Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to the Metro Inc. 2020 first quarter results conference call. At this time, all participants are in a listen only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to turn the conference over to your speaker today, Sharon Kadoche, Senior Advisor on Investor Relations and Risk at Metro Inc. Please go ahead.
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 be using today's discussion different statements that could be construed as forward-looking information. In general, any statement which does not constitute a historical fact may be viewed 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 community's 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.
Thank you, Sharon Kadoche, 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 standard, but in a nutshell, CAD 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 CAD 700,000, which is non-material and less than CAD 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 CAD 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 CAD 4.2 million. We have adjusted our numbers for this loss. Finally, we acquired the minority interest in Groupe Raymond Chabot for a cash consideration of CAD 51.6 million. Turning to our results, total sales reached CAD 4.03 billion versus CAD 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 reach CAD 4.04 billion for a 1.6% increase. Same-store sales were up 1.4% for the quarter, and our internal basket inflation was about 2%. Our food same-store sales stand at 2% when adjusting for the Christmas shift. Our pharmacy same-store sales were 3.6%. During the quarter, we captured CAD 50 million in cost synergies related to the Jean Coutu acquisition, compared to CAD 11 million for the same quarter last year.
This represents synergies of CAD 65 million on an annualized basis, the same amount, same level that we disclosed in the previous quarter. Gross margins 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 % of sales came in at 10.6% versus 11.2% last year. Excluding the loss on the disposal of MissFresh for CAD 7.5 million this quarter and the gain of CAD 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. When we exclude the impact of IFRS 16, the ratio stands at 11.7%. Adjusted EBITDA stood at CAD 370.6 million. That's up CAD 57.4 million and represented 9.2% of sales versus 7.9% for the corresponding quarter last year.
Normalized with the IFRS 16 impact, adjusted EBITDA was up 4.7% and represented 8.1% of sales. The income tax expense for the quarter was CAD 60.3 million versus CAD 66.7 million last year, representing an effective tax rate of 26.2% and 24.7%, respectively. The company recognized a CAD 3.2 million tax benefit during the first quarter of 2020 following the sale of MissFresh. Adjusted net earnings were CAD 180.9 million, compared to CAD 172.2 million last year. That's up 5.1%. Adjusted net earnings per share were CAD 0.71 versus CAD 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 issue 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 CAD 55 for a total consideration of CAD 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%-30%, to 30% and 40% of the previous year's adjusted net earnings. The board also declared a quarterly dividend of CAD 0.225 at a 12.5% increase over our previous quarter or 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.
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 shifts. 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. 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.
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 HBA. 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 the 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 continue 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 wallets from existing customers and attract new customers. We will soon be adding a second hub store in Quebec City, bringing the total up to eight stores for the province. In the quarter, CapEx totaled CAD 76.7 million, an increase of CAD 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 four new stores, including two relocations, converted two Metro stores to Food Basics, and expanded or remodeled eight stores for a net square footage addition of 86,000 sq ft or 24%. 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 a higher dividend and share buybacks, will continue to create value for our shareholders. We will now be happy to take your questions.
As a reminder, to ask a question, you will need to press star one on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the attendee roll, sir. Your first question comes from the line of Karen Short with Barclays. Please go ahead.
Hi, thanks for taking my question. Just a little color. I know you indicated that the competitive landscape was kind of consistent. Obviously tonnage did slow meaningfully sequentially. Wondering if you could just give a little bit more color on that specifically.
Again, I said in the opening statement it was intense, highly promotional like it always is. It wasn't really worse than in recent quarters. In the fall, we always see aggressive promotional prices. It was again this fall, around Thanksgiving it was, leading into Christmas it was also. What we saw was not extraordinary or out of what we're used to. I would say the competitive environment was intense, not worse than it was in the recent quarters. That's my answer.
Okay. Just on the pharmacy side, obviously the pharmacy comps were strong on a one and two-year basis. While the front end was strong, it did decelerate sequentially fairly meaningfully. Any thoughts as to why that would have happened?
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 I will 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.
Okay, last question from me. On the payout ratio, just curious if you could just go run through the philosophy on increasing the ratio from a board perspective.
