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Monday, September 22, 2014

Canadian Grocery Wars

by Amy Erixon, Toronto


In September 2013, Loblaws and Metro, two of Canada’s three largest Grocers, announced comfortable single digit increases in revenues accompanied by a shocking 40% decline in net profits.  Both of these chains had recently commenced restructuring/repricing programs designed to blunt the erosion of market share from the onslaught of American retailers, recognizing the risk that matters could soon get a whole lot worse.   Nova Scotia based Sobey’s, the #2 Canadian chain, had just completed acquisition of Safeway Canada’s 200 western Canadian stores, and reported a respectable high single digit growth in both same store revenues and profits, while anticipating cost savings synergies from the acquisition.   But its shares fell just like the others; approximately 6% on these announcements.    Later that same month Amazon announced it would begin rolling out on-line groceries in Canada in 2014 (Amazon enjoys a 2.5% share of the US grocery market) and shares fell again – in the background was more bad news - Target was scheduled to open an initial 124 stores across Canada beginning in Q2, 2014.

Wal-Mart’s response to these market changes was to redouble its expansion plans (delivering some 60 new superstores across Canada in 2014 with an additional 35 planned for 2015, bringing its store count to 430) while concurrently ramping up its on-line grocery service to include some 2000 items (Amazon now delivers over 15,000).  Grocery e-commerce in Canada currently represents less than 1% of total sales, but is growing rapidly as more providers add offerings.  Wal-Mart has a third leg to its strategy (yet to be seen in Canada);  small footprint urban “green” grocery stores comprising 12,000-18,000 sf, featuring broad day-lighting, organic produce and super energy efficient building construction and operating systems.  These stores have been wildly successful in the pilot U.S. markets.   Wal-Mart is currently petitioning the City of Vancouver to build Canada’s first Net-Zero store in this format (so far the Vancouver planning department isn’t biting).

Fast forward to September 2014 and a high octane offensive and defensive battle is evident.  Not broadly publicized, but very quickly growing Quebec based Dollarama expanded its footprint from 800 to 880 stores in Ontario and Quebec this year and has plans to add an additional 400 stores over the next few years as it moves into Central and Western Canada.   (Not surprisingly, Dollarama together with its counterparts Dollar Store and Dollar Tree are also the fastest growing format south of the border.)  Costco, another American discounter, reported earnings this week.  Canadian division profits increased 18% on 14% higher same store sales and Costco announced it is planning to add 85 stores to its 110 store Canadian footprint, including 25 next year.   Target, the most recent American entrant, is not enjoying the same success.  Although it continues to struggle with logistics and maintaining stock in its far-flung store network, last week contrary to market expectations, Target announced it will expand by constructing 34 more stores in Canada in 2015, bringing its total to nearly 160. 

Canada’s first American player, Safeway, has been struggling on both sides of the border.  Following a series of well publicized labor disputes and market positioning difficulties, Safeway began capitulating last year - closing 72 of its Chicago area Dominick’s stores, and selling its 200 store footprint in Canada to Sobey’s in a transaction valued at $5.4 billion.    A year earlier Sobeys acquired 236 retail gas stations in Quebec and Atlantic Canada with proceeds from sale of Empire Theatres chain to Century Theatres, narrowing its focus on business lines synergistic with food and drug offerings. 

Sobey’s, founded in Nova Scotia in 1907, is now 100% owned by conglomerate Empire Holdings, TSX:EMP-A.TO, whose retail roots are Lawtons Drug Stores Limited.  Empire expanded into groceries in 1981 with the acquisition of Sobey’s and this combination has so far, been the home country winner - and the company appears to be the industry’s strategic leader.  In 1964 Sobey’s organized its real estate holdings in a separate holding company and became an active shopping center developer.  It was able to IPO the property company, Crombie, in 2006 as a REIT, TSX:CRR.UN. Empire still holds 40%+ of the Crombie shares.   In 2004 Sobey’s acquired a 72 store discount chain for $61 million and launched a successful brand in this segment.  In 2013 to capitalize on the rising “foodie” movement, Sobey’s formed an association with renown Canadian Chef, Jamie Oliver to enhance food education in its stores and promote what he refers to as a “fresh food revolution”.  Oliver hosts a popular CBC TV series, and is author of a number of award winning cookbooks.   Consistent with these market leading decisions, on September 10, 2014 Sobey’s announced continued strong results, with same store sales rising 1.3% - and thanks to the Safeway acquisition synergies being realized, revenues were up 35%, and earnings rose 46.8%.   

