Barclays_Canadian_Retail__Consumer_Still_working_toward_the_new_normal_initiatin.pdf

EQUITY RESEARCH 25 January 2012

CANADIAN RETAIL & CONSUMER Still working toward the new normal; initiating coverage with a 2-Neutral rating

We expect 2012 to be a challenging year for the Canadian retail & consumer sector: “Belt tightening” is expected to continue as highly levered consumers struggle with constrained discretionary funds and a deterioration in employment and wage growth expectations. The housing market is expected to gear down in 2012, with some risk that prices could contract for the first time since 2008. Incumbent retailers are facing accelerated growth by Wal-Mart in 2H12 followed by Target’s arrival in 2013. Against this backdrop, we rate the sector 2-Neutral and recommend investors limit holdings to the more compelling defensive stocks for at least the next 6-9 months, while establishing positions in attractively valued discretionary names for potential price appreciation once the defensive-to-discretionary rotation takes hold toward the end of 2012, into 2013.

Top Picks: Of our 12 covered stocks we rate three 1-Overweight: Among defensive names we like Dollarama (DOL.TO) and Tim Hortons (THI.TO; THI.US) with their strong earnings growth (2012E EPS growth of 17% and 18%, respectively) and FCF profiles. In the discretionary segment we like Canadian Tire (CTC-A.TO), trading well below its historical P/E and poised to benefit when consumer spending bounces back.

We prefer drugstores to food retailers: The food and drugstore group, normally “go to” stocks for defensive-oriented investors, is facing extraordinary challenges that have eroded its defensive appeal. Although we prefer the drugstore stocks (2-Equal Weight: Shoppers Drug Mart (SC.TO) and Jean Coutu (PJC-A.TO)) largely on easing drug reform “drain,” continued regional reform uncertainty and modest earnings growth are likely to limit valuations, making total return potential less compelling than for THI and DOL, in our view. Food retail is likely to be the most challenged sector in our coverage universe in 2012 as already strained growth is further pressured by intensifying competition from Wal-Mart and Target’s arrival. Within the food sector our order of preference is Metro (MRU-A.TO), Loblaw (L.TO), George Weston (WN.TO), North West (NWC.TO), and Empire (EMP-A.TO), all 2-Equal Weight.

Weak consumer spending and high gas prices are expected to limit Alimentation Couche-Tard’s (ATD-B.TO; 2-EW) earnings upside in the near term beyond the benefits of acquisition activity. As for RONA (RON.TO; 2-EW), the anticipated housing slowdown is not supportive of a significant rebound in renovation spending in 2012.

Barclays Capital does and seeks to do business with companies covered in its research reports. As aresult, investors should be aware that the firm may have a conflict of interest that could affect theobjectivity of this report.

Investors should consider this report as only a single factor in making their investment decision.

This research report has been prepared in whole or in part by research analysts based outside the USwho are not registered/qualified as research analysts with FINRA.

PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE200.

INITIATING COVERAGE Canadian Retail & Consumer 2-NEUTRAL from N/A For a full list of our ratings, price targets and earnings in this report, please see table on page 2

Canadian Retail & Consumer Jim Durran 1.416.863.8967 [email protected] BCC, Toronto Benjamin Yang 1.416.863.8931 [email protected] BCC, Toronto Dennis Snopkowski 1.416.863.8932 [email protected] BCC, Toronto

Barclays Capital | Canadian Retail & Consumer

25 January 2012 2

Summary of our Ratings, Price Targets and Earnings Estimates in this Report

Company Rating Price Price Target EPS FY1 (E) EPS FY2 (E)

Old New 20-Jan-12 Old New %Chg Old New %Chg Old New %Chg

Canadian Retail & Consumer 0-NR 2-Neu

Alimentation Couche-Tard Inc. (ATD/B CN / ATD-B.TO) N/A 2-EW 29.85 N/A 32.00 - N/A 2.20 - N/A 2.39 -

Canadian Tire Corp., Ltd. (CTC/A CN / CTC-A.TO) N/A 1-OW 63.70 N/A 74.00 - N/A 5.24 - N/A 6.14 -

Dollarama Inc. (DOL CN / DOL.TO) N/A 1-OW 44.00 N/A 49.00 - N/A 2.12 - N/A 2.50 -

Empire Co., Ltd. (EMP/A CN / EMP-A.TO) N/A 2-EW 56.43 N/A 57.00 - N/A 4.58 - N/A 5.10 -

George Weston Ltd. (WN CN / WN.TO) N/A 2-EW 66.12 N/A 69.00 - N/A 4.86 - N/A 4.89 -

Jean Coutu Group (PJC/A CN / PJC-A.TO) N/A 2-EW 13.27 N/A 14.00 - N/A 0.88 - N/A 0.98 -

Loblaw Cos., Ltd. (L CN / L.TO) N/A 2-EW 37.30 N/A 39.00 - N/A 2.84 - N/A 2.91 -

Metro Inc. (MRU/A CN / MRU-A.TO) N/A 2-EW 51.58 N/A 54.00 - N/A 4.29 - N/A 4.62 -

North West Co., Inc. (NWC CN / NWC.TO) N/A 2-EW 19.95 N/A 20.00 - N/A 1.23 - N/A 1.32 -

RONA Inc. (RON CN / RON.TO) N/A 2-EW 9.55 N/A 10.00 - N/A 0.68 - N/A 0.91 -

Shoppers Drug Mart Corp. (SC CN / SC.TO) N/A 2-EW 41.45 N/A 43.00 - N/A 2.83 - N/A 3.04 -

Tim Hortons Inc. (THI CN / THI.TO) N/A 1-OW 48.80 N/A 54.00 - N/A 2.35 - N/A 2.75 -

Source: Barclays Capital Share prices and target prices are shown in the primary listing currency and EPS estimates are shown in the reporting currency.

FY1(E): Current fiscal year estimates by Barclays Capital. FY2(E): Next fiscal year estimates by Barclays Capital.

Stock Rating: 1-OW: 1-Overweight 2-EW: 2-Equal Weight 3-UW: 3-Underweight RS: RS-Rating Suspended

Sector View: 1-Pos: 1-Positive 2-Neu: 2-Neutral 3-Neg: 3-Negative

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25 January 2012 3

CONTENTS

CANADA’S CONSUMER SPENDING OUTLOOK – IT’S TOUGH OUT THERE............................15

CANADIAN FOOD RETAIL SECTOR OVERVIEW..........................................................................25

LOBLAW COMPANIES .....................................................................................................................51

GEORGE WESTON ............................................................................................................................63

METRO INC........................................................................................................................................72

EMPIRE COMPANY...........................................................................................................................82

NORTH WEST CO. ............................................................................................................................94

CANADIAN DRUGSTORE SECTOR OVERVIEW......................................................................... 101

SHOPPERS DRUG MART .............................................................................................................. 116

JEAN COUTU GROUP..................................................................................................................... 124

CANADIAN TIRE CORP................................................................................................................. 135

DOLLARAMA ................................................................................................................................. 149

TIM HORTONS ............................................................................................................................... 159

RONA INC. ...................................................................................................................................... 173

ALIMENTATION COUCHE-TARD (ATD-B)................................................................................ 187


25 January 2012 4

CANADIAN RETAIL & CONSUMER: EXPECT A CHALLENGING YEAR AHEAD

The Canadian Retail & Consumer sector comprises a wide range of industries, from food, drug, and general/specialty retailers to quick-service restaurants. We are initiating coverage of 12 companies, with 1-Overweight/2-Neutral ratings on Tim Hortons, Dollarama and Canadian Tire.

The following investment continuum provides a summary of our view about the defensive appeal of each segment within our coverage universe and a ranking of our company investment preference within each segment. Although some of these companies are considered discretionary stocks by their TSX/S&P index listing (i.e., Dollarama and Tim Hortons), they are not nearly as discretionary as specialty apparel retailers, or department stores. Dollar stores are arguably counter cyclical, benefiting from trade down in a weak economy. Tim Hortons sells mostly modestly priced items, with over 40% of sales derived by coffee sales which are minimally discretionary.

Figure 1: Barclays Capital - Canadian Retail & Consumer Sector Coverage Summary

Canadian Retail / Consumer SectorMarket Target NTM Potential

Ticker Rating Cap ($M) P/E P/E Total returnDefensive Rank "Relative" Safe Havens

1 Tim Hortons THI.TO & US 1-OW $7,813 19.5 x 17.8 x 12.0%

2 Dollarama DOL.TO 1-OW $3,304 19.5 x 17.9 x 12.2%

Drugstore retail

1 Shoppers Drug Mart SC.TO 2-EW $8,974 14.0 x 13.7 x 6.2%

2 Jean Coutu PJC-A.TO 2-EW $3,003 14.5 x 14.3 x 7.3%

Food Retail

1 Metro MRU-A.TO 2-EW $5,235 12.5 x 11.7 x 6.2%

2 Loblaw L.TO 2-EW $10,519 13.5 x 12.2 x 6.8%

3 North West NWC.TO 2-EW $965 15.2 x 14.9 x 5.1%

4 Empire EMP-A.TO 2-EW $3,837 11.3 x 11.3 x 2.6%

Food Manufacturing - CPG

George Weston WN.TO 2-EW $8,536 14.0 x 13.8 x 6.5%

Discretionary / Cyclical1 Canadian Tire CTC-A.TO 1-OW $5,207 12.0 x 10.3 x 18.1%

2 Couche Tard ATD-B.TO 2-EW $5,433 13.5 x 12.6 x 8.1%

3 RONA RON.TO 2-EW $1,245 11.0 x 10.2 x 6.2%

Discretionary

Source: Barclays Capital ratings and estimates. 1-OW = 1-Overweight; 2-EW = 2-Equal Weight. Sector rating is 2-Neutral. Data as of 1/20/12.1

A brief look back at 2011 The Canadian retail & consumer sector achieved solid returns in 2011 as mediocre 1H11 returns improved significantly in 2H11, across most subsectors, lead by gains in the more compelling defensive names such as Dollarama, Jean Coutu, Tim Hortons and Metro. The weakest performer was RONA (-33%, S&P/TSX -11%) which suffered from an industry-wide contraction in renovation spending.

1 All dollar amounts in this report are CAD unless otherwise indicated.


25 January 2012 5

Figure 2: Canadian Retail / Consumer 2011 share price appreciation

Canadian Retail / Consumer Sector Share Price Trends - 2011

2011 Price AppreciationDollarama 47%Jean Coutu 38%Tim Hortons 18%Metro 16%Couche Tard 13%Shoppers DM 6%Empire -1%North West Co -3%Canadian Tire -7%Loblaw -7%George Weston -14%RONA -33%

-20%

-10%

0%

10%

20%

30%

40%

1/03/2011 4/28/2011 8/22/2011 12/14/2011

Food Retailers Drugstore RetailersCDN Tire/Couche Tard DOL/THI

Source: FactSet.

A significant portion of the gains achieved by the defensive names were achieved through double-digit multiple expansion as risk averse investors poured their dollars into the small group of “better quality” defensive names. Given our view that 2012 will be another challenging year, we expect further, although less robust, multiple expansion on the more proven defensive companies within our coverage.

Figure 3: 2011 Change in Forward P/E and FY2 EPS

2011 Share price Change: P/E expansion and EPS forecast growth

Y/Y % ch RON WN CTC.a L NWC EMP.a SC ATD.b MRU.a THI PJC.a DOLP/E -9% -19% -18% -11% 2% -5% -2% 11% 4% 2% 17% 12%EPS -26% 7% 13% 5% -5% 4% 8% 2% 12% 15% 18% 32%Price -33% -14% -7% -7% -3% -1% 6% 13% 16% 18% 37% 47%

-40%-30%

-20%-10%

0%

10%20%30%

40%50%

RON WN CTC.a L NWC EMP.a SC ATD.b MRU.a THI PJC.a DOL

Percent Change in FY2 EPS Estimate Percent Change in Forward P/E Multiple

Source: FactSet, Reuters

2012 Outlook: a year of consumer “belt tightening” We expect 2012 to be a challenging year in the Canadian Retail & Consumer sector as a Canadian consumer spending pullback that started to take hold in 3Q11 is likely to constrain earnings growth for at least 6-9 months. This slowdown has been driven by several factors which collectively have contributed to an erosion of consumer confidence and a reduction in consumers' financial risk tolerance.

High personal debt leverage – Canadians’ personal debt leverage now exceeds 150% of personal income which is above the level achieved in the US prior to the housing crash.


25 January 2012 6

Cost inflation has outpaced wage inflation, squeezing household cash flows.

Reduced employment and wage growth expectations – the E.U. crisis and slowed domestic consumer spending have eroded employment expectations.

The housing market appears poised for a modest contraction with some risk that resale home prices could decline for the first time since 2008 (and 1998 before that).

Depressed consumer confidence – these domestic factors have combined with the headline risk of the E.U. crisis to erode consumer confidence.

U.S. retailer “invasion” picks up steam: Zellers’ one-two punch As if the challenges of a tight-fisted consumer weren’t enough, Canadian retailers will also be facing accelerated growth by Wal-Mart Canada in 2012 and Target’s arrival in 2013. In a two-part real estate transaction in early 2011, Hudson’s Bay Trading Company sold 188 Zellers locations to Target, which in turn sold 39 locations to Wal-Mart Canada. This transaction will transfer approximately 14 million square feet of underperforming retail space into the hands of two “best in class” retailers, which will open renovated stores over the span of two-and-a-half years starting with Wal-Mart’s opening of 39 converted stores in 2H12 followed by Target’s 12- to 18-month rollout, starting in March 2013. This sizeable redeployment will materially increase competition for customer traffic in a relatively short period of time, placing added pressure on incumbent retailers’ growth prospects. Within our company coverage the Wal-Mart and Target rollouts are seen as most problematic for the Food retailers, less so for Canadian Tire owing to the fragmented nature of general merchandise purchases and CTR’s differentiated offerings (i.e., auto parts and sporting goods) and finally Loblaw’s Joe Fresh apparel business.

Food Retail – in the midst of the perfect storm The Canadian food retail sector is in the midst of the perfect storm which at best is expected to evolve into a long stretch of grey skies with intermittent showers as Wal-Mart (2H12), followed by Target (March 2013 through mid-2014) increases the competitive intensity through its opening of acquired Zellers stores in late 2012 through to 2014.

The consumer spending pullback has resulted in slow to declining traffic in the food retail sector, and mounting square footage inroads from Wal-Mart’s Supercenter rollout in Canada has increased competitive pricing intensity as retailers fight for volume. Challenged Food retailers have increased their promotional intensity while stretched consumers have increasingly become bargain hunters, which collectively has resulted in an increase in the percent of sales sold at a discount.

While we are still expecting earnings growth in the group we do not see the sector being able to play its usual defensive role in 2012 as the level of earnings uncertainty is too high.

Drugstore Retail – easing drain of drug reform, but fully valued We prefer the Drugstore Retailers over the Food Retailers despite the impact of drug reforms. While drug reform has constrained earnings growth, more so at Shoppers than at Jean Coutu, the greatest period of earnings drain from phased-in reform is now in the past. Both companies offer investors relatively compelling defensive characteristics with limited downside risk at their current valuations, fuelled by the prescription drug growth of an aging population.

Increased competition from Wal-Mart and Target will pressure incumbents’ earnings growth


25 January 2012 7

Unfortunately, while we see Jean Coutu (+10%) and Shoppers’ (+8%) earnings growth reaccelerating as the earnings drain from drug reform eases, several drug reform–related risks remain unresolved (British Columbia drug reform, resolution of the Ontario private label generic drug ban and more recently the federal government’s move to reduce healthcare funding post the current 2014 agreement) which we expect to suppress further multiple expansion. At current levels, Jean Coutu is the most expensive drugstore stock in North America at a forward P/E of 14.3x. Shoppers Drug Mart is only modestly lower at 13.7x. This represents on average a 7% premium to CVS and a 19% premium to Walgreens.

Top Picks: we prefer high quality defensive investments Within this challenging backdrop we recommend investors concentrate their sector holdings in the more compelling defensive stocks for at least the next 6-9 months, while considering establishing a position in attractively valued discretionary stocks for longer term price appreciation once the defensive to discretionary rotation gains more favour toward the end of 2013. Our Top Picks for 2012 are Tim Hortons (THI.TO/THI.US), Dollarama (DOL.TO) and Canadian Tire (CTC-A.TO).

Figure 4: Canadian Retail/Consumer Sector Coverage

CDN RETAIL & CONSUMER : SECTOR COVERAGE

Current EPS growth Current Target Upside Div Potential

Rating: Yr. End Avg Avg LT NTM P/E FY1 FY2 Price Price to TGT Yield Return*

Peak Trough AVG

DEFENSIVE STOCKS:

Empire 2-EW Apr-30 14.8x 9.3x 11.8x 11.3x -8% 11% $56.43 $57.00 1.0% 1.6% 2.6%

Loblaw 2-EW Dec-31 17.3x 12.1x 14.7x 12.2x 10% 2% $37.30 $39.00 4.6% 2.3% 6.8%

Metro 2-EW Sep-30 15.0x 9.1x 11.3x 11.7x 9% 8% $51.58 $54.00 4.7% 1.5% 6.2%

NorthWest Co. 2-EW Jan-31 16.2x 4.6x 10.2x 14.9x -14% 7% $19.95 $20.00 0.3% 4.8% 5.1%

CDN Food Retail Average 15.8x 8.2x 12.0x 11.7x -1% 7% 2.6% 2.5% 5.2%

Jean Coutu 2-EW Feb-28 25.5x 8.0x 15.8x 14.3x 14% 11% $13.27 $14.00 5.5% 1.8% 7.3%

Shoppers Drug Mart 2-EW Dec-31 24.5x 12.0x 18.6x 13.7x 3% 7% $41.45 $43.00 3.7% 2.4% 6.2%

CDN Drugstore Average 25.0x 10.0x 17.2x 14.0x 9% 9% 4.6% 2.1% 6.7%

RELATIVE SAFE HAVEN STOCKS

Dollarama 1-OW Jan-31 18.1x 14.4x 15.8x 17.9x 29% 18% $44.00 $49.00 11.4% 0.8% 12.2%

Tim Hortons 1-OW Dec-31 25.0x 15.1x 18.7x 17.8x 15% 17% $48.80 $54.00 10.7% 1.4% 12.0%

Safe Haven Average 21.6x 14.8x 17.3x 17.9x 22% 17% 11.0% 1.1% 12.1%

CYCLICAL STOCKS:

Canadian Tire 1-OW Dec-31 36.1x 7.8x 12.7x 10.3x 7% 17% $63.70 $74.00 16.2% 1.9% 18.1%

Couche Tard 2-EW Apr-30 26.6x 9.2x 17.4x 12.6x 12% 9% $29.85 $32.00 7.2% 0.9% 8.1%

RONA 2-EW Dec-31 17.5x 7.4x 11.7x 10.2x -34% 34% $9.55 $10.00 4.7% 1.5% 6.2%

Discretionary Grp. Average 26.7x 8.1x 13.9x 11.0x -5% 20% 9.4% 1.4% 10.8%

Cycle P/E's

Source: Barclays Capital estimates, FactSet/Reuters, Company Reports. Pricing is as of January 20, 2012 close. Total Return is share price appreciation and dividend 1-OW = 1-Overweight; 2-EW = 2-Equal Weight; 3-UW = 3-Underweight. Sector rating is 2-Neutral.

Defensive bias in the immediate term:

We recommend that investors overweight the “better quality” defensive names such as Tim Hortons (THI.TO/THI.US) and Dollarama (DOL.TO). Unfortunately, an extremely challenging outlook for the Canadian Food retailers eliminates that sub-group as compelling defensive considerations. In the drugstore sector, while we see limited downside risk in Jean


25 January 2012 8

Coutu and Shoppers Drug Mart, they appear fully valued relative to their drug reform–constrained growth prospects in 2012. We expect this lack of compelling defensive choices to push the already sector-leading valuations of Tim Hortons and Dollarama higher in 2012.

Tim Hortons (THI.TO; 1-OW/Neu; price target $54): proven, consistent earnings growth with almost 30% of F2012 EPS growth forecast to be driven by share buybacks. We are forecasting F2011 and F2012 EPS growth of 15% and 17%, respectively. We expect Tim’s to announce a new buyback program commensurate with the expiry of the current facility in March 2012 and a dividend increase at least in line with its F2011 earnings growth. In addition to its strong earnings and FCF growth profile, Tim Hortons offers investors the following:

Compelling franchise model with low-risk earnings growth. Tim’s generates 50%-60% of operating earnings from rents and royalties providing a stable stream of income. Strong new store growth (+4% to 6%) in Canada and the US and industry-leading comparable store sales (CSS) in both markets (3%-5%) has typically ensured strong single-digit system sales growth.

Impressive track record of returning cash to shareholders. Since its IPO in 2006, Tim’s has increased its dividend four times (average 25% per year). The company has also aggressively repurchased stock to supplement EPS growth.

Valuation is attractive relative to peers. Tim’s is currently trading at a wider discount to its QSR peers compared to its historical average. Relative to MCD, Tim’s is trading at a 7% discount vs. its historical 10% premium. We believe Tim’s should be awarded a scarcity premium given its high liquidity and large market cap ($8bn; second largest in our coverage). It is also the only dual-listed stock in our coverage universe.

Dollarama (DOL.TO; 1-OW/Neu; price target $49): a defensive growth company with a dividend. Dollarama is expected to deliver the strongest earnings growth in our coverage universe with forecast EPS growth of 16% in F2013 (excludes extra week). Dollarama’s superior store economics enables it to generate strong free cash flows which far outstrip its capex needs for new store growth. As such, it has ample excess cash to reduce debt and increase returns to shareholders through dividends and potentially share buybacks. The following factors also support our 1-Overweight/Neutral recommendation:

Aggressive store network growth opportunity in an underdeveloped market. Dollarama has compelling, low-cost/quick payback, new store growth potential and best-in-class store economics driven by its dominant market position (5x greater than next largest competitor), weaker direct competition, and industry-leading offshore sourcing capabilities.

Productivity and efficiency enhancements expected to result in material cost savings. Dollarama has numerous infrastructure initiatives in the pipeline that should allow it to lower its operating expenses to offset rising wages/sourcing costs.

