[Please note that all currency references are to the Canadian dollar except if indicated otherwise.]
George Weston Ltd (symbol OTCPK:WNGRF; Food Retail and Distribution; Shares outstanding: 146.6 million; Market cap: $17.7 billion; www. weston.ca) owns controlling interests in Loblaw Companies and Choice Properties.
With the sale of the bakery business in December 2021, George Weston Limited (“Weston Ltd” ) simplified its structure and removed an underperforming asset from its portfolio. The substantial capital base and ample annual cash flow put the company in a strong position to increase the return of capital to shareholders and improve the discounted valuation.
George Weston Limited: Owner of Quality Businesses
Weston Ltd is a Canadian public company, founded in 1882 by a bread salesman, George Weston. Consecutive generations of the Weston family managed and expanded the business over the past 140 years through organic growth, and selected acquisitions. Major acquisitions include the grocery retailer Loblaw Companies in 1953 and a drugs-and-beauty-product chain, Shoppers Drug Mart, in 2013. Other major corporate highlights were the creation and listing of a real estate investment trust, Choice Properties (2013), and the sale of the bakery business in 2021, leaving Weston with two major publicly listed assets, namely Loblaw and Choice Properties.
Premier Food and Drug Retailing: Loblaw Companies (“Loblaw”) is a Canada-based company, with market-leading operations in grocery and drug retail and a smaller financial services operation. Retail, operating through 2,500 stores, contributes 95% of the earnings before interest, tax, and depreciation (“EBITDA”).
The food division which contributes 70% of the retail revenues, operates under various banners including Loblaws, Zehrs, Maxi, T&T, and Real Canadian Superstore. Joe Fresh is a smaller family clothing outlet.
Shoppers Drug Mart is a drug and beauty product retailer operating through 1,300 locations. This business was acquired by Loblaws in 2013 for $13 billion and contributes 30% of the retail revenues.
PC Financial provides credit cards, insurance brokerage, and bank accounts. This operation contributed about 5% to the EBITDA in 2021.
The balance sheet is sound with a BBB Issuer rating from S&P. Debt makes up 45% of total capital and the interest cost is covered 4.5 times.
The business has done well, especially since the Shoppers Drug Mart acquisition. Over the past five years, the gross profit increased at a compounded rate of 4.1% per year; courtesy of improving profit margins and an active share buyback program, the earnings per share increased by 11.1% per year and the dividend by 5.5%.
The company fared well during the peak pandemic period as it was able to increase prices, provide Covid vaccine services, and scaled up its online shopping services. For 2022, forecasts indicate a further 12% growth in earnings per share.
Although the share price has gained substantially over the past two years, the valuation of the stock looks reasonable when compared to a group of North American peers.
Choice Properties – Slow-growth: Choice Properties (“Choice”) is a publicly listed real estate investment trust that owns 699 properties with over 64 million square feet of leasable area. The properties are spread across Canada but the largest concentration is in Ontario (43% of net operating income), followed by Alberta (19%), Quebec, and British Columbia.
Most of the portfolio’s rental income is derived from the retail space (77% of net operating income), followed by industrial (15%), and residential (8%). In the retail portfolio, the bulk of the space is leased to grocery stores and pharmacies (70% of net operating income). Top tenants Loblaw and Shoppers Drug Mart take up 56% of the retail space with Costco, Walmart, Winners, and Home Depot among the other tenants.
Occupancy averaged 98% since the listing in 2013 but dipped to 97.1% in 2020 and 2021. Leases are mostly long-term with about 10% of the leasable area coming up for renewal every year.
Over the past five years, Choice managed to grow its adjusted funds from operations per unit by 3% while the dividend per unit increased by 5% – this is pedestrian by all accounts. However, the growth was set back by the Covid-pandemic which resulted in additional vacancies in the retail and office space (recently sold).
The balance sheet is in good order with net debt to asset value at 40.1% and the debt service coverage ratio at 3.3 times; Choice has an Issuer rating of BBB from S&P. The REIT distributes 88% of its adjusted cash flow from operations; the current yield is 4.8%.
Consensus forecasts indicate that Choice will recover most of the ground lost since the start of the pandemic with funds from operations topping the pre-pandemic high by 2023. Longer-term growth could be boosted by the 11.4 million square feet of the leasable area currently in various phases of development.
Given the quality of the portfolio and the attractive yield, the valuation seems reasonable and in line with other comparable retail REITs.