In July, 2013 Toronto based Loblaws, Canada’s largest grocer, successfully IPO’d 415 of its 2300 Corporate owned stores into a publicly traded Real Estate Investment Trust TSX:CHP.UN, in a transaction valued at $7 billion (Loblaws also operates 4,700 independently owned grocery stores).  In April of this year Loblaw’s, announced a $12.6 billion take-over of Shopper’s Drug, also Canada’s largest with over 1300 pharmacies.   This summer Loblaws rolled-out an e-commerce platform with the unique feature that you can order groceries on-line and pick them up at your local drug store if that is more convenient than the superstore location.  But below the surface Loblaws continues to show signs of trouble.  On July 17 Galen Westin, heir to the company, announced the third management shakeup in as many years, including personally taking the helm as its President as well as Executive Chairman.  Anticipated synergies are not to be found and several top executives at Shoppers Drug announced their departure as the company announced a second quarter loss of $456 million, as compared to earnings of $116 million for the same quarter a year earlier (which were down 40% from 2012).  The grocer noted that Shoppers added 40% more revenue and same store sales were up 1.6%, signaling that corporate restructuring at Loblaws is far from over.    In the most recent Analyst call Mr. Westin noted that the chain is looking to upscale its offerings including more fresh and pre-prepared offerings.

Meanwhile Quebec based Metro, which acquired Canada’s #4 Grocer A&P in a $1.7 billion transaction back in 2005 was at that time already in the drug store business, operating 573 grocery stores and 256 drug stores under 11 brands.  In 2008  Metro undertook a rebranding and retrofit program to unify the store layouts and format to 2 distinctive brands, both catering to the discount end of the market.   Metro same store sales were up nearly 2% year over year, but earnings were flat due to “extreme pricing pressure”, according to the CFO on a recent analyst call. 

Grocery store wars are far from new.  Between 1927 and 2005, 31 grocery chains went out of business in Canada.   What many Canadians don’t know is that for the last 5 years in the US grocery stores have been the most rapidly shrinking segment of the retail scene.   The grocery business, like all of retailing today is feeling the pinch of rising income inequality (with all growth at the top and bottom ends of the price scale), changing formats (buy local, fresh, and on-line) and growing store oversupply.   

In my affluent suburban Toronto neighborhood, every single grocery store (including the 3 privately owned and operated organic specialty stores) is undergoing a facelift, while the local retailer association together with a lot of support from the neighbors has redoubled efforts to keep Target, Costco and WalMart more than 5 miles away, north of the QEW.   My local stores are beginning to offer cooking classes, recipes in the aisles and are beginning to install energy efficient enclosed refrigerated units.   Competition is rising and change is evident everywhere. 

 

Friday, September 12, 2014

Mid-Year Industrial Momentum Will Continue

by Erik Foster (Chicago)

Investors have been on a buying spree in the industrial sector nationally for a number of reasons.  Many are drawn by the potential for income stability and by the long-term growth trends given the positive macroeconomic outlook for distribution facilities, as well as tempered spec development keeping rental growth on it's positive pace.  According to Avison Young’s review of data from the past two years, investment in industrial assets across the United States rose 55 percent since mid-year 2012, from $15 billion to $23 billion.

The West region continued to see the majority of activity, moving from $5.2 billion in investments at mid-year 2012 to approximately $6.6 million in 2014, according to research from Real Capital Analytics.

The gains from 2013 were particularly strong in secondary markets such as San Diego (260% increase), Orlando (202% increase), Indianapolis (138% increase), Memphis (125% increase) Atlanta (96% increase) and Charlotte (90% increase). Investors are moving into these and other secondary markets as activity, and pricing, is peaking in core markets.

The mid-year statistics also showed that the Midwest was a steady performer. It was the only region to experience gains in each period, moving from 15.1 percent of activity in 2012 to 16.4 percent in 2013 to 16.5 percent in 2014. This is not surprising, as recoveries always come later to the Central U.S.

The Southeast region was the most volatile during that time period, moving from the second most active region in 2012 to fifth in 2013 and back to second again in 2014. Markets with the greatest declines in sales activity from mid-year 2013 to mid-year 2014 were Miami, 71 percent; Eastern Pennsylvania, 56 percent; and Baltimore, 50 percent.


For the remainder of the year, look for continued strong demand from investors for all classes of industrial assets, core, core-plus and value add.  Also, look for new players to be arriving on the acquisition scene, it is not the same old cast of characters; the global marketplace is taking a very strong interest in industrial assets.



Monday, August 18, 2014

Canada maintains sub-10% office vacancy rate, while U.S. market shows improvement

By Mark E. Rose (Toronto)

Canada’s overall office market softened during the 12-month period ending at mid-year 2014, while the U.S. office market experienced strengthening tenant demand, positive net absorption and falling vacancy rates. Despite rising slightly, Canada’s average vacancy of 9.2% points to the ongoing health of the Canadian office market, and still compares favourably to the U.S. at 13.5%. The gap between Canadian and U.S. vacancy rates has narrowed during the past year.

These are some of the key trends noted in Avison Young’s Mid-Year 2014 Canada, U.S. Office Market Report, released last week.

Click here to view the full report.