Tim Hortons is the only dual-listed stock in our coverage

universe

Dollarama’s ample FCF is more than adequate for store growth

capex; it could also choose to reduce debt, buy-back shares


25 January 2012 9

Figure 5: Summary of Canadian Retail/Consumer Sector Coverage

Market Current Price PotentialCompany Ticker Rating Yr. End Cap ($M) Actual FY1 FY2 FY1 FY2 DPS Yield Price Target Ttl Return

FOOD RETAILERS/MANUFACTURERS

Empire EMP-A.TO 2-EW Apr-30 $3,837 $4.98 $4.58 $5.10 12.3x 11.1x $0.90 1.6% $56.43 $57.00 2.6%

Loblaw L.TO 2-EW Dec-31 $10,519 $2.58 $2.84 $2.91 13.1x 12.8x $0.84 2.3% $37.30 $39.00 6.8%

George Weston WN.TO 2-EW Dec 31 $8,536 $4.33 $4.86 $4.89 13.6x 13.5x $1.44 2.2% $66.12 $69.00 6.5%

Metro MRU-A.TO 2-EW Sep-30 $5,235 $3.92 $4.29 $4.62 12.0x 11.2x $0.77 1.5% $51.58 $54.00 6.2%

North West Co. NWC.TO 2-EW Jan-31 $965 $1.43 $1.23 $1.32 16.2x 15.1x $0.96 4.8% $19.95 $20.00 5.1%

DRUGSTORE RETAILERS

Jean Coutu PJC-A.TO 2-EW Feb-28 $3,003 $0.77 $0.88 $0.98 15.1x 13.5x $0.24 1.8% $13.27 $14.00 7.3%

Shoppers DM SC.TO 2-EW Dec-31 $8,974 $2.75 $2.83 $3.04 14.6x 13.6x $1.00 2.4% $41.45 $43.00 6.2%

GEN'L MERCHANDISE/SPECIALTY RETAIL

Canadian Tire CTC-A.TO 1-OW Dec-31 $5,207 $4.89 $5.24 $6.14 12.2x 10.4x $1.20 1.9% $63.70 $74.00 18.1%

Couche Tard ATD-B.TO 2-EW Apr-30 $5,433 US$1.97 US$2.20 US$2.39 13.6x 12.5x $0.28 0.9% $29.85 $32.00 8.1%

Dollarama DOL.TO 1-OW Jan-31 $3,304 $1.64 $2.12 $2.50 20.8x 17.6x $0.36 0.8% $44.00 $49.00 12.2%

RONA RON.TO 2-EW Dec-31 $1,245 $1.03 $0.68 $0.91 14.0x 10.5x $0.14 1.5% $9.55 $10.00 6.2%

QUICK SERVE RESTAURANT (QSR)

Tim Hortons THI.TO 1-OW Dec-31 $7,813 $2.04 $2.35 $2.75 20.8x 17.7x $0.68 1.4% $48.80 $54.00 12.0%

Note: ATD EPS estimates are in US$'s

DividendP/EBarCap EPS estimates

Source: FactSet, Company Reports, Barclays Capital Estimates. Prices are current as of January 20, 2012 close.

1-OW = 1-Overweight; 2-EW = 2-Equal Weight; 3-UW = 3-Underweight. Sector rating is 2-Neutral.


25 January 2012 10

Valuation supported by strong earnings growth. In the context of weakening consumer spending, we believe Dollarama should be awarded a premium valuation for its strong earnings growth (highest forecast EPS growth in our coverage) and defensive characteristics. We also expect DOL’s valuation relative to U.S. dollar-store peers to increase as Dollarama benefits from a “scarcity of choice” lift in its valuation.

Discretionary entry at the right price for longer term investors

Given our concerns about discretionary spending in 2012, particularly in the first half, we do not expect any meaningful upside in discretionary stocks for at least the first six months of 2012. However, historically, consumer discretionary stocks have initiated price appreciation six months in advance of an expected bottom in the economy. Given that we expect 2013 to be at least modestly better than 2012, once consumers can start to see some employment opportunity improvement, we recommend that investors selectively establish a position in the better discretionary opportunities.

Canadian Tire (CTC-A.TO; 1-OW/Neu; price target $74.00) – the least expensive stock in our coverage universe. Canadian Tire is currently trading at 10.3x forward P/E (21% below its long-term average of 13x) which historically has been a solid entry point for the stock. We are initiating coverage of Canadian Tire with a F2011 EPS forecast of $5.24 which is 4% below consensus EPS forecast of $5.47, reflecting weaker winter seasonal sales than consensus is currently assuming. Although we believe that Canadian Tire’s share price could suffer some contraction if Q4 results are hampered more than expected by a lack of winter weather conditions (limited snowfall in the east) we do not expect any material carryover effect into F2012 earnings. We expect consensus estimates to come down prior to the Q4 release on February 9. Although we expect that Target’s arrival in Canada starting in 1Q13 could be an overhang on Canadian Tire’s multiple expansion, if the consumer spending outlook improves as we expect it to in 2013 we believe we will see at least a 20% increase in CTC’s P/E multiple to 12x (below its LT average of 13x) before they become more cautious. Beyond Canadian Tires attractive valuation there are several other factors that support our 1-Overweight/2-Neutral recommendation.

Increased focus on improving retail ROIC. Canadian Tire’s CEO has made it a corporate priority to improve total retail returns. Actions such as head office streamlining and the Forzani acquisition are critical steps toward this goal.

We believe the Forzani synergy targets are conservative. Management has guided to $25 million in synergies in 2012, ramping up to a run rate of $35 million by 2014. We believe that these targets will prove conservative if CTC pursues the banner rationalization opportunities that Forzani was already working towards.

Regaining position as Canada’s authority in automotive. Canadian Tire is nearing completion of the roll-out of its new automotive technology platform which will become an enabler to more proactive parts and service marketing to the do-it-yourself (DIY) and do-it-for-me (DIFM) customer (estimated to be a $22 billion market).

New loyalty program with Dunnhumby. The launch of a new loyalty program in early 2012 is an important step for Canadian Tire given that most retailers either have, or are pursuing, more sophisticated programs that leverage detailed customer data and improve promotion efficiency.

Increasing shareholder returns. In conjunction with its 3Q11 results, Canadian Tire announced a 9% increase in its dividend. The company has bumped its payout ratio to a range of 20%-25% from the previous 15%-20%.

Target’s entry may prove to be an overhang on shares but we

expect multiple expansion when consumer spend rebounds


25 January 2012 11

FCF is increasingly being returned to shareholders Facing slowed earnings growth prospects, most of our companies, to varying degrees and at various stages, are pursuing the implementation of productivity and efficiency programs to improve their profitability and growth prospects. In the near term, given the various challenges that a slow growth economy and intensified competition has inflicted on sales growth and margin trends, the majority of the benefits have been used to ease earnings downside rather than delivering upside.

As many of our companies have become more comfortable with their cash flow capacity they have embraced a more balanced approach to the deployment of free cash flow that provides investors with a reasonable amount of “return certainty” through debt reduction (Dollarama), dividend increases and share buybacks. The companies that stand above the rest on this measure are Metro, Tim Hortons, Dollarama, and Couche-Tard with Shoppers Drug Mart and Jean Coutu joining the ranks with the introduction of more aggressive buyback programs.

Figure 6: Canadian Retail/Consumer Sector – Company-Generated Returns

Fiscal YEBarCap Net

Earnings Growth Est.

Buyback EPS

Impact

Current Dividend

Yield

Total "Co.Generated"

Returns

BarCap Net Earnings

Growth Est.

Buyback EPS

Impact

Current Dividend

Yield

Total "Co.Generated"

Returns

Food RetailersL Dec 12.5% -1.6% 2.2% 13.1% 2.8% 0.0% 2.2% 4.9%MRU.a Sep 1.8% 4.6% 1.4% 7.8% 5.5% 5.2% 1.4% 12.2%EMP.a Apr -6.3% 0.3% 1.5% -4.4% 10.0% 1.4% 1.5% 12.9%NWC Jan 3.1% 1.1% 4.8% 9.0% 7.9% -0.6% 4.8% 12.1%WN Dec 11.8% 0.4% 2.1% 14.4% 0.4% 0.0% 2.1% 2.7%Drug RetailersSC Dec 2.5% 0.5% 2.4% 5.3% 3.9% 3.6% 2.4% 9.9%PJC.a Feb 9.2% 5.1% 1.9% 16.2% 5.9% 5.4% 1.9% 13.2%Relative Safe HavensDOL Jan 29.8% -0.5% 0.8% 30.1% 15.3% 0.8% 0.8% 16.8%THI Dec 7.3% 7.9% 1.4% 16.6% 12.1% 5.3% 1.4% 18.8%Discretionary RetailRON Dec -33.7% -0.3% 1.4% -32.5% 29.9% 3.9% 1.4% 35.3%CTC.a Dec 7.4% -0.2% 1.8% 9.0% 17.1% 0.0% 1.8% 19.0%ATD.b Apr 4.1% 2.4% 0.9% 7.4% 5.7% 6.0% 0.9% 12.6%

Note: Growth rates for MRU.A and ATD.B are adjusted for one extra week in 2011 and DOL for 2012.Note: Growth rate for EMP.A is adjusted for one less week in 2011 and MRU.A and ATD.B for 2012.

Company Generated Returns - 2011e Company Generated Returns - 2012e

Source: FactSet, Company Reports, Barclays Capital estimates. Priced as of January 20, 2012 close.


25 January 2012 12

Figure 7: SNAPSHOT: Retail/Consumer Valuation Performance - Canada vs. US

Canadian vs U.S. Food Retailer Share Performance

Note: Canada includes L, MRU.A, EMP.A, and US includes SWY, KRSource: FactSet, Barclays Capital Estimates

-15%-10%

-5%0%5%

10%15%20%25%30%

Jan-

10

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Canada U.S.

Canadian vs U.S. Drug Retailer Share Performance

Note: Canada includes SC, PJC.A, and US includes CVS, WAGSource: FactSet, Barclays Capital Estimates

-25%-20%-15%-10%

-5%0%5%

10%15%20%25%

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Canadian Tire vs WMT/TGT/M Share Performance

Note: Canada includes CTC.A, and US includes WMT, TGT, MSource: FactSet, Barclays Capital Estimates

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Canadian Tire U.S.

Canadian vs U.S. Home Hardware Share Performance

Note: Canada includes RON and US includes HD, LOWSource: FactSet, Barclays Capital Estimates

-50%-40%-30%-20%-10%

0%10%20%30%

Jan-

10

Mar

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Rona U.S.

2011 Share price Change: P/E expansion and EPS forecast growth

Y/Y % ch RON WN CTC.a L NWC EMP.a SC ATD.b MRU.a THI PJC.a DOLP/E -9% -19% -18% -11% 2% -5% -2% 11% 4% 2% 17% 12%EPS -26% 7% 13% 5% -5% 4% 8% 2% 12% 15% 18% 32%Price -33% -14% -7% -7% -3% -1% 6% 13% 16% 18% 37% 47%

-40%-30%

-20%-10%

0%

10%20%30%

40%50%

RON WN CTC.a L NWC EMP.a SC ATD.b MRU.a THI PJC.a DOL

Percent Change in FY2 EPS Estimate Percent Change in Forward P/E Multiple

Source: FactSet, Barclays Capital Estimates


25 January 2012 13

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25 January 2012 14

Figure 8: SNAPSHOT: Economic Overview – Canada vs. US

Canada vs. US Real GDP Growth Canada vs. US Retail Trade. Ex/ Auto and Gas (SA)

Source: Bloomberg Source: Statistics Canada, U.S. Census, Haver

Canada vs. US Consumer Confidence Indices Canada vs. US Unemployment Rate

Source: FactSet, Conference Board of Canada Source: FactSet

Canadian vs. US Job Additions (m/m, 000's) Wage growth: Canada vs. U.S. (y/y)

Source: Haver Source: Haver

Personal Debt to Disposable Income: Canada vs. US Canada vs. US Housing Affordability: 1990 = 100

Source: Haver Source: Bank of Canada, National Association of Realtors

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

2006 2007 2008 2009 2010 2011

Canada U.S.

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120

2006 2007 2008 2009 2010 2011

Canada US

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2006 2007 2008 2009 2010 2011

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2007 2008 2009 2010 2011

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2006 2007 2008 2009 2010 2011

Canada Real GDP US Real GDP

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Canada U.S.

More Affordable


25 January 2012 15

CANADA’S CONSUMER SPENDING OUTLOOK – IT’S TOUGH OUT THERE

Canadian consumer spending has deteriorated over the past two quarters as highly levered consumers struggle with declining discretionary funds and eroded employment/wage growth expectations. As 2011 unfolded, Canadian consumer confidence was eroded by lowered employment/income growth expectations and renewed international economic uncertainty (E.U. financial crisis and U.S. deficit financing/budget challenges). In addition, consumers’ buying power deteriorated throughout 2011 as above-average cost inflation, particularly in food and gasoline, significantly outpaced modest wage growth, resulting in a decline in available discretionary spending dollars (including those for food). This spending constraint combined with declining expectations for international demand of Canada's natural resources resulted in deterioration in the employment outlook as the year progressed. Collectively, these inter-related domestic and international dynamics have contributed to an erosion of consumer confidence and a reduction in consumers' financial risk tolerance.

Reduced spending habits are expected to remain a constraint to growth until they begin to lap themselves in 3Q12. Hopes for an improved trend toward the end of 2012 are partly dependant on where U.S./international growth trends net out and how well housing prices hold up in Canada as the housing market undergoes what is expected to be a modest easing in 2012 toward "normalized household formation growth" in 2013.

Figure 9: Canadian Unemployment rate vs. Wage Growth

0%1%2%3%4%5%6%7%8%9%

10%

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Unemployment (%) Wage Growth (Y/Y%)

Source: StatsCan

Figure 10: CDN CPI vs. Hourly Wage growth Index

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2006 2007 2008 2009 2010 2011

Source: Haver, StatsCan, Barclays Capital estimates

Consumer confidence, risk tolerance and spending

decreased in 2011...

…3Q12 might see an improvement


25 January 2012 16

Figure 11: Canadian Consumer Confidence Index

40

50

60

70

80

90

100

110

120

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Source: Conference Board.

Customer traffic at many of Canada’s larger retailers has been down, or flat, throughout the year (Loblaw, Wal-Mart, Dollarama, Rona), or has weakened more recently (Tim Hortons) with indications from most retailers suggesting that Canadian consumers are returning to the “hunkered down” shopping habits of 2008. This has resulted in an increase in the percentage of lower margin promotional items being purchased, a re-acceleration of private label sales and a need for intensified price discounting to stimulate demand.

Figure 12: Canadian Discretionary vs. Staples Retailers Weighted Average CSS Growth

CDN Staple vs Discretionary Retail - WTD CSS trend CDN Staple vs Discretionary Retail - WTD 2 Yr stacked CSS trend

-4%-3%-2%-1%0%1%2%3%4%5%6%

Q1-

09

Q2-

09

Q3-

09

Q4-

09

Q1-

10

Q2-

10

Q3-

10

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10

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Staples CSS Discretionary CSS

-1%

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Q3-

11

Staples CSS Discretionary CSS

Source: Company Reports, Barclays Capital Estimates

Retail sales (ex auto and gasoline) achieved almost no growth through 2011 versus relatively robust spending in 2010. Inflation has driven most, if not all, of the dollar growth as “real” growth has been below 1% throughout the year. On an inflation-adjusted basis the food retail, health & personal care (pharmacy merchandise) and clothing store channels suffered “real” sales declines throughout most of 2011. Some Canadian retailers will be up against weaker prior year comparables in the first half of 2012 but we expect this to ease the downside risk rather than drive any sustainable recovery in 2011’s weakened trends.

Store traffic is flat/down; consumers are “hunkered down”


25 January 2012 17

Figure 13: Major Consumer spending trends – y/y % change

CDN Retail CSS trends - Y/Y % chgQ1-10 Q2-10 Q3-10 Q4-10 Q1-11 Q2-11 Q3-11

Food retail 0.2% -0.2% -0.3% -0.9% 0.3% 0.4% 1.8%

Drug retail - FE 2.0% 1.6% 1.4% 3.2% 5.1% 2.3% 1.4%

Specialty retail 3.9% 3.0% 1.0% 1.2% -1.2% -0.1% 0.1%

HIW retail 8.5% 0.6% -4.0% -6.3% -9.6% -5.3% -3.0%

Group avg CSS 2.4% 1.1% -0.1% -0.5% -0.9% -0.3% 0.7%

CDN Consumer spending - Y/Y % chgQ1-10 Q2-10 Q3-10 Q4-10 Q1-11 Q2-11 Q3-11

Retail Sales ex Auto & Gas 4.5% 3.4% 2.6% 3.0% -0.1% 0.3% 1.4%Personal Consumer expenditures 3.5% 3.5% 3.2% 3.2% 2.1% 2.3% 1.9%

Renovation spending (NSA) 17.7% 14.6% 8.3% 3.5% 2.3% 1.2% 5.5%Resale Housing Activity (actuals) 45.3% -2.9% -23.6% -15.7% -6.5% -1.2% 13.0%

Single unit housing starts 82.4% 51.0% 11.3% -15.0% -27.5% -16.6% -2.1%Source: Haver Analytics, Company reports, Barclays Capital estimates.

Figure 14: Canadian Retail Sales Trends – y/y % change

CDN Retail Trade - Channel sales

% Imp 2007 2008 2009 2010YTD 2011

1Q-10 2Q-10 3Q-10 4Q-10 1Q-11 2Q-11 3Q-11

Total Retail Trade 100% 6% 4% -3% 6% 3% 8% 5% 4% 5% 3% 4% 4%Auto 22% 5% -2% -6% 8% 5% 13% 7% 6% 7% 3% 6% 4%Gas Stations 12% 11% 14% -19% 16% 19% 21% 14% 10% 18% 18% 21% 19%Retail Trade Ex. Auto and Gas 66% 6% 4% 1% 3% 0% 5% 3% 3% 3% 0% 0% 1%Grocery and Food 23% 4% 5% 4% 2% 0% 0% 1% 4% 2% 2% -1% 0%Health and Personal Care 7% 9% 4% 4% 6% -1% 7% 7% 4% 6% 0% -1% -2%Clothing and Accessories 6% 5% 1% -3% 7% 3% 7% 5% 6% 8% 0% 4% 4%General Merchandise 17% 5% 5% 2% 3% 2% 5% 3% 2% 2% 1% 3% 3%Home Goods 6% 8% 3% -8% 4% 0% 3% 6% 1% 4% 0% 0% 1%Bldg. Mat'l/Garden Equip/Supplies 6% 7% 3% -1% 2% -3% 15% 4% -3% -5% -10% -5% 1%

Source: Haver Analytics, StatsCan. YTD as of November 2011.

Figure 15: “Real” Retail Sales Growth Estimates - CPI adjusted

CDN Retail Trade - Channel Sales Trends - CPI adjusted

2007 2008 2009 2010YTD 2011

1Q-10 2Q-10 3Q-10 4Q-10 1Q-11 2Q-11 3Q-11

Total Retail Trade 6% 4% -3% 6% 3% 8% 5% 4% 5% 3% 4% 4%CPI inflation 2% 2% 0% 2% 3% 2% 2% 2% 2% 3% 3% 3%"Real" Total Retail Trade 4% 1% -3% 3% 0% 6.3% 2.9% 2.2% 3.0% 0.0% 0.5% 1.0%

Gas Stations 11% 14% -19% 16% 19% 21% 14% 10% 18% 18% 21% 19%Gasoline Inflation 5% 13% -15% 12% 22% 19% 15% 3% 10% 16% 28% 23%"Real" Gas Stations - proxy 6% 1% -3% 4% -3% 2% 0% 7% 8% 2% -7% -4%Grocery and Food 4% 5% 4% 2% 0% 0% 1% 4% 2% 2% -1% 0%Food Inflation (ex alcohol) 3% 4% 5% 2% 4% 1% 3% 2% 2% 3% 4% 4%"Real" Food Store Sales 1% 2% -1% 0% -4% -1% -1% 2% 0% -1% -4% -4%Health & Personal Care 9% 4% 4% 6% -1% 7% 7% 4% 6% 0% -1% -2%H & PC Inflation 1% 1% 3% 3% 2% 3% 2% 3% 2% 2% 2% 1%"Real" Health & Pers. Care Store Sales 7% 2% 1% 4% -3% 4% 5% 1% 3% -2% -4% -3%Clothing and Accessories 5% 1% -3% 7% 3% 7% 5% 6% 8% 0% 4% 4%Clothing Inflation 3% 3% 4% 4% 4% 3% 4% 6% 3% 3% 3% 5%"Real" Clothing & Acc. Store Sales 2% -2% -7% 3% -1% 4% 1% 1% 5% -3% 1% -2%

Source: Haver Analytics, StatsCan. YTD as of November 2011.


25 January 2012 18

Figure 16: SNAPSHOT: Housing Trends - Canada vs. USA

Single-Unit Housing Starts - Canada vs. US Canada vs. US Resale Housing Activity - Y/Y % Change

Source: Haver Source: CREA, National Association of Realtors

Canada vs. US Resale Housing Price - Y/Y % Change Canada vs. US Housing Affordability: 1990 = 100

Source: CREA, National Association of Realtors Source: Bank of Canada, National Association of Realtors

Canada Sales-to-New Listings Ratio Canada 5Yr vs. US 30Yr Fixed Mortgage Rates

Source: CREA, Barclays Capital Estimates Source: Bank of Canada, Bloomberg

Personal Debt to Disposable Income: Canada vs. US Canadian Employment Growth vs Housing Resale Activity

Source: Haver Source: Bloomberg, CREA

0

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U.S. Avg - 1,108k

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More Affordable


25 January 2012 19

Canadians’ personal debt leverage exceeds the U.S. peak, presenting some concern given the weak employment outlook and meagre wage growth. Despite a less-than-robust economy, Canadian consumers have taken full advantage of low interest rates driving their personal debt leverage well above the peak levels achieved prior to the U.S. housing market crash. While normatively Canadians’ personal debt to discretionary income ratio has been higher than their U.S. counterparts’, the current index is 2.4x above its past 20-year average spread. This is obviously of some concern and provides some insight into why Canadians may be hunkering down for a while as they try to establish a more comfortable risk level.

Figure 17: Canada vs. US Personal Debt to Disposable Income

70%80%90%

100%110%120%130%140%150%160%

1Q-9

0

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Source: Haver

Housing is no longer seen as a driver of growth

Canadian housing activity growth appears to have run its course as a major driver of consumer spending and economic growth. The Canadian housing market played a major role in Canada’s economic recovery from the recession. We do not expect the Canadian housing market to experience a material contraction in 2012 (reasonable affordability, balanced sales-to listings ratio), but we do expect a modest easing of growth in the second half of 2012 as the housing market migrates toward more normative household formation trends (+1 to 2% range) over the next 3-5 years. This suggests that related renovation spending and home decor expenditures are likely to be flat to modestly up in 2012, with strength in 1H12, followed by a softening in 2H12. Of equal or greater importance, we don’t expect to see a broad-based deterioration in home prices, with the exception of more heated markets like Vancouver, which should allow consumers to avoid the psychological damage of deterioration in the value of their largest asset. This will be a major support to consumers’ spending stance as they wait for improvements in employment/wage growth.

