Disclosure issue taints Sobey’s outlook

Sobeys Inc.'s credibility on the Street is shaking like a shopping cart with wobbly wheels.

National Post
February 8, 2001

Disclosure issue taints Sobey’s outlook
Share price slumps: Analysts react after chain slow to report computer glitch
Scott Adams

Sobeys Inc.'s credibility on the Street is shaking like a shopping cart with wobbly wheels.

On Jan. 25, the grocery store chain admitted its new SAP computer system broke down for five days in early December and said it had become such a problem it would scrap the system, leading to a $49.9-million, or 82¢ a share, writedown.

This meant that Bill McEwan, the company's new chief executive, had put himself on a hot seat in record time, as he was only appointed to top spot in November.

While the computer disaster hurt the company's operations and earnings, it was the timing that knocked credibility.

It was only on Nov. 16 that Sobeys completed a stock offering of 9.2 million shares at $27.25, of which Empire Co. (EMPa/TSE) bought 62% to keep its stake at that level. Sobeys made no mention of computer troubles during the offering, nor when it reported second-quarter results on Dec. 5.

Because of the computer disruptions, the company lowered its earnings guidance to $1.48 a share for fiscal 2001 from about $1.75 a share. The company now expects third-quarter earnings of 22¢ a share, down 44% from earlier consensus of 39¢ a share.

Sobeys said it expects the computer system troubles will be limited to the third quarter, but some analysts are more skeptical.

Patricia Baker, analyst with Merrill Lynch, expects fiscal 2002 earnings to be $1.98 a share, below Sobeys' guidance. She is expecting an earnings before interest tax and depreciation margin of about 3.5%, versus about 4.4% expected by Sobeys.

Ms. Baker cut the stock to "neutral" from "accumulate." The computer troubles raise the question of "how and why a now deemed inappropriate systems solution was previously endorsed," she writes. "And was there more than simply a five-day disruption which led to the decision to abandon the platform?"

The stock (SBY/TSE) closed yesterday at $20.70, down 17.2% this year.

Denyse Chicoyne, analyst with BMO Nesbitt Burns, cut her target on the stock to $27.50 from $31.50, but kept her "market perform" rating on the stock.

Jonathan Norwood, analyst with Beacon Securities Ltd., cut the stock to "market perform" from "outperform" and his target to $26 from $30. "This [computer] system that they are scrapping, they once flogged it as the platform for their growth," he said.

The system failure affected operations accounting for about 20% of Sobeys' sales, Mr. Norwood said. Sobeys has said operations on the new system will revert to the old system. The company also said it will find a replacement system in three or four months, but Mr. Norwood believes that timing could be too ambitious, as the company began installing the now-scrapped system in January, 1998, and the company still needs to hire a new chief information officer.

Sobeys said it plans to increase sales by $5-billion in the next two years, implying 43% growth, as Ms. Baker points out. She writes she was perplexed by the growth target, as it implies Sobeys plans an acquisition — sales have been growing only 3% since it acquired Oshawa Group two years ago.

"We have yet to be convinced," she writes, "that the firm has ably integrated its Oshawa acquisition and would hold the view that an additional acquisition could severely tax the organization."

Sobeys has a long way to climb in the grocery market, as the company admitted recently it is number three in all its markets, except the Maritimes where it ranks second, and it needs to rank number one or two in all its markets to be successful.

That explains why Sobeys' stock hasn't performed as well as Loblaw Cos. Ltd. (L/TSE), for instance. Loblaw shares have a total return of 35.2% over the past two years, while Sobeys returned 10.2%. Loblaw is more expensive, with a current price-earnings multiple of 30.9, compared to Sobeys at 12.6.

"Sobeys is always going to play second fiddle to Loblaw," said Ian Nakamoto, portfolio manager with Bonham & Co. Asset Management Inc. He isn't an investor in Sobeys. Loblaw might be a more expensive stock, Mr. Nakamoto said, but it is a leader in its markets and has premier real estate locations — an advantage that can't easily be upset.

SOBEYS INC.:

CEO: Bill McEwan
Ticker: SBY
Listed: Toronto Stock Exchange
Head office: 115 King Street Stellarton, N.S. B0K 1S0
Telephone: (902) 752-8371 www.sobeys.com

INCOME STATEMENT
2nd Qtr. 1st Qtr. 4th Qtr.
11.04.00 08.05.00 05.06.00
Operating revenue $000s 2,853,100 2,856,000 2,854,649
Net income $000s 23,200 27,700 23,146
Earnings per share $ 0.41 0.49 0.41
Dividends - cash $ 0.06 0.06 0.06
Cash flow operations $000s (62,100) (55,300) 110,366
Cash flow operations per share $ (1.101) (0.982) 1.96

3rd Qtr. 2nd Qtr. 1st Qtr.
01.29.00 10.30.99 07.31.99
Operating revenue $000s 2,665,300 2,651,900 2,834,300
Net income $000s 18,500 17,600 21,000
Earnings per share $ 0.33 0.31 0.38
Dividends - cash $ 0.06 0.06 0.06
Cash flow operations $000s 16,800 47,200 131,800
Cash flow operations per share $ 0.30 0.85 2.37

P/E ratio: 12.62 Dividend yield: 1.16 (at 2/6/01)

RATIOS

05.06.00 05.01.99 05.02.98
Net profit margin 0.73 (0.13) 1.18
Return on equity 10.24 (1.71) 20.66
Return on assets 4.51 0.63 5.70
Total debt/equity 1.13 1.46 1.20
Current ratio 0.84 0.80 1.05
Avg. price/book value 1.3 1.3 n.a.

Source: Data Supplied by FP Datagroup

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