Our previous policy was 20%- 30%, target 25%. We were at the 30% number as of this year. Following the acquisition of Jean 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. That's why the policy was changed from a range of 20%- 30% to a range of 30%- 40%. The increase that we are giving for this year, 12.5%, will bring the payout ratio to almost 31%, right? 31%. That's the rationale.
Great, thanks. I'll get back in the queue.
Thank you.
Your next question comes from the line of Irene Nattel with RBC Capital Markets. Please go ahead.
Thanks, and good afternoon. 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.
There hasn't been, or we haven't seen a noticeable shift. The number of discount stores continues to grow. We have converted two, as I said in my opening remarks, two Metros were converted in Ontario. 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. Three, 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. As we speak today, the conventional business is doing well.
That's great. Thank you. Certainly when you talk about the adjustment for the shift in Christmas, when you do the math, it makes sense. 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 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?
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.
That's very helpful. Thank you. 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?
I think, Irene, that'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 7 million. We'll see obviously what marketing 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. Absolutely no change going forward on that allocation of capital. Yes.
Okay
I think the pace that we've seen so far is a good pace for the year.
Okay. 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?
Yes. The 2.5 is maintained as a target financial leverage.
That's great. Thank you.
Welcome.
Your next question comes from the line of Mark Petrie with CIBC. Please go ahead.
Hey, good afternoon. 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. By no means an overly concerning result, but definitely a departure from the run rate. How do you sort of interpret that result? When you break down the drivers and levers, what stands out to you in terms of the performance of the business?
Well, it's one quarter. The tonnage is essentially flat on a comparable basis. We were comping strong numbers. The market's competitive, as I said, nobody's giving us a free ride, 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. I think we will continue to develop effective merchandising programs, I'm confident that our tonnage will be fine. This is a result for one quarter.
Yep. Okay. In terms of the balance between sales and gross margin, I mean, another very solid gross margin performance in the quarter. I know you don't split out food or pharmacy, but can you give us a sense of the biggest drivers of that margin expansion? Was it the same carryover from Q4 in terms of synergies, mix, and private label?
Synergies, there's a bit of an uptick in synergies Q1 over Q1 last year. I would say most of the driver there is good effective merchandising, more weight on the fresh side, and good shrink management. It's a lot of small stuff by each banner and store operations to deliver a decent gross margin number. 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.
Okay, thanks. Then just the last question, I just wanted to ask 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, could you just talk about the impact that you see, sales lift, paybacks, and how that has evolved over time? As the stores mature, does the performance progress as you would expect?
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. That hasn't changed. The cost of the projects has gone up, that's for sure. The return comes up a little bit, overall, it meets our hurdle rates or more, and quite happy with the performance, in both conventional discount on the food side and also pharmacy. We're disciplined with our investments. We look at every project by project, and we challenge the pro formas, and we challenge the investments, and we try to make the returns that we have been used to. It's more challenging with higher costs of projects, but we'll manage.
Okay, just to clarify, excluding the higher upfront cost of the investment, the sales performance or uplift is consistently on track with your expectations.
Nobody's batting for 1,000.
Versus what it would've been five years ago.
Nobody's batting for 1,000, but in general, yeah, we're happy with our returns.
Yeah. Okay. Thanks a lot.
Yeah.
Your next question comes from the line of Michael Van Aelst with TD Securities. Please go ahead.
Thank you. First up, 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? If you had a crystal ball, where do you think your basket inflation would be for the year?
Well, we don't have a crystal ball, I'm not going to go there. The number we report on inflation is the number that based on what we sell at store level. It's dollars for item, department by department, this is a number that we saw in the quarter. Yeah, 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, it's the same way of reporting it. Crystal ball, 2% is a number we can live with, hopefully, it'll stay in that neighborhood. We'll have to see.
Okay. 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, then your other was up 9%, your rent, if you adjust for IFRS, looked like it was up something, I think six or seven, if I remember correctly. Can you talk about what's going on there? Like wages and benefits being down 2%, is that a headcount reduction, or is that bonus accruals being lower?
I'll ask François to take this.