Figure 18: CREA and CMHC 2011 & 2012 Housing Activity Forecasts

2009A 2010ACREA CMHC CREA CMHC

Single detached 75.7 92.6 82.2 83.8% chg y/y -19% 22% -11.2% 1.9%

Multiple unit 73.4 97.4 108.8 103.0% chg y/y -38% 33% 11.7% -5.3%

Housing Starts 149.1 189.9 191.0 186.8% chg y/y -29% 27.4% 0.6% -2.2%

Resale housing 464.5 446.9 453.3 450.1 451.2 458.5% chg y/y -3.9% 1.4% 0.7% -0.5% 1.9%

Total Housing 613.6 636.8 641.1 645.3% chg y/y -4.5% 3.8% 0.7% 0.6%

Avg Resale Price ($k) $320.3 $338.4 $362.7 $367.5 $363.6 $372.4% chg y/y 5.6% 7.2% 8.6% 0.2% 1.3%

2011E 2012E

Source: CREA, CMHC.

Canadians’ personal debt to discretionary income ratio is 2.4x

above its past 20-year average

We don’t expect a material housing correction but we do

expect growth to slow


25 January 2012 20

Since 2009 resale housing trends have been very volatile throughout each year, partly due to the impact of the 2009 Household Renovation tax credit (HRTC - expired February 2010) and the July 2010 implementation of the harmonized sales tax (HST) in Ontario, which increased the tax exposure of new and resale home purchases, acting as an avoidance stimulus.

Single unit starts have decreased 11% so far in 2011, following a 22% increase in 2010. The Canada Mortgage and Housing Corporation (CMHC) is forecasting a 2% increase in 2012, which is expected be front-end loaded.

Resale housing activity has increased 2% year-to-date recovering from a modest decline of 4% in 2010. The Canadian Real Estate Association (CREA) and CMHC are forecasting resale activity to slow, or decline modestly in 2012, with average resale house prices forecast to remain above prior year levels (+0.25% to +1.3%) after appreciating 7% to 9% in 2011.

Figure 19: Resale Housing & Single Unit Starts Activity – Y/Y % chg

Resale Housing Activity (actuals) - Y/Y % chg

Q1 Q2 Q3 Q4 H1 H2 Total Yr.2009 -27.0% 1.4% 17.7% 58.4% -10.5% 32.7% 7.7%

2010 45.3% -2.9% -23.6% -15.7% 13.6% -20.1% -3.9%

2011 -6.5% -1.2% 13.0% 6.1% e -3.5% 9.8% e 2.2% e

2012 easy PY easy PY tougher PY weak PY tough PY

Single unit housing starts (SAAR) - Y/Y % chg

Q1 Q2 Q3 Q4 H1 H2 Total Yr.

2009 -41% -33% -16% 17% -37% -1% -19%

2010 82% 51% 11% -15% 66% -3% 22%

2011 -27% -17% -2% 2.5% e -22% 0.1% e -11.2% e

2012 easy PY easy PY tougher PY tough PY weak PY tougher PY

Source: CMHC, CREA and Barclays Capital estimates

Housing trends have been volatile


25 January 2012 21

A benign rate outlook provides immediate-term comfort but be aware a 100bps rate hike pushes affordability over the edge. Fortunately, low interest rates have kept housing affordability in a comfortable range and a balanced sales-to-listings ratio has allowed prices to remain firm in most markets. However, it is important to know that once the interest rate outlook changes It only takes a 100bps increase in mortgage rates at current home prices to raise the affordability index toward levels that have historically resulted in a market contraction. For each 100bps increase in interest rates, house prices would have to fall 8% to reset affordability at current levels, or personal income would need to rise 10%.

Figure 20: Canadian Sales-to-Listings Ratio and Housing Affordability Remain in Balanced Market Territory

CDN Resale Housing Sales-to-listings ratio CDN Housing Affordability Index

20%

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50%

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70%

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90%

1990

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1996

1998

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2006

2008

2010

Balanced market territory

20

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2000

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Affordability Index (left)

Resale Activity - Y/Y (right)

Resale Price - Y/Y (right)

Source: CREA, Haver, StatsCan, Bank of Canada

Residential renovation spending has decelerated significantly since mid-2010 as resale housing activity started to weaken in 2Q10 followed by a decline in single unit starts.

Figure 21: Canadian Housing Activity Trends

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

1Q 0

6

2Q 0

6

3Q 0

6

4Q 0

6

1Q 0

7

2Q 0

7

3Q 0

7

4Q 0

7

1Q 0

8

2Q 0

8

3Q 0

8

4Q 0

8

1Q 0

9

2Q 0

9

3Q 0

9

4Q 0

9

1Q 1

0

2Q 1

0

3Q 1

0

4Q 1

0

1Q 1

1

2Q 1

1

3Q 1

1

Renovation Spending (Y/Y) Resales (Y/Y) Single Unit Starts (Y/Y)

Source: StatsCan


25 January 2012 22

Figure 22: Staples vs. Discretionary Y/Y $ Change in Seasonally Adjusted Monthly Retail Sales ($M)

Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11

Staples ($mm - Y/Y)Supermarket $222 $116 $93 $138 $85 $25 ($76) ($59) ($35) ($33) ($42) $12 ($54)Convenience ($20) ($40) $18 $12 ($1) $5 $15 $14 $12 $9 $9 $12 ($1)Beer $105 $61 $34 $7 $17 $30 $39 $45 $20 $38 $50 $44 $25Health and personal care $162 $162 $38 $42 ($41) ($38) ($57) ($46) ($41) ($44) ($63) ($20) ($60)Staples $469 $298 $182 $199 $60 $22 ($78) ($46) ($43) ($30) ($46) $48 ($90)

Discretionary ($mm - Y/Y)Clothing & Clothing Accessories $221 $151 $70 $83 ($72) $88 $79 $115 $108 $90 $67 $134 $98Sporting Goods $68 $15 $2 $16 ($29) $4 $10 $0 ($12) $17 $7 $15 $30Electronics & Appliances $41 $28 $23 $29 $27 $12 $45 ($33) ($2) ($17) ($16) ($32) $5Furniture/Furnishings $31 $37 ($27) $9 ($29) $25 ($4) ($72) $28 $41 $13 ($11) ($35)Building Materials ($125) ($146) ($348) ($96) ($262) ($250) ($78) ($22) $24 $18 $75 $62 $22General Merchandise $279 $133 $131 $148 $108 $123 $188 $260 $212 $224 $177 $204 $199Misc ($89) ($37) ($62) ($47) ($55) ($43) ($24) ($18) ($5) $2 $21 $8 $12Discretionary $426 $181 ($210) $143 ($312) ($41) $217 $231 $354 $375 $345 $380 $331

Percent Contribution to Y/Y $ ChangeSupermarket 47% 39% 51% 69% 140% 115% 97% 128% 80% 111% 90% 25% 60%Convenience -4% -13% 10% 6% -1% 24% -19% -30% -29% -29% -19% 25% 1%Beer 22% 20% 19% 3% 29% 135% -50% -99% -47% -127% -110% 91% -28%Health and personal care 34% 54% 21% 21% -68% -173% 72% 101% 96% 146% 138% -41% 66%

Percent Contribution to Y/Y $ ChangeClothing & Clothing Accessories 52% 83% -33% 58% 23% -212% 36% 50% 31% 24% 20% 35% 30%Sporting Goods 16% 8% -1% 11% 9% -10% 5% 0% -3% 4% 2% 4% 9%Furniture/Furnishings 7% 21% 13% 6% 9% -61% -2% -31% 8% 11% 4% -3% -11%Electronics & Appliances 10% 16% -11% 21% -9% -29% 21% -14% -1% -5% -5% -8% 2%Building Materials -29% -80% 165% -67% 84% 605% -36% -10% 7% 5% 22% 16% 7%General Merchandise 65% 73% -62% 103% -35% -297% 87% 113% 60% 60% 51% 54% 60%Misc -21% -20% 29% -33% 18% 104% -11% -8% -1% 1% 6% 2% 4%

Y/Y Percent ChangeSupermarket 3.7% 1.9% 1.5% 2.3% 1.4% 0.4% -1.2% -0.9% -0.6% -0.5% -0.7% 0.2% -0.9%Convenience -3.5% -6.9% 3.2% 2.1% -0.1% 0.9% 2.8% 2.5% 2.3% 1.6% 1.6% 2.1% -0.2%Beer 7.3% 4.1% 2.3% 0.4% 1.2% 2.0% 2.6% 3.0% 1.3% 2.5% 3.3% 2.8% 1.6%Health and personal care 6.2% 6.3% 1.4% 1.6% -1.5% -1.4% -2.1% -1.7% -1.5% -1.6% -2.4% -0.7% -2.2%Total 4.4% 2.8% 1.7% 1.8% 0.6% 0.2% -0.7% -0.4% -0.4% -0.3% -0.4% 0.4% -0.8%

Y/Y Percent ChangeClothing & Clothing Accessories 11.7% 7.7% 3.5% 4.1% -3.3% 4.3% 3.8% 5.6% 5.3% 4.4% 3.2% 6.5% 4.6%Sporting Goods 7.5% 1.6% 0.3% 1.7% -3.0% 0.4% 1.1% 0.0% -1.3% 1.8% 0.7% 1.5% 3.0%Electronics & Appliances 3.7% 2.5% 2.0% 2.6% 2.3% 1.0% 3.9% -2.7% -0.2% -1.5% -1.3% -2.6% 0.5%Furniture/Furnishings 2.5% 3.1% -2.1% 0.7% -2.3% 2.0% -0.3% -5.4% 2.3% 3.4% 1.1% -0.9% -2.8%Building Materials -5.3% -6.2% -13.5% -4.1% -10.6% -10.4% -3.4% -1.0% 1.1% 0.8% 3.4% 2.8% 1.0%General Merchandise 6.5% 3.0% 2.9% 3.3% 2.4% 2.7% 4.1% 5.8% 4.7% 4.9% 3.8% 4.5% 4.3%Misc -9.1% -4.0% -6.5% -5.0% -6.0% -4.7% -2.6% -2.0% -0.5% 0.3% 2.3% 0.9% 1.4%Total 3.4% 6.9% 3.8% 7.8% 5.0% 3.5% 3.1% 1.7% 1.4% 2.0% 1.0% 3.3% 1.4%Staples: Supermarket, Convenience, Pharmacy/Personal Care, BeerTtl Discretionary: Furniture/Furnishings, Electronics, Clothing/Shoes, Home Ctr/Bldg, Gen'l Merch, Sports, Misc RetailersSource: Statistics Canada

($400)($300)($200)($100)

$0$100$200$300$400$500$600

Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11

Staples Discretionary


25 January 2012 23



25 January 2012 24

Figure 23: SNAPSHOT: North American Food Retail Industry – Canada vs. US

NORTH AMERICAN FOOD RETAIL INDUSTRY

North West Co. Metro Sobeys Loblaw Kroger Safeway

12 Months Ending Jan-11 Sep-11 May-11^ Dec-10 Jan-11 Jan-11

National Market share est. 1% 10% 17% 30% 11% 6%

Store Count 230 656 1,337 1,027 2,458 1,694Retail Square Footage (mlns) 2.1 19.7 28.7 50.7 148.6 79.2

Per Store MetricsAverage store size (sq. ft.) 9,122 30,030 21,466 49,367 60,456 46,753

Revenue per Store ($M) $6.3 $17.4 $11.8 $30.2 $33.4 $24.2

Average sales / sq. ft. / week $13.27 $11.16 $10.56 $11.76 $10.63 $9.97

Revenue ($ Millions) $1,448 $11,431 $15,762 $30,997 $82,124 $41,050Revenue growth (3Yr CAGR) 10.8% 2.1% 4.6% 1.8% 5.4% -1.0%Same Store Sales (%) 2.7% 0.9% 0.2% -0.5% 2.8% -2.0%

Gross Margin (%) 29.5% 18.4% 24.3% 24.5% 22.3% 28.2%

EBITDA Margin (%) 8.9% 6.9% 5.1% 6.2% 4.6% 5.7%

Operating Margin (%) 6.5% 5.3% 2.9% 4.1% 2.7% 2.8%Net Margin (%) 5.6% 3.5% - 2.2% 1.4% 1.4%

Capex as a % of Revenue 2.6% 1.3% 3.5%* 4.1% 2.3% 2.0%Inventory Turns 5.8x 13.1x 17.0x* 11.1x 12.9x 11.5x

Net Debt to EBITDA 1.3x 1.3x 0.6x* 1.5x 1.7x 1.7x

Free Cash Flow ex Capex ($M) $88.2 $393 $132* $314 $1,447 $1,012FCF Yield (%) 9.3% 8.4% 3.6%* 3.0% 10.6% 12.1%

ROE (%) 26.0% 16.2% 4.9%* 10.4% 21.1% 11.8%

ROIC (%) 16.6% 12.1% 10%* 7.5% 9.7% 6.5%

Note: Same store sales excludes gasoline where possible *Includes Empire's other businessesSource: Company reports, Barclays Capital estimates ^53 week period

CANADA - Grocery Sales UNITED STATES - Grocery Sales

Store System Sales Market PG Store Count ACV Market

Rank Company Count Est. ($B) Share Rank Company (over $2m) est. ($B) Share

1 Loblaw Co. 1,027 $31.3 31% 1 Wal-Mart 3,001 $143.8 26%

2 Empire / Sobeys 1,077 $18.1 18% 2 Kroger 2,460 $63.1 11%

3 Metro 656 $11.0 11% 3 Safeway 1,461 $35.0 6%Top 3 Chain Grocers 3,107 $60 60% 4 SuperValu 1,504 $29.4 5%

4 Safeway Canada 223 $6.3 6% Top 3 Chain Grocers 7,206 $175 23%

5 Wal-Mart 325 $6.3 6% 5 Costco 416 $26.5 5%

Top 5 Retailers 3,308 $72.8 72% Top 5 Retailers 8,842 $345.6 53%

6 Costco 79 $5.4 5% 6 Ahold USA 746 $25.6 5%

7 Overwaitea 124 $3.3 3% 7 Publix Super Mkts 1,035 $22.2 4%

8 Federated Coop 265 $2.3 2% 8 Delhaize America 1,641 $19.0 3%9 Zellers 273 $1.9 1% 9 H.E. Butt Grocery 291 $12.4 2%

10 Calgary Co-op 23 $1.3 1% 10 Meijer 195 $8.8 2%

11 North West Co. 233 $1.0 2% 11 Whole Foods 293 $8.2 1%

12 Shoppers Drug Mart 1,238 $0.8 1% 12 A&P 373 $8.1 1%

13 H.Y. Louie 43 $0.6 1% 13 Winn-Dixie Stores 484 $7.8 1%

14 M&M Meat Shops 465 $0.5 0% 14 Trader Joe's 348 $7.2 1%15 Atlantic Co-op 107 $0.3 0% 15 Target 252 $6.7 1%

Top 15 $90 89% Top 15 $424 75%

Independents/Other $11 11% Independents/Other $139 25%

TOTAL CDN Grocery sales $101 100% TOTAL US Grocery sales $563 100%

Chain Banners $43 42% Chain Grocers $339 60%

Discount Banners $40 40% Discount Grocers $165 29%

Independents $11 11% Independents $31 6%

Sources: Company Reports, Progressive Grocer, Canadian Grocer, Barclays Capital estimates

North American Grocery Landscape - 2010


25 January 2012 25

CANADIAN FOOD RETAIL SECTOR OVERVIEW

Canadian Food retail sector – in the midst of the perfect storm 2012 and 2013 are expected to be challenging years for the Canadian food retail sector. The outlook for the Canadian Food Retail sector remains challenged as many of the factors that have made the past five years progressively more difficult for the three major grocers remain largely in place and in some cases, such as Wal-Mart’s Supercenter build-out, are becoming more of a drain. A brief look back at the past five years highlights three major factors that have combined to erode the sales and earnings growth capacity of the Canadian Food retail sector.

1. Wal-Mart’s rollout of the Supercenter format, which started in 2006 and has quickly grown to an expected 164 locations by the end of 2011, has strained the growth potential of the incumbents (flat to declining traffic) and has been a major contributor to intensified price competition over the past year. In 2007, partly in reaction to Wal-Mart’s impending launch of the Supercenter banner, Loblaw’s initiated large-scale, pre-emptive price reductions (as much as a 5% decline) to tighten its relative price indices in the conventional (indexed at 103 to 105) and discount (indexed at 100) segments versus Wal-Mart to protect its tonnage share and minimize Wal-Mart’s near-term opportunity gap.

2. The 2008/09 recession and its lingering impediment to discretionary spending growth. Initially the food retailers benefited from the recession as consumers shifted from eating out to eating in and traded down toward less expensive, higher margin private-label products. However, a generally weak, elongated economic recovery (modest employment improvement after an initial recovery of recession losses, wage growth lagging cost inflation) has left consumers extremely price sensitive, which in combination with Wal-Mart’s Supercenter rollout has increased price competition and increased the percentage of products sold on deal, pressuring food retailers’ margins.

3. Volatile food inflation has made margin management challenging. Hyper-inflation in 2009 (CPI measured food inflation peaked at 9.5% in March 2009) shifted into store measured deflation in 2010 (troughed at 0.08% by June 2010) which quickly returned to above average inflation of 5.72% as of November 2011. The revaluation of the Canadian dollar versus the U.S. dollar (increased by 14% in 2009) played a major role in curbing the level of hyper-inflation in Canada through 2009 relative to what the U.S. consumer experienced. Through most of 2011, the grocers struggled with above-average COGS inflation (2H10 wheat +85%, corn +73%, sugar +92%), passing along some but not all of the increases as they managed the price/volume trade-off. A weakening of the Canadian dollar in 2H11 has increased inflation pressure on imported produce, which in combination with intensifying price competition elevated margin risk in 4Q11.

Figure 24: Canadian Grocers: Comp-store-sales and EBITDA margin trends

Calendar Years 2006 2007 2008 2009 2010 2011E 2012E 2013E

CSS- Average 1.7% 2.1% 3.4% 1.7% -0.3% 1.1% 0.4% 0.9%

EBITDA Margin Variance -10 bps -36 bps -13 bps 41 bps 26 bps 11 bps 6 bps 25 bpsNote: Calendarized and adjusted for extra weeks

Source: Company reports and Barclays Capital estimates.

The past five years have been difficult; the next two years will

be challenging, too


25 January 2012 26

1H12: some relative calm before the next storm

While we believe 4Q11 will prove to be the peak period of margin risk, the 2012 and 2013 outlook remains very difficult. As we wait for 4Q11 results and enter 2012 the Canadian food retail sector is in the midst of a perfect storm, which at best is expected to evolve into a long stretch of grey skies with intermittent thunderstorms. We expect 4Q11 to be more challenging than 3Q11, followed by a brief reprieve in 1H12 before Wal-Mart re-opens 39 acquired Zellers locations in 2H12 and Target brings on 135 locations starting in March 2013.

We do not expect the current challenging environment to get materially easier in 2012, or even 2013. In the immediate term, a noticeable contraction in consumer spending and Wal-Mart’s continued build out of the Supercenter format have conspired to create a limited to no-volume growth (traffic down, item basket count up, increased % on deal) market place for the established food retailers with price competition intensifying as 2011 has progressed (increased promotion depth, combined with unfavourable mix shift toward promo priced items) just as COGS food inflation has picked up (aided by a weakening Canadian dollar). Several retailers have indicated that consumers noticeably ratcheted down their spending habits in 2H11 (similar to what 2008 was like) resulting in flat-to-down traffic, trade-down and an increase in the percent of sales sold at a discount.

The food retailers have entered the peak margin risk period as ramping COGS inflation clashes with increasing price competition. This progression of dynamics outlined above finally resulted in gross margin erosion in calendar 3Q11 at Metro and more significantly at Sobeys in its fiscal 2Q12, as its results included the more promotional month of October. These results and commentary by Metro and Sobeys has confirmed that margin pressure will be worse in calendar Q4. Holiday period promotional activity (starting with Canadian Thanksgiving – week of October 3) intensified as retailers fight for volume bringing net realized food inflation down materially versus Q2. As if these pressures weren’t enough, a weakening Canadian dollar versus the U.S. dollar is increasing produce inflation after three quarters of it being an assist. Our COGS inflation analysis (see Figure 44) suggests that 4Q11 and 1Q12 are the peak input cost inflation periods. The Canadian dollar headwind is expected to continue for at least the next two quarters.

Wal-Mart and Target are poised to increase competitive intensity through the addition of significant new grocery square footage over the next 2-3 years. HBC Trading Company’s sale of 188 of its 273 locations across Canada to Target (retained 149 of 188) and Target’s subsequent sale of 39 locations to Wal-Mart is expected to result in the redeployment of about 14 million square feet of retail space starting in 2H12 with Wal-Mart’s re-opening of 39 renovated stores, followed by Target’s phased re-opening of 135 locations from March 2013 through to mid-2014. While the food industry will get a brief reprieve during the Zellers store closure/renovation period (6-9 months per store), ultimately the redeployed square footage is expected to inflict an increased drain on incumbent sales as the new banners’ food square footage should benefit from greater traffic at these stores than what Zellers was able to attract.

It’s a limited/no-growth environment in food retail right

now


25 January 2012 27

The Canadian food retail landscape The Canadian Food Retail sector, with estimated sales of $101 billion, is dominated by the three publicly traded retailers, which collectively hold almost 60% of the Canadian grocery market. An emerging fourth player is Wal-Mart Canada (~6% market share), whose 2006 launch of the Supercenter format has significantly increased the company’s grocery sales growth, predominantly at the expense of the three large incumbents.

Loblaw Co.’s is the only truly national coast-to-coast competitor, except for Wal-Mart. Loblaw competes with a mix of conventional and discount formats/banners with industry-leading market share in both segments.

Empire Co./Sobeys – With the acquisition of British Columbia–based Thrifty Foods (20 stores) in 2007, Sobeys has only recently established itself as a national player with a toehold in British Columbia. Sobeys is predominantly a conventional store retailer with more than 90% of sales in that segment.

Metro Inc. has a solid No. 2 position in Canada’s two largest provinces following the 2005 acquisition of A&P Canada, operating both conventional and discount banner formats in each market.

Wal-Mart Canada is the newest major player, having arrived in Canada in 1994 through its acquisition of 122 Woolco stores. As part of its conventional store build-out, Wal-Mart aggressively added “Pantry” sections to all of its conventional stores. In 2006, Wal-Mart launched its first Supercenter store in Canada.