The report covers the office markets in 39 Canadian and U.S. metropolitan regions: Calgary, Edmonton, Guelph (Southwestern Ontario), Lethbridge, Mississauga, Montreal, Ottawa, Quebec City, Regina, Toronto, Vancouver, Winnipeg, Atlanta, Austin, Boston, Charleston, Chicago, Columbus, Dallas, Denver, Detroit, Fairfield County, Houston, Las Vegas, Long Island, Los Angeles, New Jersey, New York, Orange County, Philadelphia, Pittsburgh, Raleigh-Durham, Reno, San Diego County, San Francisco, San Mateo, South Florida, Tampa and Washington, DC.

With improving economic conditions in the U.S. and Canada experiencing moderation, office markets across North America remain healthy – with strong indicators for downtown areas. As we have seen with industrial markets, quite a bit of momentum is building in the U.S., as increasing demand from tenants and falling vacancy rates have led to a substantial increase in new development. Construction is partially being driven by tenant demand for modern, efficient workspaces that are in transit-served and mixed-use environments.

Office job growth in the U.S., led by business and professional services employment, has continued to expand this year, buoying confidence in the leasing and investment sectors, and leading to rising rental rates and strengthening statistical performance for office product. Some Canadian markets have had the wind taken out of their sails lately, but an uptick in cross-border activity could help rectify the imbalance between supply and demand that some markets are witnessing, as considerable levels of new supply are scheduled for delivery over the next several years.

North America’s office markets are well-positioned to show further growth for the remainder of the year and into 2015. Even markets that have seen slower recovery, negative absorption or oversupply present opportunities for our tenant and investor clients.

According to the report, of the 39 office markets tracked by Avison Young across North America, 23 markets saw vacancy rates fall by varying degrees during the 12-month period ending June 30, 2014. The difference between the two countries’ year-over-year improvement was quite apparent as two-thirds of the U.S. markets posted vacancy decreases.

Collectively, the Canadian office market registered an overall vacancy rate of 9.2% at mid-year 2014 – up from 8% at mid-year 2013 – and is trending towards the recent recessionary peak of 9.9% in mid-year 2010. Though still in double-digit territory, the U.S. office market vacancy rate is trending lower, finishing the first half of 2014 at 13.5%, down from 14.2% one year earlier.

Improving market fundamentals in the U.S. office sector are a welcome respite, and although the recovery has not been moving as quickly as we would like it to, metrics are trending in the right direction. An improving U.S. economy and commercial real estate sector – in this case, the office sector – bodes well for Canada.

The report shows that more than 83 million square feet (msf) was under construction across Canada and the U.S. at mid-year 2014, up from 66 msf one year prior. In Canada, downtown areas account for roughly two-thirds of construction activity, whereas in the U.S., approximately 61% is focused in the suburbs. 

Click here to listen to my Q3 2014 audiocast. 

Monday, August 11, 2014

Rents continue to rise in London

By Mark E. Rose (Toronto)

As a follow-up to my blogs on the North American commercial real estate markets last week, I’d like to now have a closer look at the U.K., where Avison Young opened two offices this spring, in London and Thames Valley.

In Central London: The current office vacancy rate is 7.2%, with a sub 5% level in some districts, such as Victoria, Bloomsbury and Holborn. The average West End headline rents are £100 per square foot (psf), up from £65 psf at the low point in the market in the third quarter of 2009. The average City headline rent is £60 psf, up from £42.50 psf from that third-quarter 2009 low point.

There is 4.5 msf in the development pipeline, but take-up for new-build space was 5.5 msf in the last year, suggesting we are moving into a period of mismatch between demand and supply. Therefore, Central London offices’ shortfall is set to become acute from 2015 onwards, and this trend suggests that rents will continue to increase.

On the investment front, yields in prime office investments in the West End have remained steady at 3.75%, while yields in the City have hardened to 4.5, the lowest level since the second quarter of 2007. £2.2bn transacted across London in the first quarter of this year. Private Investors are prolific in the West End, transacting more than 60% of the deals in the first quarter for a total of £454 million. In the City, investment is led by pension and life insurance companies, which transacted £404 million, or approximately 35% of the total volume, in the first quarter.

In the South East, the vacancy rate ranges from 6.8% to 8.3%, and take-up is being led by the financial and business services, who represent 28% of the market. Rents range from £18 psf in Basingstoke to £32 psf in Maidenhead. Prime headline rents increased by an average of 5% over the past 12 months, and they are expected to continue increasing due to the ripple effect of tenants being priced out of Central London. On the investment front, there is a lack of buying opportunities in the South East, putting pressure on the pricing, and yields have therefore hardened to 5.25%. UK Funds remain the dominate buyer in the South East market, but overseas buyers are starting to compete there.

Thank you and please watch for the Avison Young Mid-Year 2014 Canada, U.S. Office Market Report next week. 

You can also now listen to my Q3 2014 Commercial Real Estate Audiocast “New office supply outpacing demand in Canada, int’l capital continues to favour U.S., rents continue to rise in London” here: http://www.avisonyoung.com/media-room/ceo-video-audiocasts

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