Oh, I think it's good productivity numbers. The employee benefits expense has gone up, as you see, by CAD 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 costs in Ontario. We've had significant increases in utility energy expense in Ontario. 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. As we said, we're going to start cycling the higher transportation costs in Q2. Everything else being equal, we should cycle that. These are the main items that explain the differences.
Okay. Duplicate overhead costs from where they stand now and where do we see those when you're talking about the merging of the DCs and trying to ramp up Varennes and prepare it?
They would be in the SG&A, mostly in the SG&A.
The other line item?
There's no huge duplicate overhead costs relating to the DC projects in Toronto. Yes, we have some consultants and-
You saw that, yeah.
Huh?
You saw that-
Oh, Varennes?
Yeah, Varennes.
Oh, sorry about that.
Yeah.
It's all there in the transportation expense, in the wages. 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. It's all in those numbers.
Just finally, on your balance sheet, there's some big increases in accounts receivable and inventories on a year-over-year basis. Can you explain what's happening there?
You're talking not accounting for IFRS 16?
Well, I don't know how big of an impact there is on accounts receivable or inventories.
Well, there's a big long-term accounts receivable increase due to the IFRS 16 of CAD 629 long-term and CAD 87 million on short-term.
No, I'm talking more about, I think it's just your normal inventory.
Yeah. It's in line. It's the growth of business ahead of the Christmas season. You look at the trend between the accounts receivable, inventory, and the payables, are in line.
Okay. I'll follow up after. Thank you.
Your next question comes from the line of Tricia Baker with Scotiabank. Please go ahead.
Yeah, good afternoon. Actually, all of my questions have been answered. I'll just let someone else get on the line.
Your next question comes from the line of Vishal Sridhar with National Bank Financial. Please go ahead.
Hi, this is Ryan for Vishal. Most of my questions have been asked, just one last one. With the MissFresh divestiture, what was the reasoning behind that? 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? Are you able to comment on that?
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. In the subscription e-com model, that's not a model that we were willing to continue, and we thought we were not the best owner going forward for that business. 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, better someone else than us.
Okay. Thank you. That's it.
Your next question comes from the line of Chris Li with Desjardins. Please go ahead.
Hi. Good afternoon. 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?
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 certainly contributing to the wage and benefit improvement.
Okay. I should probably note 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?
For now, it's all on the food side, not on the pharmacy side. We have it in Metro stores, and we have it also in discount stores. Mostly Metro.
Is pharmacy a potential for rollout in the future?
Some potential. I've seen it at competitors, it really depends location by location. When the customer count is very high, it could be helpful. It's something we will look at, but nothing to announce yet.
Okay. You mentioned also you're building another hub store in Quebec from seven to eight. What would that coverage be going forward once you have that store up and running for e-commerce?
Our strategy is to target urban centers, not the whole province for now, for obvious reasons, and Quebec City is a larger urban area. We were operating with one store, and it's reaching or will soon reach capacity. We decided to open a second store. 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. That's why we're opening that second store in the next few weeks.
In Ontario, we have two stores, I believe, right now. What's the plan for the next 12 months in Ontario?
For competitive reasons, we're going to keep our plans to ourselves. The two stores are ramping up. Sales are growing. Operational metrics are improving every month. More work to do. It's more competitive out there in Ontario as in other domains. Pleased with our progress, work in progress.
Okay. 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.
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.
Okay. Maybe one quick one for François. Just your leverage target of 2.5 times, I just wanna make sure I understand. If you based on now Q1 with IFRS 16 fully baked in, as you calculate that leverage, is that 2.5 times as of Q1, or is that your target?
It's measured on the pre-IFRS impact. Okay, taking the existing debt and using the methodology by S&P, capitalizing the leases as per the S&P method. 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 equivalents. I wanna make sure that we get further ahead in the year before we adjust for any leverage. For now, it's the same methodology that we've been using in the past.
I see. Okay. Thank you both for your answers.
You're welcome, Chris.
There are no further question at this time. I will turn the call back over to the presenters for closing remarks.
Thank you all for your interest in Metro, and we will speak again soon to discuss our second quarter results on April 22nd. Thank you.
This concludes this conference call. You may now disconnect.