Figure 25: Canadian Food Retail Market Shares by Region (by estimated system sales)

Atlantic Quebec Ontario West CanadaMAJOR FOOD RETAILERS:Loblaw 30% 22% 31% 33% 30%Metro 0% 22% 16% 0% 10%

Empire 27% 22% 16% 12% 17%

Safeway Canada 0% 0% 0% 17% 6%Other Major Grocer 0% 0% 0% 13% 4%

Independent 18% 15% 13% 5% 11%

Total Major Food Retailers 75% 80% 77% 80% 78%

ALTERNATIVE GROCERY:Wal-Mart 5% 4% 7% 7% 6%Costco 4% 5% 6% 4% 5%

Drugstores 3% 4% 5% 3% 4%

Convenience Stores 13% 6% 5% 6% 6%

Total Alternative Grocery 25% 20% 23% 20% 22%

Total 100% 100% 100% 100% 100% Source: Barclays Capital estimates, Statistics Canada, Canadian Grocer, Company Reports

Wal-Mart’s hungry for food sales You cannot discuss the grocery industry in the United States, or Canada, without mentioning Wal-Mart, whose appetite for food sales and the related traffic lift of food shopping frequency have been a major factor in both markets for almost two decades. Wal-Mart holds very different market positions in the U.S. and Canadian grocery markets. In the United States, Wal-Mart, predominantly through the national rollout of the Supercenter format, has established itself as the clear national market share leader with an estimated

Three publicly traded retailers own 60% of the grocery market,

but Wal-Mart is growing its share of the pie

Wal-Mart has a 26% share of the U.S. market...


25 January 2012 28

share of 26% (source: Progressive Grocer magazine – ACV share) versus the Top 3, more regional, conventional retailers (Kroger, Safeway, SuperValu) which collectively hold a national share of 23% share. In Canada, the top three conventional retailers control an estimated 57% of the market, with Wal-Mart having attained an estimated 6% share of grocery industry sales, placing it in fifth place behind the top 4 conventional players. In the United States, the regional nature and absolute size of the regional markets (California is as big a market as all of Canada) does not make Wal-Mart’s U.S. presence as dominant as it appears, with Wal-Mart having a diverse range of regional market shares, but Wal-Mart’s absolute size in U.S. grocery does provide it with some cost advantage levers.

In Canada, at its current relative size, Wal-Mart still lacks the critical mass advantage it has in the United States. Even assuming suppliers are providing Wal-Mart with additional growth funding, it is doubtful that Wal-Mart’s grocery expense rates (product and specialized distribution) are superior to any of the incumbents. We believe this expense rate differential and Wal-Mart Canada’s ROE focus has tended to result in a relatively stable pricing environment, with the exception of this year, where an increasingly tight-fisted consumer and accelerating food inflation have increased price competition for volume, and in 2007 when Loblaw’s moved to lower its relative price index versus Wal-Mart.

Figure 26: Top 15 Grocery Retailers in Canada and the US by estimated market share

CANADA - Grocery Sales UNITED STATES - Grocery Sales

Store System Sales Market PG Store Count ACV Market

Rank Company Count Est. ($B) Share Rank Company (over $2m) est. ($B) Share

1 Loblaw Co. 1,027 $31.3 31% 1 Wal-Mart 3,001 $143.8 26%

2 Empire / Sobeys 1,077 $18.1 18% 2 Kroger 2,460 $63.1 11%

3 Metro 656 $11.0 11% 3 Safeway 1,461 $35.0 6%

Top 3 Chain Grocers 3,107 $60 60% 4 SuperValu 1,504 $29.4 5%

4 Safeway Canada 223 $6.3 6% Top 3 Chain Grocers 7,206 $175 23%

5 Wal-Mart 325 $6.3 6% 5 Costco 416 $26.5 5%Top 5 Retailers 3,308 $72.8 72% Top 5 Retailers 8,842 $345.6 53%

6 Costco 79 $5.4 5% 6 Ahold USA 746 $25.6 5%

7 Overwaitea 124 $3.3 3% 7 Publix Super Mkts 1,035 $22.2 4%

8 Federated Coop 265 $2.3 2% 8 Delhaize America 1,641 $19.0 3%

9 Zellers 273 $1.9 1% 9 H.E. Butt Grocery 291 $12.4 2%

10 Calgary Co-op 23 $1.3 1% 10 Meijer 195 $8.8 2%

11 North West Co. 233 $1.0 2% 11 Whole Foods 293 $8.2 1%

12 Shoppers Drug Mart 1,238 $0.8 1% 12 A&P 373 $8.1 1%

13 H.Y. Louie 43 $0.6 1% 13 Winn-Dixie Stores 484 $7.8 1%

14 M&M Meat Shops 465 $0.5 0% 14 Trader Joe's 348 $7.2 1%15 Atlantic Co-op 107 $0.3 0% 15 Target 252 $6.7 1%

Top 15 $90 89% Top 15 $424 75%

Independents/Other $11 11% Independents/Other $139 25%

TOTAL CDN Grocery sales $101 100% TOTAL US Grocery sales $563 100%

Chain Banners $43 42% Chain Grocers $339 60%

Discount Banners $40 40% Discount Grocers $165 29%

Independents $11 11% Independents $31 6%

Sources: Company Reports, Progressive Grocer, Canadian Grocer, Barclays Capital estimates

Wal-Mart Canada’s growth in food has been executed through several different stages since the company’s arrival in 1994 following the acquisition of 122 Woolco stores. Food sales growth started with the addition of “Pantry” sections in 1998 (dairy, dry and frozen grocery products), followed by the launch of the SAM’s Club format in 2004 (closed in 2009 with the sale of locations to Lowe’s Canada) and more recently through the introduction/rollout of the Supercenter format starting in 2006. As we have seen in the United States, the Supercenter banner deployment in Canada has several format variations, all including a fresh food offering (produce, meats and baked goods):

1. Conventional conversions – the addition of a fresh offering (produce, meats, baked goods) within an existing conventional store.

…but still lacks critical mass in Canada


25 January 2012 29

2. Expansions of conventional stores – virtually every new Wal-Mart that was opened since the company’s arrival in 1994 was built with expansion space adjacent to the conventional store to accommodate conversion to the Supercenter format. In some cases, Wal-Mart has chosen to not expand these stores to ensure they achieve acceptable store productivity improvement and returns from increased food sales and traffic.

3. Greenfield Superstores – the first new Greenfield locations (i.e., Stoufville, Ontario) were modelled on the larger U.S. Supercenters. As we have seen in the United States, the newer Supercenters tend to be smaller. Wal-Mart is estimated to have opened eight greenfield Supercenter locations in 2011.

New Urban 90 concept – a smaller foot print designed to increase Wal-Mart’s urban center presence. In addition to the Supercenter rollout, Wal-Mart is in the process of launching a new format in Canada in 2012 called the Urban 90 concept. This new, smaller store concept is designed to allow Wal-Mart to achieve greater penetration of urban population centers.

Wal-Mart’s pragmatic approach to food sales growth in Canada and its relative pricing stance has been partly, if not largely, in recognition of the Big 3’s (Loblaw, Metro and Sobeys) strong position in Canada and the already highly developed discount grocery segment in Canada (27% ex WMT vs. less than 10% in the US in the mid-1990s). These circumstances are significantly different than the world that Wal-Mart faced when it initiated its attack on the U.S. grocery industry (less market concentration – strong regional players, limited discount segment development, high-priced conventional retailers). Within the context of some healthy tension, Canada’s Big 3 are allowing Wal-Mart to take its share of the market provided Wal-Mart pursues this growth without creating an irrational pricing environment that threatens industry profitability beyond a tolerable level.

Figure 27: Canadian Discount Segment Development – share of Grocery Sales

Atlantic Quebec Ontario West Canada

Loblaw 25% 13% 12% 32% 20%Metro 0% 7% 6% 0% 4%

Empire 3% 0% 3% 0% 1%

Other Major Grocer 0% 0% 0% 4% 2%

Total Major Food Retailers 28% 20% 22% 37% 27%

Wal-Mart 5% 4% 7% 7% 6%

Costco 4% 5% 6% 4% 5%

Canadian Grocery Discount share 37% 29% 35% 47% 38%

Source: Statistics Canada, Canadian Grocer Magazine and Barclays Capital estimates.

Zellers break up: a brief reprieve and then a one-two punch Canada’s retail sector started 2011 off with a big bang when in two separate transactions the leasehold ownership of 188 of Zellers’ 273 stores was sold to Target (149) and Wal-Mart Canada (39). On January 13, 2011, Hudson’s Bay Trading Company (owned by private equity firm NRDC Equity partners – banners include Lord & Taylor in the United States, The Bay and Zellers in Canada) and Target announced a real estate deal that is expected to result in Target opening at least 135 locations in Canada starting in the Greater Toronto Area (GTA) in 1Q13. Starting in early 2012, Target’s acquired/retained Zellers

Canada’s Big 3 are unlikely to remain “passive” if they see an irrational pricing environment

developing

Enter Target…135 stores scheduled to open in 1Q13


25 January 2012 30

stores (149) will go dark for nine-plus months on a phased basis until Target begins re-opening them between March 2013 and mid-2014. The renovation closures will provide a temporary windfall for Zellers’ competitors; this will include the potential closure of pharmacy counters and grocery aisles. Target intends to open stores in clusters over a period of 5-6 cycles structured to capture as much critical mass efficiency as possible. After the GTA openings, they intend to head west and then swing back east with most of the stores re-opened by Q1, or Q2 of 2014.

In a subsequent transaction Wal-Mart announced the acquisition of 39 Zellers stores from Target. Wal-Mart has indicated that it will convert and reopen the 39 Zellers locations toward the end of 2012 with limited closure or renovation disruption.

Figure 28: The Sale of Zellers Stores to Target and Wal-Mart

273 Zellers Stores

85 Zellers Stores

Remaining

15 to be Closed/Sold by

Target

135 to be Target Stores

39 Purchased by WMT

Target Had the Right to Purchase up to 220 Zellers

Locations

189 Potential Target Locations - 188 from Zellers and 1 Undeveloped Site from Wal-Mart


This change of ownership of over 14 million square feet of retail space will have significant implications for many of Canada’s leading retailers as it places underperforming square footage in the hands of two “best-in-class” retailers which are expected to generate substantially higher sales productivity in several categories that represents a material threat to many established retailers in Canada.

Figure 29: Estimated sales productivity lift of redeployed Zellers locations

TGT WMT Remaining Increase

Zellers Canada Canada Zellers TOTAL vs Zellers

Store count 273 135 39 85 259 -5%

Avg store size - sf 78 83 83 68 78 1%

Sales / selling sf. $189 $440 $545 $189 $385 104%

Sales estimate $4,000 $4,930 $1,764 $1,092 $7,786 95%

Source: Company reports, Barclays Capital estimates

Most of the Zellers stores have dry grocery merchandise. We estimate that 47% (70) of the Zellers stores that Target will open have a Neighbourhood Market grocery section (dry/frozen grocery and dairy), while only 13% (5) of Wal-Mart’s acquired locations have full grocery sections. Target has confirmed that it will not have a food offering in all stores as the Zellers stores are much smaller than Target’s typical U.S. footprint. We estimate the average store size of the acquired locations is almost 30% smaller than a typical Target store in the United States (83k sq. ft. versus 122k sq. ft.). We expect Wal-Mart to have at least some element of food in all of its stores when they are re-opened, except where incumbent leasehold exclusivity agreements prove immovable. Over time, we expect most of the locations to end up with an expanded food offering.

Expect an impact as 14mn sq. ft. of retail space changes

ownership


25 January 2012 31

Figure 30: Zellers Store Network Redistribution

ATL QUE ONT WEST CANADAconfirmed 6 19 45 35 105remaining 5 8 16 15 44

TARGET locations 11 27 61 50 149had Rx and Grocery 4 3 33 21 61

had Grocery only 0 9 0 0 9

had RX only 7 6 27 24 64had neither RX or Grocery 0 9 1 5 15

WAL-MART locations 5 8 19 7 39had Rx and Grocery 1 0 4 0 5had Grocery only 0 0 0 0 0

had RX only 4 0 13 5 22

had neither RX or Grocery 0 8 2 2 12

ZELLERS remaining locations 12 17 39 17 85had Rx and Grocery 1 1 8 3 13had Grocery only 0 1 0 0 1

had RX only 8 2 29 11 50had neither RX or Grocery 3 13 2 3 21

Source: Company Reports, Barclays Capital estimates

WalMart’s Grocery growth gets an extraordinary boost in 2012/13

2012 will be Wal-Mart Canada’s biggest year of store activity since 1994. Subsequent to Target’s acquisition of the 188 leases from HBCT/Zellers, Target sold 39 locations to Wal-Mart. These locations are expected to be converted into either the Supercenter format, or Wal-Mart’s s new “Urban 90” concept with the re-openings planned toward the end of 2012. In addition, Wal-Mart will be opening 34 other Supercenter banner locations throughout 2012 through a combination of conversions, expansions and Greenfield locations. This will make 2012 the biggest single year of new store openings for Wal-Mart Canada since its arrival in 1994.

The addition of the 39 Zellers stores in 2012 accelerates WMT Canada’s grocery growth plan by a full year. We now expect WMT Canada to achieve almost a 10% share of the Canadian grocery sector by 2015, nearing Metro’s current 10% market share.

Figure 31: Wal-Mart Canada’s Evolution

Calendar Year 1994 2006 2010 2012E 2015E

Conventional 124 276 201 135 30

Supercenter 7 124 237 360

SAM's Club 6

Total stores 124 289 325 372 390

WMT share of retail sales (ex auto/gas) 1.4% 5.5% 6.6% 8.5% 9.7%WMT CDN Grocery share 1.3% 4.7% 5.9% 7.9% 9.7%

Sources: Barclays estimates and Company Reports

Target’s grocery threat is limited, for now

Target’s near-term incremental grocery sales threat is modest with the company focussed on its bigger areas of upside: apparel and home fashions/housewares. We estimate that on average the Zellers stores that Target has acquired are approximately 30% smaller than Target’s conventional discount stores in the United States, at an estimated average selling space per store of 83k sq. ft. versus Target’s 122k sq. feet. This smaller

Conversions plus new stores will make 2012 a bumper year for

single store openings for Wal-Mart Canada


25 January 2012 32

footprint and the significant sales productivity lift we expect Target to achieve in the higher margin apparel and home fashions/housewares categories suggests that in the immediate term (12-24 months), as they have indicated during their September 2011 investor day, Target will only include food in locations where its feels it needs the additional lift of food sales/traffic. This is similar to how Target has treated its food offering in the United States, where it has only been recently that it has committed to adding some element of food to all of its locations. Within this report we are limiting our analysis of Target’s impact to the food sector as the primary areas of Target’s sales growth represent minimal risk to the companies we are initiating on in this report.

Apparel – We expect Sears Canada, Old Navy, Wal-Mart, Joe Fresh (Loblaw), and Winners (TJMaxx) to be most at risk.

Home fashions/housewares – Competitors with the greatest risk are Sears Canada, Wal-Mart, IKEA, HomeSense (TJMaxx) and to a lesser degree Canadian Tire.

We do expect Target’s food sales to lift versus Zellers due to increased traffic and through the addition of some new locations with an expanded food offering. Almost all of the Zellers stores include at least dry grocery merchandise. We estimate that 70 of the 135 Zellers stores Target is expected to open in 2013/14 already had a Neighbourhood Market grocery offering (similar to Wal-Mart’s Pantry department), which adds dairy and frozen grocery to the base dry grocery offering. There is also a possibility that a majority of the other 65 locations may not be allowed to materially expand into other mainstream grocery merchandise due to leasehold exclusivity held by an incumbent food retailer in the same mall. We suspect that many landlords will go out of their way to allow Target to get around these restrictions depending on the importance of the incumbent food retailer, or the legal clarity of the lease terms; many of Zellers’ leases are long-term legacy agreements written over 20-30 years ago when Zellers was a better traffic draw. Of note, Target has signed a supply agreement with Sobeys for dairy and dry grocery products – no details have been provided by either company. We estimate that once Target has fully deployed its stores that Sobeys annualized wholesale revenues could reach $400mn by the early part of 2014.

Discount segment growth is expected to accelerate through 2015 We expect Discount Grocery sales growth by alternative channel competitors to accelerate over the next five years primarily due to Wal-Mart’s continued Supercenter rollout and the redeployment of 188 of Zellers’ 273 stores into the hands of Target and Wal-Mart. In addition, the established food retailers have been skewing their store investments toward the discount segment to capture a piece of its above-average growth.

Loblaw has deployed its industry-leading No Frills discount concept to the east and west and is converting many Loblaw stores in Quebec to Maxi & Cie. Loblaw has taken the highly successful Ontario-based No Frills banner into Atlantic Canada and the West predominantly through conversions of less productive banners such as Extra Foods (west) and the Supervalu banner in the east. Loblaw has also converted several Loblaw stores in Quebec to the Maxi & Cie discount banner.

Empire/Sobeys launched Fresh Co. in Ontario - a new discount banner. Empire/Sobeys relaunched the majority of its underperforming Price Chopper stores under the new FreshCo. banner concept (64 locations) which emphasizes discount prices on fresh produce. They launched with aggressive grand opening price points which established

Sobeys annualized wholesale revenues could reach $400mn

by the early part of 2014


25 January 2012 33

credibility of the concept’s promise but was also a catalyst to a price skirmish in Ontario’s hard discount segment.

Metro’s new store openings are skewed to discount. In fiscal 2011 Metro opened nine discount stores versus three conventional stores, with similar plans in F2012.

Figure 32: Conventional vs. Discount segment sales importance by retailer


Loblaw 15% 41% 62% 5% 32%

Metro 67% 60% 64%

Empire 87% 100% 79% 99% 92%Safeway Canada 100% 100% 100%

Overwaitea 50% 50%

Calgary Co-op 100% 100%Independents 100% 100% 100% 100% 100%

Drugstore / Convenience 100% 100% 100% 100% 100%Total Conventional 63% 71% 65% 53% 62%

Loblaw 85% 59% 38% 95% 68%

Metro 33% 40% 36%Empire 13% 0% 21% 1% 8%

Overwaitea 50% 50%

Wal-Mart 100% 100% 100% 100% 100%Costco 100% 100% 100% 100% 100%

Total Discount 37% 29% 35% 47% 38%

Total CDN Grocery retail 100% 100% 100% 100% 100% Source: Barclays Capital estimates, Company reports

So far, Loblaw has taken the biggest hit; losing share within the top 3 grocery retailer subgroup. Based on Loblaw’s relative CSS performance over the past seven quarters, Loblaw has been losing market share within the “Big 3” subgroup, while the group has been losing share of total market due primarily to Wal-Mart’s significant grocery sales growth. It is worth noting that Sobeys, with very limited presence in the discount segment (less than 7% of sales) actually gained share (industry leading real CSS growth through all of 2010) through 2010 into early 2011 among the “Big 3”. Given the amount of growth expected in the discount segment over the next two years it seems highly likely that Sobeys will have to invest margin to gain share in a segment that will be losing market share overall.

Figure 33: Top 3 Canadian Grocery Retailers CSS Trends

Canadian Grocery Retailers CSS Trends Canadian Grocery Retailers "Real" CSS Trends

-3%-2%-1%0%1%2%3%4%5%6%7%8%

1Q-09

2Q-09

3Q-09

4Q-09

1Q-10

2Q-10

3Q-10

4Q-10

1Q-11

2Q-11

3Q-11

Loblaw Metro Sobeys

-3%

-2%

-1%

0%

1%

2%

3%

4%

1Q-09

2Q-09

3Q-09

4Q-09

1Q-10

2Q-10

3Q-10

4Q-10

1Q-11

2Q-11

3Q-11

Loblaw Metro Sobeys


Wal-Mart and Target’s grocery sales growth is estimated to fuel more than $1 billion a year in discount segment sales growth. We estimate that once fully ramped, Target’s

Loblaw has been losing market share within the “Big 3”

subgroup


25 January 2012 34

grocery sales in Canada could exceed $1 billion through its network of 135-145 stores versus our estimate of Zellers’ current grocery sales of $1.9 billion in 273 stores. We expect Wal-Mart’s grocery sales to increase from a 2011 estimate of $5.8 billion to almost $9 billion by 2015. In combination with Zellers’ remaining stores (85) we estimate that the total grocery sales coming from Zellers’ 273 locations could increase by 26% to $2.4 billion by 2015 versus the current $1.9 billion driven by: 1) more stores with grocery, 2) expanded grocery offerings, and 3) higher traffic at Wal-Mart and Target than at Zellers.

Figure 34: Wal-Mart & Target’s Canadian Grocery Sales Forecast

Wal-Mart, Target Grocery Sales Grab - Sales forecast ($M)Store Count 2010 2011 2012 2013 2014 2015

WMT Supercenters 124 164 237 277 317 357

Target 100 135 135

Zellers 273 273 164 85 85 85

Stores w Grocery 397 437 401 462 537 577

Sales 2010 2011 2012 2013 2014 2015

Wal-Mart $5,150 $5,794 $6,580 $7,628 $8,313 $8,953Target $216 $775 $1,118

WMT & TGT ($M) $5,150 $5,794 $6,580 $7,844 $9,088 $10,071Zellers $1,892 $1,892 $1,474 $673 $547 $547

Total Grocery Sales ($M) $7,042 $7,686 $8,053 $8,517 $9,635 $10,618

Source: Company reports and Barclays Capital estimates

We estimate that 2013 will be Wal-Mart’s biggest year of grocery sales growth over the next five years as the 2H12 Zellers openings (39) and other Supercenter openings (34) in 2012 ramp up and Wal-Mart opens another 40 Supercenter banners in 2013. When combined with Target’s launch timing, the 2013 and 2014 threat is just as daunting for the incumbent retailers. In an industry struggling to achieve any comparable store sales (CSS) growth, this level of alternative channel discount sales growth will continue to make it difficult for the incumbents to grow their sales, particularly in the conventional segment. With this degree of competition for volume, it will be very difficult to return to normalized earnings growth (8%-10%) until consumers become less price focussed.

Target’s gift to Canada’s retailers – Zellers’ 2012 renovations

Grocery retailers could suffer less sales drain in 2012 and 2013 than they did in the past two years as Target closes/renovates the Zellers stores. It is important to highlight that Target will be closing all of the Zellers stores for renovation, presumably on a phased-in basis to accommodate a nine-month renovation of each store before it begins re-opening them starting in March 2013 through to early 2014.

This renovation “blackout period” could provide the established grocers with a significant reprieve in 2012/13 from the relentless sales drain that Wal-Mart’s Supercenter rollout has inflicted upon them since 2007. We estimate that, in isolation, these Zellers closures could reduce the combined grocery sales drain of Wal-Mart’s Supercenter rollout and Target’s store openings in 2012 and 2013 to levels below the drain that Wal-Mart is estimated to have brought to the market in 2010 and 2011.

