to be more of a challenge than they originally thought, but they are likely to eventually get it right."

The distribution problem should not be an issue when the supercenters open up, Caicco said. He said Loblaw has more pressing challenges, most notably stimulating its core food business in its conventional supermarkets and its Superstores.

It won't be a slam-dunk for Wal-Mart supercenters, according to analyst Keith Howlett of Desjardins Securities, Toronto, as the retailer faces a highly segmented market.

"The biggest difference in Canada is that discount supermarkets have 30% of the market, led by No Frills [Loblaw], Price Chopper [Sobeys] and Food Basics [Metro]," he said. "In most communities in the U.S. market, there really wasn't a discount segment when Wal-Mart supercenters started going in. Wal-Mart supercenters are the discount segment.

"All that is to say they're up against a much better segmented market here than they faced in the U.S. Their real competition is to pull people from the discount segment."

In addition, Howlett isn't convinced Canadians will want to buy food and clothes at the same time. He predicted Wal-Mart supercenters will have some success with their food offering due to high traffic volume, but it will be a tough slog compared to the U.S., he said.

Metro and Sobeys already have good discount banners and Sobeys is aggressively expanding its Price Chopper banner in Ontario, he pointed out.

"But their main strategy is more like a Kroger or Safeway with extremely good conventional stores with a great fresh assortment to differentiate themselves from Wal-Mart by not having the lowest prices on everything, but to be competitive on the basics," he said.

"Metro has a bit more of a challenge because about 40% of their business in Ontario is in the discount segment through Food Basics, which they acquired through A&P, and they're trying to integrate A&P and not taking many active steps to address the first wave of Wal-Mart supercenters."

He said Dominion is the stronger of the two banners with more renovated stores than A&P and a stronger market position in the metropolitan Toronto area.

"So while they're No. 2 in Ontario [behind Loblaw] they might be No. 1 in the Toronto area," he said.

Price, Selection

Howlett said all chains are adjusting their prices, partly because of Wal-Mart supercenters and partly because of the arrival of Loblaw's Real Canadian Superstores.

"But by introducing Real Canadian Superstores to Ontario, they're sort of narrowing the space for Wal-Mart supercenters, because on one side you've got all these hard discount guys with 8,000 food items, and Real Canadian with 50,000 items, so Wal-Mart will come in sort of in the middle with a typical supermarket selection of 25,000 items. But there's not a lot of room in there."

As for Loblaw's distribution problems, Howlett said they have had a big impact on the bottom line as earnings "have struggled" over the last three quarters while the company's stock has dropped from $63 per share a year ago to around $47 today.

Loblaw alluded to the problems on July 25 when it reported operating income for the second quarter that ended June 17 fell to $294 million or 64 cents a share from $332 million or 70 cents a year earlier.

"Progress continues to be made in stabilizing the supply chain function of the business," said company President John Lederer, with the third-party owned and operated distribution center in Toronto recording productivity improvements. However, continuing investments in lower food prices to drive sales had a "short-term negative impact" on overall earnings.

Lederer said the transformation to meet new challenges is costing Loblaw more than anticipated and that the expected gains from lower operating costs are a year behind schedule and won't be fully realized until 2007.

"It's been a seismic shift in Ontario lately with Loblaw [introducing 20 Real Canadian Superstores in the last three years] and Wal-Mart [supercenters] coming," Howlett said.

In a recent conference call discussing Wal-Mart's first-quarter results, Lee Scott, chief executive officer, said the company has seen double-digit sales growth in Canada and plans on adding 20 stores there this year, including the three supercenters. Last year the company opened 26 stores north of the U.S. border.

"There are many good competitors in Canada, and we look forward to bringing a strong food offering to the Canadian customer," Scott said. "We are leveraging the strong food capability we have in our [British] and U.S. businesses, and we're applying best practices in our Canadian stores and in the supply chain."

He also said the company has been training its supercenter managers outside of Canada to prepare for the openings.

Wal-Mart Canada at a Glance

Based in Mississauga, Ontario, Wal-Mart Canada was launched in 1994 when parent Wal-Mart Stores acquired the 122-unit Woolco Canada chain. It employs 70,000 people.

Discount stores272

Sam's Clubs6

Supercenters0*

*The first three supercenters are planned for this fall in the Ontario towns of London, Ancaster and Stouffville.