Corporate governance – minority shareholders in the hands of the controlling shareholders
Galen Weston beneficially owns and controls, through Wittington Investments Limited, 53.6% of Weston’s outstanding common shares. He is also the Chairman of the Weston Board in addition to his roles as Chairman and President of Loblaw. He effectively controls the whole group including the three listed entities.
Weston Ltd discloses an extensive list of related party transactions between group companies and other businesses controlled by the Weston family. These transactions include rental payments to Wittington, purchases from Associated British Foods (a UK-listed company also controlled indirectly by the Weston family), various property transactions between Wittington and Choice Properties, and a venture capital partnership.
Presumably, all these transactions are done at arm’s length at market-related prices. Nevertheless, minority shareholders need to be aware that the Weston family is in full control of Weston Ltd as well as all the listed entities.
Unlocking value from the portfolio
Our primary valuation measure for the valuation of Weston Ltd is the assessment of the net asset value of the company.
Weston Ltd owns 52.6% of Loblaw and 61.7% of Choice; these account for 75% and 25% of the net asset value, respectively. There was a cash balance of $1.3 billion at the end of December 2021 as well as corporate debt of $571 million and preferred shares of $835 million.
We estimate the current discount to the net asset value at 15%. Over the past five years, the discount fluctuated between a premium of 4% and a discount of 23%.
Through various corporate actions in 2021, Weston Ltd strengthened the holding company balance sheet and created a cleaner structure. These actions included the sale of the bakery business at the end of 2021 for net proceeds of $1.2 billion, raising cash by participating in the Loblaw share repurchase program, and redeeming some expensive debentures.
We estimate that Weston Ltd will have capital of $2.4 billion available to deploy in 2022 and $5.7 billion through 2025. This assumes a continuation of the regular dividend payments by the operating companies and the share buyback program from Loblaws (and Weston’s participation). This does not take into account any further borrowing against their almost unencumbered asset base of $27 billion.
The question is how the capital will be deployed. Here are some options, ranked in order of preference of a minority shareholder with an eye on the narrowing of the discount:
- Ramp up the share purchase program: Weston Ltd could buy back 4% of the issued shares annually based on the current share price. This will cost around $3.5 billion until 2025 and reduce the share count by 15%.
- Increase the dividend growth rate: If the company increases the dividend growth rate from the historical 4.7% to 7.5% per annum it will cost $1.5 billion through 2025.
- Pay off debt: Weston Ltd has debentures with a face value of $550 million due in 2024, 2032, and 2033. The longer-dated debentures with a face value of $350 million carry interest rates of 7.1% and 6.7% respectively. The 2024 debenture has a lower interest rate at 4.12% and has a face value of $200 million. We estimate the annual interest cost on the debentures around $26 million.
- Redeem the preferred shares: Weston Ltd considers its perpetual, non-voting preferred shares as shareholder capital but has the option to redeem the shares for cash; the nominal value is $835 million, pays a weighted dividend yield of 5.26% with a dividend cost of $44 million per year.
- Privatize Weston Ltd: Galen G Weston, through Wittington Investments Limited, holds 53.6% of George Weston’s shares. To buy out minorities at the current net asset value will cost $12.7 billion. It was reported in December 2021 that Wittington sold its interest in Selfridges Group for 4 billion pounds (C$6.9 billion) which may be helpful should the family decide to privatize Weston Ltd.
- Further acquisitions: The (now sold) bakery business has not performed well over the past 5 years and was an ongoing drag on Weston Ltd’s performance. Further investment in food and drug retailing or real estate will probably be done directly in the operating companies. However, the family may decide to become more adventurous in their investment endeavors. In this regard we note that Wittington established a venture capital fund in 2020 with Weston Ltd and Loblaw as co-investors. The purpose of the fund is to invest in technology-oriented companies at all stages of their life cycle that operate in commerce, healthcare, and food sectors. The capital commitment for Weston Ltd and Loblaw was $66 million.
We think that options 1, 2, 3, and 5 can support a narrowing of the valuation discount, while venture capital investments (option 6) will probably cause the discount to widen given the limited transparency normally afforded to these investments.
A sound dividend record
Weston Ltd has paid a dividend every year since at least 1994 and has increased the dividend by 4.7% per year over the past decade. The company paid a dividend of $2.25 per common share in 2021; the yield on the current share price is 1.4%. The dividend was covered 1.25 times by the unconsolidated free cash flow from ongoing operations in 2021 (excluding proceeds from the participation in the Loblaw share purchase program).
Quality assets at a discount
Weston Ltd holds a portfolio of quality assets that should trade at no more than a small discount to its net asset value. Access to a considerable pool of capital provides the board with a range of options to narrow the discount.