2013 could be Wal-Mart’s biggest year of grocery sales

growth over the next five years


25 January 2012 35

Figure 35: Wal-Mart & Target’s Incremental Grocery Sales Growth – Y/Y variance

Store Count 2010 2011 2012 2013 2014 2015

WMT Supercenters 40 40 73 40 40 40

Target 100 35 0

Zellers 0 0 -109 -79 0 0

Stores w Grocery 40 40 -36 61 75 40

Sales 2010 2011 2012 2013 2014 2015

Wal-Mart $578 $644 $786 $1,048 $686 $640

Target $0 $0 $0 $216 $559 $343

WMT & TGT ($M) $578 $644 $786 $1,264 $1,245 $983Zellers $0 $0 -$419 -$801 -$126 $0

Group Grocery sales ($M) $578 $644 $367 $463 $1,118 $983


Who’s most at risk from Wal-Mart and Target’s growth?

To establish a sense of relative risk exposure that Wal-Mart and Target’s grocery sales growth represents for each of the Food retailers we have done some directional analysis to size and trend the risk. This analysis is based on: 1) our forecast of Wal-Mart and Zellers grocery sales growth from 2011 to 2015, and 2) our estimate of Loblaw, Metro and Sobeys’ regional and segmented market share exposure to that growth. We emphasize this analysis is directional. We have assumed a three-year ramp-up to full sales capacity on the portion of the food offering that is new at the location. This could push the risk out 6-12 months later than what actually occurs depending on the timing of new store openings. We have not made any adjustments for regional nuances that could affect each of the food retailers’ exposure to that risk; we have qualitatively outlined some of these on the next page.

EPS risk exposure – our major takeaways:

1. Target’s closure/renovation of 135 Zellers stores could materially ease the grocers’ sales and EPS risk in 2012 and 2013 with Empire likely the biggest absolute benefactor of the closures. Proportionately, Loblaw should see the greatest easing of EPS risk.

2. Empire/Sobeys is most exposed, proportionately, with a material increase in risk exposure starting in 2013 once Wal-Mart enters Atlantic Canada. If Target’s temporary renovation closures deliver the eased risk we estimate, Sobeys should feel significantly less pressure in 2012 vs. 2011 before it gets more challenging in 2013. Sobeys’ suburban location skew in Ontario suggests that its risk exposure to the Wal-Mart and Target conversions of Zellers stores may be greater than we are estimating. Sobeys’ greater exposure after 2012 reflects Wal-Mart’s eased build-out in Ontario after completing the Zellers conversions, which is Sobeys’ least developed market. Empire’s large-scale productivity and efficiency initiatives should start to contribute by spring 2013 (new Quebec DC, SAP completion and the “Reset” initiatives) through to 2015 providing some meaningful offsets.

3. Metro is the least exposed, as a percentage of EPS, with the risk of Wal-Mart’s Supercenter launch in Quebec partly offset by eased pressure in Ontario. So far, Metro has indicated that the sales drain it has felt from the Supercenter openings in Quebec has been less than what it experienced in Ontario. If Target’s store closures contribute the estimated benefit, we believe Metro has sufficient EPS risk offsets planned for 2012 to achieve our EPS forecast. Metro’s store skew to Toronto’s urban center also shields it from some of this risk.


25 January 2012 36

Figure 36: Estimated EPS at risk from WMT & TGT Grocery Growth

Loblaw 2008 2009 2010 2011 2012 2013 2014 2015

WMT $0.11 $0.10 $0.11 $0.12 $0.14 $0.19 $0.12 $0.11 TGT $0.04 $0.09 $0.06 WMT/TGT $0.11 $0.10 $0.11 $0.12 $0.14 $0.23 $0.21 $0.17 Zellers -$0.07 -$0.14 -$0.02 $0.00

EPS at risk $0.11 $0.10 $0.11 $0.12 $0.07 $0.09 $0.20 $0.17% of EPS 5.3% 3.8% 4.1% 4.3% 2.5% 2.8% 5.3% 4.2%% of EPS pre Zellers 5.3% 3.8% 4.1% 4.3% 4.9% 6.9% 5.8% 4.2%

Empire 2008 2009 2010 2011 2012 2013 2014 2015



Metro 2008 2009 2010 2011 2012 2013 2014 2015


EPS at risk $0.05 $0.06 $0.06 $0.07 $0.05 $0.09 $0.17 $0.16% of EPS 2.1% 1.8% 1.8% 1.9% 1.2% 1.9% 3.3% 2.8%

% of EPS pre Zellers 2.1% 1.8% 1.8% 1.9% 2.8% 4.2% 3.7% 2.8% Source: Barclays Capital Estimates and Company reports

Additional risk exposure puts and takes for consideration are:

Ontario: Loblaw is most developed in this largest region, but about 60% of Loblaw’s Ontario business is franchised and 37% is discount, which reduces some of the risk. Metro’s strong urban Toronto presence (50+ stores) will blunt some of our estimated risk, while Sobeys’ bias toward suburban locations will increase its exposure to Wal-Mart and Target’s re-opening of the Zellers stores. Sobeys predominantly franchise (60%) business in Ontario (lower margin) and significant secondary market presence (Foodland banner) offsets some of its suburban exposure risk.

Quebec: Loblaw’s 10+ year struggle to establish a winning banner/format strategy in Quebec has provided its competitors with a relatively easy source of sales growth. Although we think Loblaw is heading in a better direction it seems unlikely that it can move fast enough to avoid the accelerated risk of Wal-Mart’s and Target’s growth. Loblaw’s EPS risk exposure in Quebec is further increased by the fact that 80% of its sales are done in high-margin corporate banners. Metro has a strong discount banner in Quebec, Sobeys has none; this favours Metro as the discount segment is growing faster than conventional sales, providing some mitigation of sales decline risk.

Western Canada: Loblaw has significantly improved the quality and price perception of its mostly discount (>90%) business in western Canada. Sobeys does not have a discount presence in the West but it has a very strong price perception due to some aggressive price investments over the past three years.

Atlantic Canada: 2012 is expected to mark the beginning of the Supercenter rollout in Atlantic Canada with at minimum the conversion of five Zellers stores. We expect the


25 January 2012 37

Atlantic Canada Supercenter rollout to be very gradual at first as Wal-Mart focuses more on Quebec. This will save Empire from more immediate pressure in its most developed market.

Figure 37: Wal-Mart & Target Regional Sales Growth Forecast


WMT $28 $113 $398 $247 $786

TGT $0 $0 $0 $0 $0

2012 total $28 $113 $398 $247 $786

WMT $93 $237 $389 $330 $1,048

TGT $0 $0 $145 $71 $216

2013 total $93 $237 $534 $401 $1,264

WMT $45 $195 $175 $260 $674

TGT $39 $102 $235 $182 $559

2014 total $85 $296 $410 $442 $1,233

WMT $82 $185 $153 $231 $651

TGT $39 $102 $90 $112 $343

2015 total $122 $287 $243 $343 $994

2012-15 $327 $933 $1,585 $1,432 $4,277

Regional skew

2012 4% 14% 51% 31% 100%

2013 7% 19% 42% 32% 100%

2014 7% 24% 33% 36% 100%

2015 7% 24% 33% 36% 100%

2012-15 8% 22% 37% 33% 100% Source: Barclays Capital estimates, Company Reports


25 January 2012 38

Figure 38: Canadian Retail Food Inflation by Province

Canada Retail Food Inflation By ProvinceJan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11

Canada 1.88% 1.96% 3.66% 3.67% 4.23% 4.80% 5.11% 5.04% 4.82% 4.93% 5.72% 5.03%

Y/Y Change 97 bp 138 bp 292 bp 326 bp 399 bp 472 bp 453 bp 381 bp 265 bp 283 bp 473 bp 363 bp

Ontario 1.71% 1.78% 3.63% 4.23% 5.44% 5.77% 6.31% 5.91% 5.56% 5.59% 6.70% 4.92%


Quebec 2.09% 1.68% 4.56% 3.50% 2.85% 3.48% 4.26% 4.29% 3.51% 4.19% 5.47% 4.46%


West 2.47% 2.29% 3.14% 3.38% 4.54% 4.72% 4.33% 4.18% 6.11% 5.17% 4.75% 5.59%


Atlantic 1.38% 3.44% 3.42% 4.27% 4.36% 5.15% 4.84% 5.70% 3.95% 4.95% 5.76% 6.41%

Y/Y Change -32 bp 246 bp 194 bp 336 bp 462 bp 509 bp 370 bp 404 bp 199 bp 158 bp 391 bp 526 bp

Source: Statcan

Figure 39: Canadian Retail Food Inflation by Category

Canada Retail Food Inflation By CategoryJan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11

Total Retail Food CPI Inflation 1.88% 1.96% 3.66% 3.67% 4.23% 4.80% 5.11% 5.04% 4.82% 4.93% 5.72% 5.03%

Y/Y change 188 bps 196 bps 366 bps 367 bps 423 bps 480 bps 511 bps 504 bps 482 bps 283 bps 473 bps 363 bps

Bakery & Cereal Products 0.72% 1.72% 2.81% 5.81% 6.32% 6.21% 5.97% 6.10% 6.07% 6.38% 7.80% 5.99%


Dairy Products / Eggs 0.93% 1.45% 2.99% 2.46% 3.23% 3.07% 3.08% 3.37% 3.29% 4.01% 3.69% 3.46%


Fish / seafood -1.46% -1.01% -0.18% -0.92% 0.28% 1.37% 0.18% 0.72% 0.92% 1.40% 0.83% 1.88%

Y/Y change -146 bps -101 bps -18 bps -92 bps 28 bps 137 bps 18 bps 72 bps 92 bps 340 bps 193 bps 471 bps

Fresh Fruits 2.55% 0.49% -3.07% 0.50% 4.07% 4.01% 9.22% 7.26% 4.90% 6.20% 6.67% 8.25%

Y/Y change 255 bps 49 bps -307 bps 50 bps 407 bps 401 bps 922 bps 726 bps 490 bps 601 bps 761 bps 653 bps

Fresh Vegetables 2.00% 7.40% 18.62% 4.35% 4.52% 8.36% 12.29% 8.75% 13.00% 10.47% 13.24% 11.11%


Fresh / frozen meat (ex-poultry)4.27% 3.79% 6.88% 7.48% 6.55% 7.79% 6.89% 8.03% 7.58% 7.09% 8.63% 7.37%


Fresh / frozen poultry 2.76% 2.01% 1.08% 1.83% 4.05% 2.85% 3.19% 3.50% 5.20% 2.22% 4.50% 2.73%


Source: Statcan


25 January 2012 39

Food Inflation – a short-lived rally with increased margin risk As expected, retail food inflation in Canada, as reported by StatsCan, ramped up over the past 10 months from its June 2010 low of 0.08% to a potential cycle high of 5.7% in November 2011 driven by major increases in fresh produce, meats, baked goods and, to a lesser extent, consumer packaged goods (CPG). On a store-level measured basis, the food retailers started to see a modest easing of deflation in 3Q10 and a return to inflation in 1Q11 as some “choppy” inflation mostly led by produce was followed by inflation in meats, grain-based products and eventually CPG.

Figure 40: Canada Retail Food Inflation vs. US Food at Home Inflation

-5%

0%

5%

10%

15%

20%80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Canada US

Canada: -1162 bpsUS: -879 bps




Canada: +564 bpsUS: +670 bps

Source: StatsCan, Barclays Capital estimates

Figure 41: Canadian Food Retailers – CPI food Inflation vs. Retail measured inflation

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4E

Retail Food CPI 0.7% 0.2% 1.3% 1.5% 2.5% 4.2% 5.0% 4.5%

Q/Q Change (bps) -81 -49 108 17 100 174 75 -49

Loblaw (BarCap Est.) -1.5% -2.0% 0.0% 0.0% 0.5% 1.5% 2.0% 1.5%

Metro -2.0% -2.0% -1.0% -1.0% 1.0% 0.4% 2.4% 1.9%

Sobeys (BarCap Est.) -2.0% -2.5% -1.0% -1.5% 0.0% 1.5% 1.5% 1.0%

Retail measured Inflation -1.8% -2.2% -0.7% -0.8% 0.5% 1.1% 2.0% 1.5% Q/Q Change (bps) -67 -33 150 -17 133 63 83 -50

2010 2011

Source: StatsCan, Company reports, Barclays Capital estimates

Unfortunately, this lift in food inflation has not aided margins as the PPI food inflation rate has continued to outpace the CPI Food retail inflation rate, leaving the CPI/PPI spread in negative territory right up to September 2011, which, as the chart below shows, typically results in weakened margins for the food retailers.

We have seen EBITDA margin expansion compress quite materially over the past 2-3 quarters in Canada with Loblaw’s margins still up 40bps or more, while Metro and Sobeys have seen their margins held flat y/y. Loblaw’s margin outperformance has been achieved despite it having the weakest CSS growth over the past three quarters and significant IT/supply chains costs. The U.S. grocers have generally had a tougher time, with the Canadian retailers having some benefit from the strong Canadian dollar versus the U.S. dollar.

Food retailers saw a return to inflation in 1Q11


25 January 2012 40

Figure 42: Food Retailer EBITDA Margin Variance vs. CPI/PPI Spread: Canada vs. US

CANADA UNITED STATES

Canadian Food Retailer EBITDA Margin Trends - y/y bps var US Food Retailer EBITDA Margin Trends - y/y bps var

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3Loblaw 85 120 64 71 47 57 51 48 40 45 40 Kroger 50 -5 -74 -110 -83 -18 10 12 -8 -47 -37Metro 79 47 29 22 35 16 9 -10 -3 1 3 Safeway -63 -42 -54 -84 -73 -79 -37 -23 -23 -52 -32Sobeys 8 10 18 5 -19 23 24 -5 -1 -9 -63 SuperValu -20 -73 -79 -30 -69 9 0 -166 -89 -26 -6

Group 57 59 37 33 21 32 28 11 12 12 -7 Group -11 -40 -69 -75 -75 -29 -9 -59 -40 -42 -25

Spread 363 321 175 -9 -54 -100 -9 -149 -119 -18 -6 Spread 415 477 613 174 -225 -202 -252 -416 -467 -618 -629

2009 2010 20102011 20112009

-80-60-40-20

020406080

2007 2008 2009 2010 2011

-400-300-200-1000100200300400

EBITDA Margin Variance (bps) - Left Axis

Food CPI/Food Wt. PPI Spread (bps) - Right Axis

-100

-50

0

50

100

Q1-07 Q1-08 Q1-09 Q1-10 Q1-11

-800-600-400-2000200400600800

EBITDA Margin Var (bps) - Left Axis

Food CPI/PPI Spread (bps) - Right Axis

Source: StatsCan, Bureau of Labor Statistics, Company reports, Barclays Capital estimates

The fourth quarter of 2011 was likely the peak margin risk quarter due to intensified price competition; inflation is expected to ease as 2012 unfolds with lessened margin risk in 2H12. We estimate that COGS inflation pressure will peak in the 4Q11 to 1Q12 period and will begin easing as we move further into 2012 with retail price inflation working its way toward a temporary period of stagflation potentially by 3Q12, before lifting modestly again in early 2013. While our analysis incorporates Canadian dollar FX impact where appropriate it is important for investors to take note that after almost two years of being a tailwind the Canadian dollar has become a headwind as of 4Q11 and will likely be a greater burden through 1H12.

Figure 43: USD/CAD Exchange Rate Since 2010

$0.80

$0.85

$0.90

$0.95

$1.00

$1.05

$1.10

Jan-

10

Feb-

10M

ar-1

0A

pr-1

0M

ay-1

0

Jun-

10Ju

l-10

Aug

-10

Sep-

10O

ct-1

0N

ov-1

0D

ec-1

0

Jan-

11

Feb-

11M

ar-1

1A

pr-1

1M

ay-1

1

Jun-

11Ju

l-11

Aug

-11

Sep-

11O

ct-1

1N

ov-1

1

Dec

-11

-25%

-20%

-15%

-10%

-5%

0%

5%

USD/CAD Value Y/Y Change

Stronger CAD

Source: Bloomberg

The Canadian dollar became a headwind in 4Q11


25 January 2012 41

While this scenario means a potential deceleration of top-line growth, over the next six months Food retailers should start to experience a gradual easing of COGS margin pressure as we approach 2H12 when they will lap last year’s period of high COGS inflation when they could not pass all of the product cost inflation on to the struggling consumer.

The food retailers will begin to lap volatile produce and meat price inflation starting in February/March and the steady stream of commodity-induced price increases by the CPG companies which started in earnest in early 2Q11, which will gradually ease the margin risk of the impeded pass-through of COGS inflation that occurred between 2Q11 and 4Q11. Unfortunately, this also means that sales growth will ease unless consumer traffic picks up, which in combination with Wal-Mart’s accelerated sales growth in 4Q12 will make operational earnings growth difficult to achieve. This outlook is based on the following analysis of expected cost inflation for the food retailers which is a compilation of several inputs: 1) historical PPI by category, 2) USDA forecasts and futures as appropriate, and 3) a six-month lagged/Canadian dollar adjusted adaptation of our U.S. Consumer Foods Group’s commodity outlook analysis for the U.S. CPG companies which we are using as a proxy for the possibility of price increases in the “center-of-the-store.” For more details about the CPG input cost outlook, please see the report entitled “3Q11 Commodity Update: Deflation in ’12? Be Careful What You Wish For,” published on October 18, 2011.

Figure 44: Canadian Food Retail Product Cost inflation (C$ FX adjusted)

% IMP CY09 CY10 CY11 CY12 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12

Vegetables 9% 10% 0% 7% -2% 3% 4% 12% 10% 5% 5% -1% -2%Fruits 5% 4% 3% -2% -2% 0% -2% -3% -1% 6% 6% 0% -2%

Fish/Seafood 2% 3% -4% 2% 0% 1% 3% 3% 5% 7% 7% 2% 0%

Fresh Meat 14% 1% 0% 5% 4% 5% 5% 5% 5% 7% 4% 1% 2%

Unlagged Fresh 30% 4% 1% 4% 1% 3% 3% 5% 5% 6% 5% 0% 0%

Deli Meat 6mo. lag 9% 4% -2% 4% 9% 1% 3% 5% 5% 11% 13% 7% 4%Bakery (Wheat) 6mo. lag 6% 4% 1% 6% 1% 4% 6% 6% 7% 18% -4% -13% 2%

Total Fresh 47% 4% 0% 4% 2% 3% 3% 5% 5% 8% 5% 0% 1%

Dairy 11% 2% 1% 2% 2% 1% 2% 2% 1% 2% 2% 2% 2%

Center of Store 6mo. Lag 44% 13% -7% 10% 5% 7% 5% 10% 11% 9% 4% 2% 2%

Weighted Total 8% -3% 7% 4% 5% 4% 7% 8% 8% 4% 1% 2%

US$:C$ exchange rate $1.14 $1.04 $0.99 $1.00 $0.98 $0.96 $0.99 $1.01 $1.02 $1.00 $0.98 $0.98

Y/Y % chg in US:CN FX rate 6% -9% -5% 1% -6% -8% -5% 0% 4% 4% -1% -3%

Energy (WTI) -18% 3% 10% 3% 8% 5% 2% 10% 2% -1% 11% -1%

Note 1: Some costs have been lagged six months to reflect the retail price lag of hedging/pass through

Note 2: Where applicable we have applied a C$ FX rate to adjust the US$ commodity inflation for a CDN retailer

Note 3: A negative change in the exchange rate indicates a stronger Canadian dollar Source: Barclays Capital US Foods Equity Research, USDA, Bloomberg, StatsCan, Barclays Capital estimates.

While on average the group has fared well through this challenging period, avoiding any major contraction in EBITDA margins with the exception of third quarter and potentially fourth quarter 2011, the current consumer spending environment remains challenging and competition for the consumer’s food dollar remains high. This analysis suggests that the high-risk period for margin contraction could be behind us by mid-2012, although we do not foresee the retailers being able to recoup what they have lost.

Sales growth is likely to ease unless consumer traffic picks up

By mid-2012 the high-risk period for margin contraction might be behind us. But retailers may not

be able to recoup losses

https://live.barcap.com/go/publications/content?contentPubID=FC1755909�

https://live.barcap.com/go/publications/content?contentPubID=FC1755909�


25 January 2012 42

Figure 45: Canadian Food Retail COGS Inflation Outlook (C$ FX adjusted)

-4%-2%0%2%4%6%8%

10%

CY2006

CY2007

CY2008

CY2009

CY20101Q11

2Q113Q11

4Q111Q12

2Q123Q12

4Q12

Food Retail CPI Barclays' CDN food retailer PPI proxy Food - Retail Weighted PPI

Source: Barclays Capital US Food Group estimates, USDA, Bloomberg

Productivity & efficiency gains – timing is everything All three Canadian food retailers have been implementing productivity and efficiency initiatives over the past decade that they have used to either improve their relative price position, offset price/margin pressure, or enhance earnings depending upon market conditions. These efforts have been stepped up over the past five years as the retailers prepared for the encroachment of the Wal-Mart Supercenter rollout, or dealt with the lingering realities of constrained consumer spending.

The two biggest differences in the current outlook versus what the retailers would have been anticipating two years ago are: 1) a second round of consumer spending contraction, and 2) the sale of Zellers locations to Wal-Mart and Target. Collectively these elements have created a much more challenging price/margin outlook for 2012 and 2013 than anyone would have expected. The earnings implications of this more challenging environment are different for each of the Food retailers as they are all at different stages of generating earnings benefits from their productivity and efficiency efforts.

Figure 46: Wheat Prices in $CAD/bushel

Figure 47: Corn Prices in $CAD/bushel

$5.50

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Productivity and efficiency efforts have accelerated


25 January 2012 43

Metro appears to be best positioned to protect its earnings in 2012. Metro is the poster child for the benefits of patience and balance: never too much focus on one thing and just the right amount of effort against the right initiatives at the right time – easier said than done. Beyond the successful acquisition of A&P Canada, the related generation of over $95 million of synergies and the subsequent rebannering of all of A&P’s Ontario conventional banners into the Metro banner, the majority of Metro’s productivity and efficiency improvements are the result of many sizeable, but smaller, initiatives that are part of an ongoing evolutionary process. In fiscal 2010 the major earnings enhancement initiatives were a lower cost Ontario trucking agreement, a new lower cost distribution centre union contract and the acquisition of GP Marche (incremental sales of $100mn). So far in fiscal 2012 Metro’s arsenal consists of $2 million of cost reductions (outsourcing of meat processing and the closure of a small warehouse in Ontario), the acquisition of Adonis (a Mediterranean ethnic foods retailer and distributor) which is expected to contribute incremental sales of at least $200mn in fiscal 2012 and the rollout of an improved “fresh produce” initiative. We estimate that the $2mn cost reduction and the Adonis acquisition could contribute EPS of $0.05 in 2012, which is already reflected in our EPS forecast.

Loblaw: at least one more year of incremental expense before the benefits start to scale up. Despite the challenging marketplace over the past five years and the burden of the most extensive IT/supply chain infrastructure upgrade among the group, Loblaw has managed to increase its EBITDA margins by 130bps (to an LTM rate of 7%, or 85% of the prior peak) predominantly through: 1) procurement savings, 2) improved general merchandise and private label margins, and 3) reduced shrink rates. These EBITDA margin gains have been achieved despite an estimated incremental IT/supply chain burden of $160mn since fiscal 2008, which has eroded EBITDA margin capacity by 34bps as of 2011.

Unfortunately, as Loblaw enters the sixth year of the IT/supply chain infrastructure upgrades it is still a year or two away from achieving the major cost savings and productivity gains from these investments. So far profit enhancement has been limited to the benefits of transportation and warehouse management software and more recently the deployment of store level labour cost scheduling software (STAS). The big upside for Loblaw is not expected to be achieved until late 2013 when the stores and distribution centres (DCs) are linked to SAP, flow through (cross docking) inventory handling is rolled out more extensively and the incremental IT/supply chain SG&A expenses begin to decline. For now, investors are waiting for details about the incremental expense in fiscal 2012, which is expected to be at least $50mn of depreciation expense.

Empire Co. – next round of cost reductions is not happening soon enough to deal with 2012: Over the past 5-10 years Sobeys has made significant progress on a broad array of productivity and efficiency initiatives including banner consolidation (from 22 to 6), implementation of operational best practices, a regional rollout of the SAP enterprise system (started in fiscal 2006; will be completed by fiscal 2013) and the opening of Canada’s first fully automated distribution centre in fiscal 2010 which is being followed by the opening of a similar facility in Quebec in fiscal 2013. The benefits of these programs have been utilized to either enhance returns or invested into sustaining, or improving, their competitive price position, which in the current pricing environment has been a critical need.

Empire continues to have a compelling line-up of earnings enhancement initiatives under way; unfortunately, however, the benefit timing (2013 and beyond) is not well aligned with the more immediate timing of price/margin risk. Only a small portion of the benefits from these programs are likely to impact 2012, namely some administrative streamlining savings

Metro has an arsenal to protect earnings

Loblaw has been able to increase EBITDA margins...

…but efficiency gains might take a while to have an impact

Empire has made good progress on a number of fronts...

...but benefits may not offset risk due to timing


25 January 2012 44

from the recently announced “Reset” program and the acquisition of 250 Shell gas stations. The rest are more skewed to late fiscal 2013: Quebec SAP implementation, new Quebec automated DC, the Target wholesale supply agreement and the more sizeable benefits of the Reset program. Although Sobeys continues to derive benefits from its earlier initiatives we are sceptical that they are material enough to protect Sobeys from further margin contraction risk over the next 6-12 months.

Deployment of free cash flow Metro is the only one of the group that has materially and consistently used free cash flow to buy-back shares as a meaningful assist to earnings growth while also increasing its dividend every year.

Figure 48: Canadian Food Retailers’ Free Cash Flow Summary ($ mn)

Loblaw Free Cash FlowFiscal Year (Dec) 2006 2007 2008 2009 2010 2011E 2012E 2013E

Operating Cash Flow $1,249 $1,288 $1,237 $1,238 $1,550 $1,822 $1,602 $1,721Change in W/C -$69 -$43 -$282 $707 $73 -$48 $18 $4Cash from Operations $1,180 $1,245 $955 $1,945 $1,623 $1,774 $1,619 $1,725Capex -$937 -$613 -$750 -$971 -$1,280 -$1,000 -$800 -$750Free Cash Flow $243 $632 $205 $974 $343 $774 $819 $975

Dividends -$173 -$230 -$288 -$112 -$65 -$76 -$253 -$276Net Change in Share Capital $0 $0 $0 -$56 $0 -$6 $0 $0Acquisitions $0 $0 $0 -$204 $0 $0 $0 $0Net Change in Debt $49 -$241 -$309 -$7 $83 $247 -$77 -$419Remaining cash flow $119 $161 -$392 $595 $361 $939 $490 $280

Metro Free Cash Flow ManagementFiscal Year (Sep) 2007 2008 2009 2010 2011 2012E 2013E 2014E

Operating Cash Flow $437 $435 $521 $580 $566 $580 $586 $617Change in W/C -$74 $7 -$1 -$33 -$25 $13 -$7 -$1Cash from Operations $363 $442 $520 $547 $542 $593 $578 $616Capex -$230 -$176 -$235 -$165 -$148 -$215 -$225 -$225Free Cash Flow $134 $265 $285 $382 $393 $378 $353 $391

Dividends -$52 -$55 -$59 -$69 -$77 -$84 -$92 -$102Net Change in Share Capital -$21 -$110 -$99 -$151 -$188 -$213 -$233 -$231Acquisitions $0 -$7 $0 -$152 -$74 $0 $0 $0Net Change in Debt -$82 -$28 -$5 -$7 -$4 $0 $0 $0Remaining cash flow -$21 $64 $122 $2 $50 $81 $28 $58

Empire Free Cash Flow ManagementFiscal Year (Apr) 2007 2008 2009 2010 2011 2012E 2013E 2014E

Operating Cash Flow $605 $670 $612 $665 $678 $710 $747 $795Change in W/C -$137 -$26 $48 $125 $8 -$78 $0 $23Cash from Operations $468 $644 $660 $790 $687 $631 $747 $818Capex -$539 -$549 -$431 -$447 -$554 -$700 -$500 -$500Free Cash Flow -$72 $94 $229 $343 $133 -$69 $247 $318

Dividends -$40 -$43 -$46 -$51 -$54 -$61 -$67 -$66Net Change in Share Capital -$2 -$1 $128 $0 -$28 -$28 -$56 -$56Acquisitions -$150 -$1,341 -$41 -$34 -$17 -$20 $0 $0Net Change in Debt -$9 $653 -$288 -$89 -$64 -$50 $0 $0Remaining cash flow -$272 -$638 -$18 $170 -$31 -$228 $124 $197

Source: Company Reports, Barclays Capital Estimates.


25 January 2012 45



25 January 2012 46

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Figure 49: Loblaw – Share Price vs. Historical Fwd. P/E Figure 50: Metro – Share Price vs. Historical Fwd. P/E

Figure 51: Empire – Share Price vs. Historical Fwd. P/E Figure 52: North West – Share Price vs. Historical Fwd. P/E

Figure 53: Kroger – Share Price vs. Historical Fwd. P/E Figure 54: Safeway – Share Price vs. Historical Fwd. P/E


25 January 2012 47

Recommendation & Valuation Summary

The Food retail segment is the most challenged segment in our coverage universe with a confluence of growth constraints converging into a perfect storm in the second half of 2011. As we await 4Q11 results the food retailers are in the midst of what appears to be the highest earnings risk period. We expect the next three years to be difficult for the incumbent food retailers with 2012 and early 2013 being the most challenging period as there are several earnings risk factors at play (weak demand, continued inflation margin risk, accelerated Wal-Mart Supercenter rollout in 2H12).

Overall, we recommend that investors minimize their exposure to the Canadian food retail sector in 2012. For investors looking for relatively defensive positions with attractive price appreciation potential we prefer Tim Hortons and Dollarama. For investors who are more focussed on downside risk protection we view the drugstore sector as more appealing than the food retail sector as the earnings drain of drug reform should gradually ease through 2012 and both players have re-established earnings growth.

Within the food retail sector our rank order preference over the next 12 months is Metro, Loblaw, North West Co. and then Empire.

Figure 55: Canadian Food Retailers: Recommendation Summary


FOOD RETAILERS/MANUFACTURERS

Empire EMP-A.TO 2-EW Apr-30 $3,837 $4.98 $4.58 $5.10 12.3x 11.1x $0.90 1.6% $56.43 $57.00 2.6%

Loblaw L.TO 2-EW Dec-31 $10,519 $2.58 $2.84 $2.91 13.1x 12.8x $0.84 2.3% $37.30 $39.00 6.8%

George Weston WN.TO 2-EW Dec 31 $8,536 $4.33 $4.86 $4.89 13.6x 13.5x $1.44 2.2% $66.12 $69.00 6.5%

Metro MRU-A.TO 2-EW Sep-30 $5,235 $3.92 $4.29 $4.62 12.0x 11.2x $0.77 1.5% $51.58 $54.00 6.2%

North West Co. NWC.TO 2-EW Jan-31 $965 $1.66 $1.23 $1.32 16.2x 15.1x $0.96 4.8% $19.95 $20.00 5.1%


Source: Company reports, FactSet, Barclay Capital estimates. Priced as of January 20, 2012. 1-OW = 1-Overweight; 2-EW = 2-Equal Weight; 3-UW = 3-Underweight. Sector rating is 2-Neutral.

Metro (MRU/A CN/MRU-A.TO; 2-EW/Neu; $54 price target): least earnings risk exposure of the group to Wal-Mart in 2012 and the best earnings growth track record. Metro is currently trading at 12.1x FY1 consensus EPS, 5% above its long-term average, 9% above its 2011 trough (10.7x) and 31% above its LT trough of 8.9x. As we have seen over the past few years, investors’ comfort with Metro’s ability to deliver EPS growth should ensure first mover advantage within the group, especially given its reasonable valuation.

Our preference for Metro is supported by the following:

Least proportionate EPS risk exposure (~3%) to Wal-Mart’s Supercenter openings in 2012 and 2013, despite their recent Quebec entry. We have estimated Metro’s fiscal 2012 EPS risk at $0.12, or 3% of forecast EPS (only 1% if we include the favourable impact Target’s renovation closures could have), this compares to Loblaw at 5% and Empire at 7% EPS risk.

Strongest line-up of EPS risk offsets in 2012. We estimate that Metro’s announced incremental earnings activities (meat processing plant closure and Adonis acquisition) will generate up to $0.05 of incremental EPS in fiscal 2012.

Of the food retailers, we favor Metro, Loblaw, and Empire, in

that order


25 January 2012 48

Share buyback program is expected to contribute earnings growth of 4%, or 42% of total fiscal 2012 EPS growth which minimizes EPS downside risk. Metro is the only one of the Big three Food retailers with a meaningful buyback program. Over the past six years it has repurchased more than 19% of shares outstanding.

Best earnings and dividend track record of the group. Metro has increased earnings in 20 of the past 21 years and increased the dividend every year for 18 years. In the last two years Metro’s dividend has increased 40%.

Loblaw (L CN/L.TO; 2-EW/Neu; $39 price target): potential valuation lift from depressed levels but 2012 fundamentals remain challenged. Loblaw’s valuation contraction in 2011 has pushed its NTM forward P/E multiple down to 12.2x which is well below our estimate of the stock’s normalized P/E of 14.7x and only 9% above Metro and Empire’s forward P/E of 11.2x versus its historical valuation premium of 28%. While we expect that any meaningfully positive catalyst (e.g., 4Q11 results come in better than expected, 2012 incremental IT/supply chain spend lower than expected, announcement of new merchandising initiatives to improve sales trends) could push Loblaw’s shares back toward a valuation premium of at least 14x representing potential upside of 13%, the fundamental concerns we have about the company’s near- to intermediate-term earnings outlook are likely to remain unchanged. For now, we will maintain a cautious stance on the stock given the industry-wide challenges and Loblaw’s continued infrastructure upgrade constraints. We see 2013 into 2014 as the more compelling investment horizon for Loblaw’s shares.

Empire (EMP/A CN/EMP-A.TO; 2-EW/Neu; $57 price target): greatest EPS risk exposure to competitive square footage growth, with the least offsets in 2012. Empire has suffered the greatest pullback among the group (-14% from the mid-September peak) but its NTM forward P/E of 11.3x is only modestly below Metro’s 11.9x multiple. According to our estimates, Empire faces the greatest EPS drain risk (7% of EPS) to Wal-Mart’s accelerated Supercenter openings in 2012 before giving consideration to the favourable benefit Target’s renovation closures could have (reduces risk to 3.4%). Given Empire’s weak margin performance in its 2Q12 results and a lack of meaningful cost savings available to the company until late fiscal 2013 (April YE), we believe Empire’s 2012 outlook is the most challenged of the group.

Recent share price trend and valuation perspective

Metro’s shares achieved solid price appreciation in 2011 (+16%; S&P/TSX -11%)), however, so far into 2012 the shares have contracted 4.5% lagging pullbacks over the past two months by Empire (-8%) and Loblaw (-2%) following Empire’s Q2 release (S&P/TSX -11%). We attribute the pullback to increased Q4 margin concerns following Metro (1Q12) and Empire/Sobeys (2Q12) most recent quarterly releases. Loblaw’s shares declined 7% in 2011, driven by a 15% multiple contraction from a 14.3x peak in 2011 to 12.2x at the end of December in response to three factors: 1) lagging real CSS growth, 2) Q4 margin concerns, and 3) Target’s potential impact on Joe Fresh.

We see 2013 into 2014 as the more compelling investment horizon for Loblaw’s shares

We believe Empire’s 2012 outlook is the most challenged of

the group


25 January 2012 49

Figure 56: Canadian Food Retailers 2011 Price appreciation and Forward P/E trend

Canadian Food Retailer 2011 Share Performance Food Retailers Forward P/E

-15%-10%

-5%0%5%

10%15%20%25%30%

2/11/2011 5/06/2011 7/29/2011 10/21/2011 1/13/2012

L MRU.A EMP.A

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2007 2007 2008 2008 2009 2009 2010 2010 2011 2011

L MRU.A EMP.A

Source: FactSet/Reuters

After a recent pullback we believe food retailers’ valuations adequately reflect the 4Q11 and fiscal 2012 earnings challenges – unfortunately multiple expansion seems unlikely in the immediate term. Metro’s NTM forward P/E multiple has pulled back toward its long-term average while Loblaw (-16%) and Empire (-12%) are below theirs. Although the 2012 outlook is challenged we are still forecasting EPS growth for the group which we believe is supportive of the current valuations. If price/promotion margin concerns ease we expect Metro’s shares to be the first to see a rebound, followed by Loblaw given its depressed premium versus the group. We expect that Empire’s greater WMT/TGT risk exposure and lack of immediate-term cost savings offsets, combined with its lower trading volume, will likely suppress the shares’ performance relative to the group.

Figure 57: Canadian Food Retailer P/E Contraction Risk and Upside Potential

P/E Contraction P/E ExpansionHistorical Cycle P/E's Current Cycle PE's risk to Trough upside to

January 2011 to 2012 LT Trough Recent LT Avg Recent PeakP/T

Peak Trough AVG Peak Trough % Chg Current % Chg % Chg % Chg % ChgLoblaw 17.3x 9.8x 14.7x 14.3x 11.9x -16.8% 12.2x -19.7% -2.5% 20.5% 17.2%Metro 15.0x 8.9x 11.3x 12.4x 10.7x -13.7% 11.7x -23.9% -8.5% -3.4% 6.0%

Empire 14.6x 9.3x 12.6x 12.4x 11.0x -11.3% 11.3x -17.7% -2.7% 11.5% 9.7%Average 15.6x 9.3x 12.9x 13.0x 11.2x -13.9% 11.7x -20.4% -4.6% 9.5% 11.0%

Source: FactSet, Barclays Capital Estimates.

Despite the challenges facing the group, we still forecast EPS

growth


25 January 2012 50

Figure 58: North American Food Retailers Comparable Forward PE Valuations FOOD RETAIL COMPARABLE VALUATIONS: PROJECTED EPS, P/E MULTIPLES - FISCAL BASIS

Price SOS Market Fiscal EPS P/E EPS GrowthTicker 20/01/2012 (M) Cap ($M) PY FY1 FY2 PY FY1 FY2 PY-FY1 FY1-FY2 PY-FY2

Loblaw L $37.30 281.4 $10,496 $2.59 $2.84 $3.01 14.4x 13.1x 12.4x 10% 6% 8%

Metro MRU.A $51.58 100.5 $5,182 $3.87 $4.28 $4.65 13.3x 12.1x 11.1x 10% 9% 10%

Empire EMP.A $56.43 67.9 $3,834 $4.31 $4.57 $5.14 13.1x 12.3x 11.0x 6% 13% 9%

North West Co. NWC $19.95 48.4 $965 $1.66 $1.21 $1.34 12.0x 16.5x 14.9x -27% 11% -10%

Canadian Grocer Average (ex-NWC) 13.6x 12.5x 11.5x 9% 9% 9%

Kroger KR $23.91 574.8 $13,743 $1.74 $2.00 $2.22 13.7x 12.0x 10.8x 15% 11% 13%

Safeway SWY $21.85 339.9 $7,427 $1.55 $1.72 $1.82 14.1x 12.7x 12.0x 11% 6% 8%

Supervalu SVU $6.88 212.3 $1,460 ($7.13) $1.23 $1.23 -1.0x 5.6x 5.6x na 0% na

Whole Foods Mkt WFM $76.30 179.5 $13,696 $1.93 $2.26 $2.59 39.5x 33.7x 29.4x 17% 14% 16%

U.S. Grocer Average 16.6x 16.0x 14.5x 14% 8% 12%

Loblaw (Barclays Capital Est.) $37.30 281.4 $10,496 $2.59 $2.84 $2.91 14.4x 13.1x 12.8x 10% 2% 6%

Metro (Barclays Capital Est.) $51.58 100.5 $5,182 $3.87 $4.28 $4.65 13.3x 12.1x 11.1x 11% 9% 10%

Empire (Barclays Capital Est.) $56.43 67.9 $3,834 $4.64 $4.72 $5.23 12.2x 12.0x 10.8x 2% 11% 6%

North West (Barclays Capital Est.) $19.95 48.4 $965 $1.66 $1.24 $1.37 12.0x 16.1x 14.6x -25% 10% -9%

Source: FactSet and Barclays Capital estimates; EPS figures are consensus from FactSet.


25 January 2012 51

LOBLAW COMPANIES

Loblaw Cos., Ltd.(L.TO): Quarterly and Annual EPS (CAD)

2010 2011 2012 Change y/y

FY Dec Actual Old New Cons Old New Cons 2011 2012

Q1 0.48A N/A 0.57A N/A N/A N/A N/A 19% N/A



Q4 0.64A N/A 0.67E N/A N/A N/A N/A 5% N/A

Year 2.58A N/A 2.84E 2.84E N/A 2.91E 3.01E 10% 2%

P/E 14.5 13.1 12.8

Source: Barclays Capital

Consensus numbers are from Thomson Reuters

Recommendation & Valuation

We are initiating coverage of Loblaw Companies (L CN/L.TO) with a 2-Equal Weight/2-Neutral rating and a $39 price target, offering a total potential return of 5% from recent levels. Our 12-month price target is supported by a 13.5x P/E multiple (below its historical average of 17x) on our 2012 EPS forecast of $2.91. Loblaw’s shares are trading at 12.2x NTM consensus EPS, which is 3% above its five-year trough multiple. This places Loblaw at a 3% and 7% premium to Metro and Empire, respectively, compared with an average premium of 28%-29% over the last five years. While this may be an attractive entry point for long-term value investors, the immediate-term backdrop limits the likelihood of sustainable upside over the next year, in our view.

Frugal consumers are unlikely to begin more lucrative food spending for a while and the sales growth pressure being applied by Wal-Mart is poised to increase as it redeploys 39 Zellers stores in late 2012. Loblaw’s extensive IT upgrade and supply chain transition will not be sufficiently complete until late 2013 as it works through the critical linking of stores, distribution centers (DCs) and merchandise data to SAP and rolls out the inventory flow processes. We expect that 4Q11 sales and margins experienced material deceleration due to increased price discounting. We may miss out on a “relief rally” from the near-trough levels, but we need to see more positives before we get excited about sustainable upside.

Figure 59: Loblaw P/E Valuation Range

2012 2013 Valuation References

EPS range $2.80 $2.91 $3.10 $3.15 $3.24 $3.30Y/Y % chg -1.3% 2.8% 9.3% 8.1% 11.3% 13.2%

P/E Multiples8.0x $22 $23 $25 $25 $26 $26 <= SFWY/Kroger trough fwd P/E's

9.0x $25 $26 $28 $28 $29 $30

10.0x $28 $29 $31 $32 $32 $33

11.0x $31 $32 $34 $35 $36 $36

12.0x $34 $35 $37 $38 $39 $40 <= Loblaw's historical trough P/E

13.0x $36 $38 $40 $41 $42 $43

13.5x $38 $39 $42 $43 $44 $45 <= BarCap target multiple14.0x $39 $41 $43 $44 $45 $46

15.0x $42 $44 $47 $47 $49 $50 <= Loblaw's Avg. normalized P/E

16.0x $45 $47 $50 $50 $52 $53

BarCap est BarCap est

Source: Company Reports, Barclays Capital estimates. EPS range is for illustrative purposes only.

We expect price discounting took a toll on sales and margins

in 4Q11

L CN / L.TO

Stock Rating 2-EQUAL WEIGHT

Sector View 2-NEUTRAL

Price Target CAD 39.00

Price (20-Jan-2012) CAD 37.30

Potential Upside/Downside +5%


25 January 2012 52

Despite increased earnings pressure over the past five years and the lengthy disruption of the 5+ year renewal program, Loblaw’s valuation multiple has typically remained industry leading. In 2011, Loblaw’s shares experienced a significant deterioration in their relative valuation, which we attribute to three factors:

1. Implied market share losses based on the weakest CSS in the group

2. An extension of the market’s understanding of how long it will be before the IT systems implementation is no longer a risk factor and impediment to growth

3. Target’s announced entry into Canada, which is modestly negative for Loblaw on two fronts: i) Target’s apparel sales appeal with consumers could hurt Joe Fresh, and ii) Target’s food sales growth (2013E/14E) when combined with the sales growth pressure of Wal-Mart’s accelerated growth will make it even harder for the incumbents to grow sales.

Near-term catalysts/key dates that could provide a boost to Loblaw’s valuation include its 4Q11 results release on February 23. Should Loblaw be able to convince the market that it can sustainably stem the loss of market share (i.e., grow “real” CSS) or continue to offset gross margin pressure through further cost savings, we expect a modest re-valuation in the stock’s multiple toward the 14x P/E level (consistent with the valuation level at which Loblaw was trading at prior to the deterioration in mid-2011). However, given the above-mentioned medium- to long-term risks (i.e., ongoing supply chain renewal; Target’s entrance), we do not expect Loblaw’s valuation to immediately revert back to its long-term mean.

Figure 60: Loblaw’s Historical Forward P/E

Loblaw Forward P/E

Note: Avg. PE Normalized to exclude M&A Speculation period from 1997-2003

12.1x

16.4x

12.5x

16.9x

12.1x

19.1x

14.1x

18.1x

17.0x

27.4x

19.9x

30.0x

13.1x

18.3x

12.1x

15.5x

9.8x

17.0x

10.5x

15.9x

8x

13x

18x

23x

28x

33x

19851987

19891991

19931995

19971999

20012003

20052007

20092011

Normalized Avg: 14.7x

Source: FactSet

Towards late 2013, we expect Loblaw’s earnings and share price performance to begin outperforming the group as it completes, and begins to benefit from, its significant infrastructure renewal (2007 to mid-2013), reduces IT expenses, and improves its merchandising execution. In the immediate term (2012/13), we expect Loblaw’s earnings performance to continue to be constrained by increased infrastructure expenses in 2012 (unknown increment), expenditures on four new growth initiatives (e.g., PC Financial, Joe Fresh) and intensely competitive market conditions. Over the longer term, we expect Loblaw’s productivity and efficiency upside to drive superior returns versus the group. We note that despite adding estimated IT/supply chain infrastructure related G&A expense of

We don’t expect Loblaw’s valuation to revert to historical

levels for some time

We could see relative outperformance in 2013


25 January 2012 53

roughly $38mn so far this year ($160mn since 2008), Loblaw has managed to hold total SG&A relatively flat this year.

Under these circumstances, we believe Loblaw’s valuation premium could potentially revert back to its historical mean versus its peers. At a 28% premium (5-year average versus Metro and Empire), Loblaw would command a 15x forward P/E multiple.

Figure 61: Loblaw Valuation Premium to Metro and Empire

-20%-10%

0%10%20%30%40%50%60%70%80%

2006 2007 2008 2009 2010 2011 2012

Loblaw vs Metro Loblaw vs Empire

Source: FactSet/Reuters

Corporate Profile: Loblaw is Canada’s leading food retailer Loblaw is Canada’s largest retailer and the leading food retailer, with an estimated national market share of around 30% (almost twice that of its nearest competitor) through an industry-leading national network of 1,403 stores (corporate 576, franchised 451 and affiliated 376) under 22 banners, which combined represents 50.7 million retail square feet. Loblaw owns 74% of its corporate and 46% of its franchised square footage, which compares to less than 9% ownership by Metro and 15% by Sobeys.

Loblaw operates in the conventional and hard discount segments. Loblaw’s conventional business consists of three primary conventional banners (Loblaw, Fortino’s and Zehrs in Ontario) and three primary discount segment banners (No Frills - East/West, Maxi and Maxi & Cie. – Quebec, and the Real Canadian Superstore – West). Loblaw also owns and operates PC Financial (bank loans and credit cards), which represents roughly 5% of EBITDA.

Loblaw is 62.9% owned by George Weston (WN), which is 62.5% owned by the Weston family. This leaves investors with a free float market cap of approximately $4bn versus the total market cap of $10bn.

Loblaw is in the midst of transition in the president’s office under the supervision of Galen Weston. Allan Leighton (a long time Weston Family advisor) is departing after guiding Loblaw through five years of renewal. He is passing the reins to Vicente Trius, another experienced International retailer, who comes to Loblaw from Carrefour and prior to that Wal-Mart International. Mr. Trius has had extensive retail experience from many markets, many sectors and a variety of growth strategies which we believe will be beneficial to Loblaw.


25 January 2012 54

Figure 62: Loblaw Corporate Profile

Loblaw Companies - Store Network Profile

Market Share Revenue EBITDA % Margin

30% $31 bln $2 bln 6.2%

Corporate Franchise Total Primary BannersConventional 174 238 412 Ontario: Loblaw, Zehrs, Fortinos; Quebec: Loblaw, Provigo

Soft Discount 182 182 Real CDN Superstore (West, Ont), Maxi & Cie (Que), Atlantic Superstore

Hard Discount 185 213 398 No Frills (Ont, Atlantic, West), Maxi (Que)

Specialty stores 24 24 T&T - Asian specialty (20 stores); Joe Fresh standalone stores (1)

Other 11 11 Real Canadian Wholesale Club and Others

Total stores 576 451 1027

Affiliated stores 376

Total Sq. Footage 37.3 mln 13.5 mln 50.8 mln

Owned locations 74% 46% 69%

Source: Company Reports, Barclay Capital estimates

A brief history lesson before looking forward

After many years of industry-leading growth, driven primarily by the build-out of large box food and everyday general merchandise retail stores (average size of 65k to 120k sq. ft.), Loblaw’s new store growth strategy hit a wall with incremental growth capital failing to generate adequate returns. In a slower-growth environment, dated/inefficient supply chain and IT systems proved to be a cumbersome burden that could no longer be ignored, especially with the pending arrival of Wal-Mart’s Supercenter format in Canada. As the company attempted to shift gears, the “new store growth” oriented management team lacked the skills necessary to deal with these new challenges, which resulted in significant changes in the senior management ranks.

After an extensive review process with external consultative support, Loblaw launched a multifaceted five-year renewal program, which was designed to return the organization to best-in-class status. As we enter year five of Loblaw’s renewal program, the company has made significant progress but still has a lot of heavy lifting to do. In the meantime, the marketplace has become more competitive than ever with retailers battling aggressively on price just to hold volume.

Growth strategy & Outlook – Renewal is an ongoing process Making strides, but renewal program remains in “high risk period,” which when combined with challenging market conditions and the growing pains of a new organizational structure and a new president warrants caution. Loblaw will enter the final phase of its huge SAP enterprise system installation in 2012/13 with the integration of the stores (first stores to be linked in 3Q12) and distribution network, having just completed the merchandise category on-boarding process in 3Q11. Related incremental IT/supply chain expenses, which currently total $305mn since 2008, will have one more year of an unknown incremental amount (at least $50mn in depreciation) in 2012 before easing off in 2013.

Loblaw needs to re-establish “real” same-store sales growth to stop market share erosion and establish sustainable earnings growth outlook. In the immediate term, all of the Canadian food retailers will see their CSS improve due to an assist from increased food inflation. However, we expect the competitive environment and easing commodity cost pressure to allow food inflation to decelerate from 4Q11 through to the end of 2012. Loblaw needs to show “real” CSS growth driven by volume and a favourable mix shift (more traffic, increased basket counts and favourable trade up mix) if its hopes to establish stronger earnings growth. We believe this will require another step up in the shopping

Margins could remain at risk until at least the second half of

2012


25 January 2012 55

experience through continued improvements in merchandising, new private label innovations and store design. We are encouraged by some of the new elements at the Maple Leaf Gardens test store that could selectively be expanded chain-wide such as improved Home Meal Replacement (HMR) extensive cheese offering, sampling booths, new/unique ACE bakery artisan breads and the tea emporium.

Figure 63: Top 3 Canadian Grocery Retailers CSS Trends

Canadian Grocery Retailers CSS Trends Canadian Grocery Retailers "Real" CSS Trends

-3%-2%-1%0%1%2%3%4%5%6%7%8%

1Q-09

2Q-09

3Q-09

4Q-09

1Q-10

2Q-10

3Q-10

4Q-10

1Q-11

2Q-11

3Q-11

Loblaw Metro Sobeys

-3%

-2%

-1%

0%

1%

2%

3%

4%

1Q-09

2Q-09

3Q-09

4Q-09

1Q-10

2Q-10

3Q-10

4Q-10

1Q-11

2Q-11

3Q-11

Loblaw Metro Sobeys


4Q11 was likely the peak margin risk period due to increased price competition. As Loblaw and Metro’s 3Q11 results showed, a return to food inflation does not always mean margins are safe. The competitive environment, consumers’ frugality and commodity cost pressures suggest that margins could remain at risk until at least 2H12. Metro has confirmed that increased price discounting had reduced measured food inflation through Canadian Thanksgiving shopping, which we expect continued into the Holiday period. This will increase the margin risk versus 3Q11 as COGS inflation remains high.

Competitive square footage growth in the discount segment is expected to continue to strain organic growth of all the food retailers. Wal-Mart is continuing its Supercenter roll-out with a planned addition of 34 new/rebannered Supercenters in 2012, plus the opening of 39 converted Zellers locations toward the end of 2012. This will be Wal-Mart’s biggest year of new store openings/rebannerings since its arrival in 1994 and the year of greatest growth drain for the incumbents since Loblaw’s substantial price reductions in 2007/08.

Loblaw’s extensive presence across Canada and industry-leading market share (30%) represents the greatest exposure to Wal-Mart’s Supercenter rollout, although from a proportionate stand point, Empire faces greater risk (5%-11% EPS risk exposure vs. Loblaw at 4%-7%). This risk is only partially mitigated by Loblaw’s industry-leading discount segment development (65% of system sales, 53% of Canada’s discount segment) and predominantly franchise operations in Ontario. It’s important to note that Wal-Mart’s future growth is expected to be more focussed on markets where Loblaw’s business is skewed to Corporate system sales (Western Canada - 90%, Quebec- 80%, Atlantic - 72%).

Margins could remain at risk until at least 2H12


25 January 2012 56

Figure 64: Sales and Earnings risk exposure to WMT & TGT Grocery Growth

Loblaw 2008 2009 2010 2011 2012 2013 2014 2015 WMT $176 $162 $201 $221 $258 $334 $216 $200 TGT ($M) $69 $169 $100 WMT/TGT $176 $162 $201 $221 $258 $403 $385 $300 Zellers ($M) -$129 -$243 -$35 $0

Sales at risk ($M) $176 $162 $201 $221 $129 $160 $350 $300



Source: Barclays Capital estimates, Company reports.

Loblaw’s new growth initiatives aren’t expected to be meaningful contributors for some time. Completion of the Renewal program and implementation of new growth initiatives means continued investment spending for at least the next two years. IT/supply chain spending will be up by an unknown amount again in fiscal 2012 before declining by an unknown amount in 2013 and Loblaw is investing in its PC Financial business and Joe Fresh apparel test in the United States.

Five-year renewal program nearing completion

In 2006, Loblaw embarked on a five-year renewal program. The goal of this initiative was to make Loblaw the “best again” by: 1) bringing the IT/supply chain infrastructure up to best in class so the company can better leverage its critical mass advantage, and 2) enhancing the shopping experience through renovated stores, a rejuvenated industry-leading premium private label program (President’s Choice) and improved merchandising.

Centralized services supporting segmented business operations. Early in the renewal process Loblaw moved to centralize its procurement, marketing, Control label management and real estate into a new head office. In January 2011, Loblaw decided to create two separate business units for its Conventional and Discount operations in recognition of their distinctive characteristics and needs.

Infrastructure investment in IT systems and Supply chain. This has been a major focus of the renewal efforts in the areas of IT platform upgrades and supply chain improvements. On the IT front, these investments include SAP’s largest enterprise system installation, Transportation and Warehouse management systems (TMS and WMS), a Store Time and Attendance system (STATS) and a new forecasting tool called IPFR (integrated planning forecasting replenishment).

SAP is entering the final on-boarding phase in 2012/13, which involves the integration of the distribution network and the stores onto the platform – this stage is as, or more, risky than the merchandise category listing stage, which was successfully completed in 3Q11 as planned. The DC integration will occur throughout 2012 with the first store integration planned for 4Q12. Throughout 2013 and into early 2014, Loblaw plans to bring its entire store network onto the SAP platform.

We don’t expect investment spending to decrease for at least

the next two years


25 January 2012 57

The TMS rollout was completed in 2Q11 and 90% of the DC network will be on WMS by early 2012 with the addition of three more facilities. Per the company, benefits from both systems are already being achieved.

STATS will be in all corporate stores (570+) by year-end 2011 and is already contributing to labour productivity improvements as noted over the past few quarters.

As of 3Q11, 70% of Loblaw’s purchases were on the new IPFR forecasting system, involving 130 users from various categories.

Test of supply chain transition to flow system is under way. The next stage of distribution efficiency is the test/rollout of a “flow” (cross docking) inventory process versus the current warehousing system. Loblaw began testing flow through handling in its Ajax and Maple Grove DCs earlier this year with good labour cost results. The company expects the flow rollout to ramp up toward the end of 2012 into 2013. Directionally we estimate that inventories could drop by at least 35% as they reduce the need for buffer stock.

Store renovation and revitalization program is nearing completion. By the end of 2011 Loblaw will have renovated more than 500 of its stores (almost 50%) since 2008 after years of neglect at a capex cost of approximately $1.7bn.

No Frills in Western Canada and the Atlantic – In addition to renovations of existing banners, Loblaw has been expanding the use of its highly successful No Frills discount banner into Western Canada and more recently Atlantic Canada. It has opened eight new No Frills in the west since 2007 and converted 25 stores (primarily Extra foods, some RCWC) with more to be done. In Atlantic Canada it has completed seven conversions involving the Supervalu banner and smaller Atlantic Superstores with plans to have at least 20 No Frills locations over time.

Private label renewal – the brand that’s “worth switching supermarkets for” is back. Although Loblaw’s control label program remains the largest in Canada, over the past 10 years the brand’s loyalty draw has weakened materially. An increased emphasis on innovative and differentiated new products has definitely been noticed by consumers. Also over the past two years, Loblaw has significantly improved the profitability of its private label program through a rationalization of the supplier base and formulas/SKUs.

Through this period, despite the high disruption risk, Loblaw has managed to …

Hold revenue essentially flat, although this means it has lost market share, which, given competitive inroads and the amount of internal change, has been impressive.

Increase consolidated EBITDA margin by 130bps over 12 consecutive quarters to a 3Q11 LTM rate of 7%, bringing margins 85% of the way back to the 2004 peak of 8.2% (pre IFRS). Most recently this has been achieved through SG&A cost containment despite the estimated addition of $160mn of incremental IT SG&A expense since 2008.


25 January 2012 58

Figure 65: Loblaw Financial Performance Summary

Loblaw - Financial Statement SummaryGAAP IFRS IFRS IFRS IFRS2009A 2010A 2011F 2012F 2013F

Estimated Co. food inflation (%) 1.6% -0.8% 1.4% 0.5% 0.7%

Same Store Sales Growth (%) -1.1% -0.6% 0.5% 0.0% 0.8% Real CSS growth -2.7% 0.2% -0.9% -0.6% 0.1% Square Footage Growth (%) 1.7% (0.4%) 0.5% 0.6% 1.0%

Retail Revenue Growth (%) 0.0% 0.8% 0.4% 1.5%

Retail Revenue ($Millions) $30,312 $30,563 $30,697 $31,155Financial Services Revenue ($Millions) $524 $527 $573 $602

Financial Services Revenue Growth (%) 0.0% 0.6% 8.8% 5.0%

Total Revenue ($ Millions) $30,735 $30,836 $31,090 $31,270 $31,757 Total Revenue Growth (%) -0.2% 0.3% 0.3% 0.6% 1.6%

Total Gross Margin Variance na 27 bps -6 bps 28 bps 20 bps

Total Adj. SG&A Variance na -42 bps -26 bps 4 bps -18 bps

Total Adj. EBITDA Variance 62 bps 49 bps 20 bps 24 bps 37 bpsTotal Adj. EBITDA Margin 6.0% 6.7% 6.9% 7.2% 7.5%

Net Debt/EBITDA (LTM) 1.7x 2.2x 1.7x 1.3x 1.1x

Capex as a % of Sales (LTM) 3.2% 4.2% 3.2% 2.6% 2.4%

Free Cash Flow ($M, after Divs & Capex) $862 $278 $698 $567 $699Return on Equity 10.9% 11.9% 12.1% 13.1% 12.7%

Return on Invested Capital 7.0% 6.6% 8.1% 8.7% 9.3% Source: Company Reports, Barclays Capital estimates Note: Growth rates/variances comparing 2010 /2009 use GAAP figures, while 2010 raw figures are presented in IFRS

Getting ready to shift gears toward pursuing growth

Although improved comp-store sales growth within the Canadian grocery business is its top priority as it prepares to move beyond the five-year renewal program, Loblaw has identified four areas of growth that leverage existing strengths and can enhance total company growth.

1. Joe Fresh – US test represents Loblaw’s biggest upside strategy. Joe Fresh is Loblaw’s owned label apparel brand, led by Joe Mimram, co-founder of Club Monaco. Joe Fresh sells “stylish clothing for less” for children, women and men which is a similar proposition to Target (entering Canada in 2013) and Old Navy. The majority of this apparel is sold through the Real Canadian Superstore banner, with 12 stand-alone stores now open in Canada.

Loblaw intends to open up to 20 stand-alone stores in Canada and has opened five test stores in the United States to gauge the potential in that market (as of 3Q11 it has opened two pop-up stores, two mall-based stores and one flagship store on Fifth Avenue in New York). Loblaw doesn’t expect to get a good read on the U.S. test until sometime in 2012. Loblaw sees the potential for 500 to 800 stores if the test is successful.

2. Health & Wellness – leverage food traffic to take share of valuable Rx sales and other healthy offerings. Loblaw has extended some of its Rx counter hours, is adding in-store pharmacies to its discount store network and has been expanding its healthy foods offering.

3. Ethnic – capitalizing on Canada’s diverse population growth. Almost all of Canada’s population growth is coming from new immigrants, with the Asian population making up a large proportion. Loblaw’s acquisition of T&T Supermarkets in 2009 (a 19-store chain in


25 January 2012 59

metropolitan BC, Alberta and Ontario markets) provides a modest new store growth vehicle, but more importantly an incubator that can guide Loblaw to a well informed deployment of an enhanced Asian food offering in their established network, which has just begun in earnest. Over the next four years, Loblaw plans to double T&T’s store count while pursuing the establishment of similar platforms for South Asian, East African, and Middle Eastern segments.

4. PC Financial – The PC Financial business represents about 1.5% of Loblaw’s sales but has been as high as 9% of Loblaw’s EBIT on a quarterly basis. PC Financial offers bank accounts, mortgages, insurance and credit cards. The largest portion of this business is the President’s Choice Financial MasterCard, which has 2.5mn card holders. Loblaw has recently added mobile phone kiosks to the PC Financial offering through in store kiosks/pavilions.

Risks Margin risk of increased price/promotion intensity. A slow economy, high

unemployment, above-average inflation and unsustainable square footage growth in the hard discount segment as Wal-Mart builds out its Supercenter stores.

IT and supply change implementation risk is high as Loblaw begins to link the distribution and store network to the centralized merchandise platform. This risk is modestly heightened by a change in the company president’s position and a reorganization of the business units that was implemented over the past two quarters.

Stronger-than-expected 4Q11 results, or any number of pronouncements by Loblaw that address current uncertainties (e.g., incremental IT/supply chain spending for 2012 lower than expected; provision of estimated expense reductions for 2013, in-store merchandising improvements for 2012) could provide a catalyst to an improved valuation.


25 January 2012 60

COMPANY SNAPSHOT

Loblaw Companies Canadian Consumer & Retail

Income statement ($mn) 2010A 2011E 2012E 2013E CAGRRevenue 30,997 31,090 31,270 31,757 0.8% Stock Rating 2-EQUAL WEIGHTEBITDA 1,924 2,111 2,243 2,397 7.6% Sector View 2-NEUTRALEBIT 1,269 1,418 1,492 1,622 8.5% Price (20-Jan-2012) $37.30Pre-tax income 996 1,091 1,173 1,306 9.4% Price Target $39.00Net income 744 828 851 947 8.4% Ticker L.TOEPS (adjusted) ($) 2.58 2.84 2.91 3.24 8.0%Diluted shares (m) 285 292 292 292 0.8% Investment caseDividend per share ($) 0.84 0.84 0.92 1.00 5.9%

Margin and return data (%) AverageEBITDA margin 6.2 6.8 7.2 7.5 6.9EBIT margin 4.1 4.6 4.8 5.1 4.6Pre-tax margin 3.2 3.5 3.8 4.1 3.6Net margin 2.4 2.7 2.7 3.0 2.7ROIC 6.9 8.1 8.7 9.3 8.2ROA 4.4 4.7 4.8 5.2 4.8 Upside case $44ROE 10.4 12.1 13.1 12.7 12.0

Balance sheet and cash flow ($mn) CAGRTangible fixed assets 9,123 8,682 8,731 8,706 -1.5%Total assets 15,919 17,413 17,968 18,291 4.7%Short and long-term debt 8,065 9,111 9,069 8,721 2.6%Total liabilities 9,039 11,214 11,172 10,824 6.2% Downside case $29Net debt/(funds) 2,982 3,573 3,027 2,697 -3.3%Shareholders' equity 6,880 6,199 6,796 7,467 2.8%Change in working capital 73 (48) 18 4 -63.0%Operating cash flow 1,623 1,774 1,619 1,725 2.1%Capital expenditure 1,280 1,000 800 750 -16.3%Free cash flow 343 774 819 975 41.7%

Valuation and leverage metrics Average Upside/downside scenariosP/E (x) 14.5 13.2 12.8 11.5 13.0 EV/EBITDA (x) 7.1 6.8 6.2 5.7 6.4 FCF yield (%) 3.2 7.1 7.5 9.0 6.7Price/sales (x) 0.3 0.4 0.3 0.3 0.3 Price/BV (x) 1.5 1.8 1.6 1.5 1.6 Dividend yield (%) 2.3 2.3 2.5 2.7 2.4Total debt/capital (%) 54.0 59.5 57.2 53.9 56.1Total Debt/EBITDA (x) 4.2 4.3 4.0 3.6 4.0

Source: FactSet

Selected operating metrics Same Store Sales vs. Sq. Ft. GrowthSame store sales growth (%) -0.6 0.5 0.0 0.8 0.2Square footage growth (%) -0.2 0.2 0.3 0.5 0.2Inventory growth (%) 5.7 2.0 0.7 2.5 2.7Capex/sales (%) 4.1 3.2 2.6 2.4 3.1

Source: Company data, Barclays Capital Note: FY end Dec.

Price discounting intensifies due to a furtherweakening of demand and margins contract. Ourdownside case would be 10x our F2012 EPSestimate.

The immediate term outlook for Loblaw isdominated by a lack of volume growth, margin riskfrom rising food costs and increasing pricecompetition as well as 2 more years of IT/supplychain implementation risk. Our target is based on aP/E multiple of 13.5x our F2012 EPS estimate.

Loblaw is able to pass through COGS inflationmitigating related margin risk. Our upside casewould be 15x our F2012 EPS estimate.

-1.0%

-0.5%

0.0%

0.5%

1.0%

2010A 2011E 2012E 2013E

Same Store Sales Sq. Ft. Growth

$29(-22.2%)

DownsideCase

$39(4.5%)

PriceTarget

$44(17.9%)

UpsideCase

14

24

34

44

54

1/27/2011 1/20/2012


25 January 2012 61



25 January 2012 62

Figure 66: SNAPSHOT: Canadian Bakery Industry Overview

2004 2005 2006 2007 2008 2009 2010 2011Commercial bread sales ($M) $1,559 $1,661 $1,760 $1,874 $2,040 $2,230 $2,260 $2,340

Growth 6.5% 6.0% 6.5% 8.9% 9.3% 1.3% 3.5%

Source: Canadian Grocer, Nielson (Year End July), Barclays Capital estimates

Share

Sales ($M) $ Share Sales ($M) $ Share Growth Change

White bread $523 23.1% $545 23.3% 4.3% 17 bps

Grain bread/organic / diet $323 14.3% $337 14.4% 4.4% 12 bps

Buns & rolls $331 14.6% $337 14.4% 1.9% -23 bps

Specialty $308 13.6% $335 14.3% 8.5% 65 bps

Whole wheat bread $286 12.7% $278 11.9% -2.6% -75 bps

Bagels $132 5.8% $140 6.0% 6.2% 15 bps

Tortillas & wraps $134 5.9% $138 5.9% 2.7% -5 bps

Pita & Naan $73 3.2% $75 3.2% 2.7% -3 bps

English nuffins $65 2.9% $63 2.7% -3.4% -19 bps

Fruit/sweet/raisin Bread $50 2.2% $51 2.2% 3.0% -1 bps

All other $35 1.5% $40 1.7% 15.0% 17 bpsCommercial bread $2,260 100.0% $2,340 100.0% 3.5%


GrowthDollars per Trip Spent on Bread 3.4%

Number of Trips (M) 0.2%

Dollars per Buyer Spent on Bread Annually 0.2%

Number of Buyers (M) 3.3%


White bread

Whole wheat bread

Grain bread/organic/diet

Buns & rolls

Bagels

Tortilla & wraps

Commercial bread


98.3%

94.8%

1.8%

3.3%

21.6%

0.7%

2.2%

1.7%

5.2%

96.7%

78.4%

99.3%

97.8%

Canadian Commercial Bread Innovation (SKU Count Importance)

Established Items New Items98.2%

$85.72

26.4

2011$4.30

544.2

$85.91

27.2

Canadian Dollars Spent on Bread per Buyer and Trip

2010$4.16

543.3

2010 2011

Canadian Commercial Bread Sales

Canadian Commercial Bread Segmentation


25 January 2012 63

GEORGE WESTON

George Weston Ltd.(WN.TO): Quarterly and Annual EPS (CAD)

2010 2011 2012 Change y/y






Year 4.33A N/A 4.86E 4.67E N/A 4.89E 4.77E 12% 0.62%

P/E 15.3 13.6 13.5




We are initiating coverage of George Weston (WN.TO) with a 2-Equal Weight/2-Neutral rating and $69 target price. WN owns 63% of Loblaw, with approximately 38% of Weston Foods’ sales coming from Loblaw. Our fiscal 2012 valuation is supported by a NAV of $69 consisting of: 1) our $39 Loblaw price target, which carries a per Weston share value of $54, and 2) a Weston Foods (WF) valuation of $17/WN share based on an 7x EV/EBITDA multiple (below LT industry average of 8x, but above Canada Bread at 6x) applied to our WF F2012 EBITDA forecast of $329mn. Loblaws’ share price within WN is currently $51 (as of January 20, 2012), or 78% of the WN share price, which implies an EV/EBITDA multiple for the Weston Foods stub of 7x, which is in line with the current average bakery industry range.

With Loblaw struggling to achieve volume growth, Wal-Mart accelerating its Supercenter rollout in 2012 and WF’s valuation in a reasonable range it is difficult to see any material upside to WN shares over the next 12 months despite Weston Foods’ impressive management of commodity cost pressure so far in 2011. WN through Weston Foods continues to review uses for its $2bn cash position with the preferred deployment being acquisitions that enhance the prospects of the current businesses.

Figure 67: George Weston Net Asset Value (NAV) – 2012E

Target WN Shares Total Value perPrice Owned Value ($M) WN Share % of NAV

Loblaw $39.00 177.4 $6,918 $53.58 78%EV/EBITDA

EBITDA MultipleWeston Foods $329.2 7.0x $2,304 $17.85 26%Less: Weston Foods Debt -$1,588 ($12.30) -18%

Less: Weston Foods Pref. Shrs -$817 ($6.33) -9%

Add: Weston Foods Cash $2,037 $15.78 105%

Net debt + WN preferred shares -$368 ($2.85) -19%Total Weston Foods $1,936 $15.00 22%

WN NAV $8,854 $68.58 100%

Source: FactSet, Barclays Capital estimates

We don’t see potential catalysts in 2012 as yet, but cash could be

put to use

WN CN / WN.TO




Price (20-Jan-2012) CAD 66.12



25 January 2012 64

Figure 68: Weston Foods Implied EV/EBITDA

Weston Foods - Implied Stub Value2011E 2012E

WN Share Price $66.12 $66.12

Less: L Share Price Per WN Share $51.25 $51.25

Implied Weston Foods Share Price $14.87 $14.87

Implied Weston Foods Mkt Value (mln) $1,919.9 $1,919.9

Add: WF Debt (mln) $1,588.0 $1,588.0

Add: WF Preferred Shares (mln) $817.0 $817.0

Less: WF Cash (mln) $2,037.0 $2,037.0

Implied Weston Foods EV (mln) $2,287.9 $2,287.9

Weston Foods EBITDA (mln) $311.0 $329.2

Implied Weston Foods EV/EBITDA 7.4x 7.0x

Source: FactSet, Company reports, Barclays Capital estimates.

Figure 69: North American Bakery Valuations – Consensus Estimates

Price EV Fiscal EBITDA ($M) EV/EBITDA EBITDA GrowthTicker 20/01/12 ($M) PY FY1 FY2 PY FY1 FY2 PY-FY1 FY1-FY2 PY-FY2

Canada Bread Co. CBY $43.95 $1,100 $161 $159 $178 6.8x 6.9x 6.2x -1% 12% 5%George Weston Ltd. WN $66.12 $13,420 $2,306 $2,363 $2,512 5.8x 5.7x 5.3x 2% 6% 4%Flowers Foods Inc. FLO $19.98 $3,047 $291 $302 $333 10.5x 10.1x 9.2x 4% 10% 7%Ralcorp Holdings Inc. RAH $85.91 $6,876 $772 $872 $921 8.9x 7.9x 7.5x 13% 6% 9%Sara Lee Corp. SLE $19.24 $11,947 $1,142 $1,227 $1,345 10.5x 9.7x 8.9x 7% 10% 9%Grupo Bimbo (MX) BIMBOA $28.99 $138,729 $11,723 $15,541 $18,426 11.8x 8.9x 7.5x 33% 19% 25%Average 9.1x 8.2x 7.4x 10% 10% 10%George Weston (BarCap Est.) $66.12 $13,420 $2,306 $2,450 $2,551 5.8x 5.5x 5.3x 6% 4% 5%

Source: FactSet, Barclays Capital Estimates. EBITDA figures are consensus from FactSet except where noted.

Corporate Profile George Weston is a vertically integrated food company with operations in food retailing through its 63% stake in Loblaw (95% of revenue, 88% of EBITDA in 2010) and in the North American Bakery industry through its wholly owned subsidiary Weston Foods (WF), which manufactures and distributions Fresh, Frozen, and Specialty Bakery products in Canada and the United States. The Weston family controls 62.5% of George Weston’s shares which implies a 39% ownership of Loblaw.

Weston Foods is one of two national players in the Canadian Bakery industry (the other being Canada Bread, majority owned by Maple Leaf Foods) with 31 production facilities in Canada and 11 in the United States. The company sells products under the Wonder, Country Harvest, and Gadoua brands and is a supplier of ice cream cones to the dairy industry and sandwich wafers for Girl Scout cookies. In 2010, the company purchased Keystone Bakery Holdings, a supplier of frozen cupcakes, donuts, and cookies for $188 million which strengthened its U.S. frozen bakery network’s reach and productivity. Also in 2010, Weston acquired Canada-based ACE Bakery Limited, an artisan bread manufacturer, for $110 million, which has provided Weston’s with a stronger/specialty artisan fresh bread offering in Canada and a growth vehicle the United States.


25 January 2012 65

Figure 70: George Weston Company Snapshot

Business Unit Description % of Sales % of EBITDA Margin (%)

Loblaw Companies Limited

Leading Canadian food retailer with ~30% national market share; Strong presence in Conventional and Discount formats; owner of the President's Choice Brand

95.0% 87.6% 6.5%

Weston Foods (WF) 5.0% 12.4% 17.4%

Fresh Bakery - Canada

Branded and private label fresh baked bread, rolls, bagels, tortillas, sweet goods; operates a large DSD network, servicing the retail and foodservice channels; one of two national players

38.0%* na na

Frozen Bakery - Canada & U.S.Frozen & par-baked bread, rolls, sweet goods; portfolio is largely private label, servicing the retail and foodservice channels

46.0%* na na

Biscuits & Other - U.S.Wafers, ice cream cones, crackers, cookies (largest supplier of Girl Guide cookies in the U.S); majority of products are private label

16.0%* na na

Total ($M) $32,008.0 $2,339.0 7.3%*Percent of Weston Foods sales Source: Company reports, Barclays Capital estimates.

Growth Strategy & Outlook As we are initiating coverage of Loblaw in this report as well (Loblaw: 2-EW/Neu rating with a $39 target price) we will limit our review of George Weston to Weston Foods and the use of the company’s still sizeable cash position of $2bn, or $15.80/share.

Loblaw’s performance improvement is the key driver of WN’s upside potential over the longer term. Loblaw represents 78% of George Weston’s NAV and 88% of EBITDA. As such, proportionately over the long term Loblaw is the predominant earnings and value driver for George Weston’s share price performance. Given our tepid view of Loblaw’s near-term growth prospects (WMT’s growth inroads, stagnant volumes, intense price competition and IT/supply chain upgrade constraints/risk) which affects almost 40% of Weston Foods, we are estimating limited valuation lift from either business over the next 12 months. While Weston Foods can contribute to WN’s upside Loblaw remains the largest swing factor, as we estimate that each $1.00 change in Loblaw’s share price represents a $1.37 change in George Weston’s share price, or a 2% impact on the current WN share price value.

Figure 71: George Weston – Sources of Possible Upside to our 2012 Valuation

WN - Potential Upside AnalysisLoblaw Weston Foods Total

Current value per WN Share $51.25 $14.87 $66.12

BarCap Target Value per WN Share - F2012E $53.58 $15.00 $68.58

Upside Potential (%) 4.5% 0.9% 3.7%Upside Potential ($) $2.33 $0.13 $2.46

% of Total Upside / downside 95% 5% 100%

Upside Potential (%) - weighted 3.5% 0.2% 3.7%

Source: FactSet, Barclays Capital estimates.


25 January 2012 66

Figure 72: George Weston – Valuation Sensitivity to Weston Foods

Weston Foods - f2012 EBITDA Margin, y/y Margin Change, EBITDA17.6% 17.7% 17.8% 17.9% 18.0% 18.1% 18.2%

10 bps 20 bps 30 bps 40 bps 50 bps 60 bps 70 bps

$68.58 $323.7 $325.5 $327.3 $329.2 $331.0 $332.8 $334.7

8.5x $72.04 $72.16 $72.28 $72.40 $72.52 $72.64 $72.76

8.0x $70.78 $70.90 $71.01 $71.13 $71.24 $71.35 $71.477.5x $69.53 $69.64 $69.74 $69.85 $69.96 $70.06 $70.17

7.0x $68.28 $68.38 $68.48 $68.58 $68.68 $68.77 $68.87

6.5x $67.02 $67.12 $67.21 $67.30 $67.39 $67.49 $67.58

6.0x $65.77 $65.86 $65.94 $66.03 $66.11 $66.20 $66.28

5.5x $64.52 $64.59 $64.67 $64.75 $64.83 $64.91 $64.99

5.0x $63.26 $63.33 $63.40 $63.48 $63.55 $63.62 $63.69Wes

ton

Food

s EV

/EBI

TDA

M

ultip

le

Source: Barclays Capital estimates.

Figure 73: George Weston – Valuation Sensitivity to Loblaw

Loblaw - f2012 EPS$68.58 $2.60 $2.70 $2.80 $2.91 $3.00 $3.10 $3.20

16.5x $73.54 $75.81 $78.08 $80.57 $82.61 $84.88 $87.1415.5x $69.97 $72.10 $74.23 $76.57 $78.49 $80.62 $82.7514.5x $66.40 $68.39 $70.38 $72.57 $74.37 $76.36 $78.3513.5x $62.83 $64.68 $66.54 $68.58 $70.24 $72.10 $73.9512.5x $59.25 $60.97 $62.69 $64.58 $66.12 $67.84 $69.5611.5x $55.68 $57.26 $58.84 $60.58 $62.00 $63.58 $65.1610.5x $52.11 $53.55 $54.99 $56.58 $57.88 $59.32 $60.769.5x $48.54 $49.84 $51.15 $52.58 $53.76 $55.06 $56.37

Lobl

aw P

/E M

ultip

le


Strategic tuck-in acquisitions are the top priority for use of the remaining cash war chest.

Following the tuck-under acquisitions of Keystone and Ace Bakery, and a $1bn special dividend, Weston Foods’ cash war chest is now at $2bn as of 3Q11 (excluding $1.8bn of cash held at Loblaw). Management has reiterated that the preferred use of the remaining cash is to enhance the prospects of the current businesses. Given the high market share concentration of the fresh/frozen business in Canada, which is almost equally shared between Weston Foods and Canada Bread, acquisition potential in Canada is limited.

The highly fragmented U.S. frozen bakery industry provides considerably greater opportunity and we could see Weston aggressively pursuing more acquisitions like the 2010 Keystone purchase. The U.S. frozen opportunity could allow Weston to generate enhanced value in several ways: 1) extended geographic reach, access to new customers and possibly new product offerings; 2) production and distribution efficiencies/synergies; 3) leverages its strong capital position and operational expertise; and 4) provides potential valuation leverage of private company acquisitions into public company earnings, which typically represents a valuation lift of 25% to 30%.

Possible alternative uses of the cash: WN or Loblaw minority purchase seem unlikely. The Weston Family already controls 62.5% of George Weston’s shares which implies 39% ownership of Loblaw. Given its ownership stake, it is possible that the Weston Family could seek to capture a greater portion of Loblaw’s pending turnaround through:

1. A George Weston purchase of the Loblaw minority, or

In terms of acquisition potential, Canadian opportunities seem

limited…

…but U.S. frozen bakery industry could present opportunities


25 January 2012 67

2. A Weston Family purchase of the George Weston minority, leaving Loblaw as the sole public entity.

In either scenario, the Weston Family would end up owning approximately 60% of Loblaw. However, we believe neither scenario is likely, especially after WN decided to pay out a $1bn special dividend in fiscal 2010, as each scenario would likely lead to higher leverage ratios, with minimal synergies. We estimate that the take-in of the Loblaw minority or George Weston minority would increase WN’s net debt/EBITDA ratio to over 3.5x versus its current ratio of 2.1x, which could potentially put WN’s debt rating at risk. Management has stated that they wish to maintain the current investment grade rating; as such we do not expect the company to take on significantly more debt.

Repurchasing WN shares through the normal course issuer bid process would be a slow/indirect way for the Family to increase its stake. However, so far management has indicated that the company will not be active in buying back shares other than to offset the dilutive impact related to exercising of stock options.

Hedging strategy provides some certainty on costs. Weston Foods’ production process involves wheat flour (~60% of commodity costs), natural gas and heating oil (15-20%, includes fuel for delivery fleet), soy (~10%), and sugar (<10%). Weston Foods employs a fairly consistent, systematic approach to hedging its commodity cost exposure 6-9 months out. The company’s hedging strategy is primarily to lock-in cost certainty rather than trying to opportunistically enhance profits. This strategy enables Weston Foods to more effectively plan and execute price increases. Weston Foods relies on price increases and cost reduction initiatives in order to mitigate higher commodity and energy costs.

Commodities should become less of a headwind in 2H12. As a result of the significant run-up in commodity and energy costs in 1H11, Weston Foods likely faced an incremental $60 million in costs in the second half of the year. Through price increases and cost reduction initiatives, management hopes to achieve flat operating margins for F2011 compared to F2010. As the commodity pressures have eased management expects the incremental commodity/energy costs to be about $15mn in 2H12. As shown in Figure 74, the spot price of wheat (WF’s largest input cost) has retreated from the record highs reached mid-2011. Front month futures suggest near-term prices could decline further but longer dated contracts suggest more increases in 2012.

Figure 74: Wheat prices have stabilized, but futures prices suggest more increases in 2012

$5.50

$6.00

$6.50

$7.00

$7.50

$8.00

$8.50

Jan-

11

Feb-

11

Mar

-11

Apr

-11

May

-11

Jun-

11

Jul-

11

Aug

-11

Sep-

11

Oct

-11

Nov

-11

Dec

-11

Jan-

12

Feb-

12

Mar

-12

Apr

-12

May

-12

Jun-

12

Jul-

12

Aug

-12

Sep-

12

Oct

-12

Nov

-12

Price in $CAD Max Min Average NTM Futures Prices

Source: Bloomberg, Barclays Capital Estimates

We do not expect the company to take on significantly more

debt


25 January 2012 68

Figure 75: George Weston Financial Performance Summary

GAAP IFRS IFRS IFRS IFRSF2009 F2010e F2011e F2012e F2013e

Total Revenue ($ Millions) $31,820 $31,847 $32,221 $32,427 $32,954 Total Revenue Growth (%) -0.2% 0.9% 0.8% 0.6% 357.1%Loblaw Revenue ($Millions) $30,735 $30,836 $31,090 $31,270 $31,757 Loblaw Revenue Growth (%) -0.2% 0.9% 0.8% 0.6% 357.1%Weston Foods Revenue ($Millions) $1,686.0 $1,624.0 $1,774.1 $1,836.1 $1,900.9 Weston Foods Revenue Growth (%) -23.3% -3.7% 9.2% 3.5% 3.5% Weston Foods Revenue Growth ex FX (%) -23.3% 0.3% 9.2% 3.5% 3.5% Fresh Foods Revenue Growth (%) -2.0% -1.0% 0.5% 2.0% 1.5% Frozen Foods Revenue Growth (%) -1.5% -5.5% 22.9% 5.8% 5.5% Biscuits Revenue Growth (%) 23.2% -7.0% 0.5% 1.7% 1.0%

Weston Foods Gross Margin 74.9% 75.7% 69.7% 71.7% 72.0%Adj. Weston Foods SG&A as a % of Retail Revenue 61.9% 58.5% 52.2% 53.8% 53.8%Adj. Weston Foods EBITDA Margin 13.0% 17.9% 17.5% 17.9% 18.2%

Weston Foods Gross Margin Variance 377 bps 421 bps -600 bps 200 bps 30 bpsAdj. Weston Foods SG&A Variance 137 bps -10 bps -629 bps 160 bps 0 bpsAdj. Weston Foods EBITDA Variance 240 bps 432 bps -33 bps 40 bps 30 bps

Total Gross Margin 24.7% 24.9% 24.6% 25.0% 25.2%Total Adj. SG&A as a % of Total Revenue 18.0% 18.1% 17.0% 17.1% 16.9%Total Adj. EBITDA Margin 6.4% 7.3% 7.7% 7.9% 8.3%

Total Gross Margin Variance 113 bps 116 bps -23 bps 38 bps 23 bpsTotal Adj. SG&A Variance 14 bps 63 bps -115 bps 12 bps -17 bpsTotal Adj. EBITDA Variance 75 bps 77 bps 32 bps 26 bps 38 bps

Net Debt/EBITDA (LTM) 3.3x 3.4x 3.6x 3.4x 3.2xCapex as a % of Sales (LTM) 3.2% 4.4% 4.3% 4.3% 4.2%Free Cash Flow ($ Millions, After Capex/WC) $947 $1,551 $317 -$468 $553Return on Equity 6.6% 10.5% 11.6% 10.9% 11.1%Return on Invested Capital 12.2% 14.5% 12.6% 11.5% 12.1%

Source: Company Reports, Barclays Capital estimates Note: Growth rates/variances comparing 2010/2009 use GAAP figures, while raw figures are presented in IFRS

Risks High commodity prices, particularly wheat, could continue to impact margins in 2012.

Increased pricing to offset higher input costs is unlikely to occur given the promotional intensity of the food retailer environment. Management estimates that a 10% increase (decrease) in commodity prices would result in a net loss (gain) of $8 million in net earnings before income taxes and minority interest.

Wal-Mart is in the midst of the rollout of its Supercenter format in Canada which is adding considerable fresh category square footage (produce, meats, baked goods) to a modest growth industry, resulting in slowed growth for incumbents and intensified price competition.

With the majority of George Weston’s value and WF sales coming from Loblaw, Weston generally faces the same slow growth earnings prospects as Loblaw and the risk/uncertainty of two more years of IT/supply chain upgrades (see details in Loblaw company section).

The primary upside risk to our valuation is upside at Loblaw through either a valuation lift and/or better-than-expected earnings. As outlined in our Loblaw risk section, Loblaw’s currently depressed valuation could achieve a recovery if Loblaw achieves


25 January 2012 69

stronger-than-expected 4Q11 results, or the company makes any number of pronouncements that address current uncertainties (e.g., incremental IT/supply chain spending for 2012 lower than expected; provision of estimated expense reductions for 2013, in-store merchandising improvements for 2012). Weston Foods valuation could improve as well if Loblaw’s growth prospects improve.


25 January 2012 70

COMPANY SNAPSHOT

George Weston Canadian Consumer & Retail

Income statement ($mn) 2010A 2011E 2012E 2013E CAGRRevenue 31,847 32,221 32,427 32,954 1.1% Stock Rating 2-EQUAL WEIGHTEBITDA 2,219 2,405 2,572 2,738 7.3% Sector View 2-NEUTRALEBIT 1,536 1,647 1,757 1,898 7.3% Price (20-Jan-2012) $66.12Pre-tax income 1,064 1,298 1,420 1,562 13.7% Price Target $69.00Net income 420 620 631 688 17.9% Ticker WNEPS ($) 4.33 4.86 4.89 5.33 7.2%Diluted shares (m) 130 129 129 129 -0.2% Investment case

Dividend per share ($) 1.44 1.44 1.44 1.44 0.0%

Margin and return data (%) AverageEBITDA margin 7.0 7.5 7.9 8.3 7.7EBIT margin 4.8 5.1 5.4 5.8 5.3Pre-tax margin 3.3 4.0 4.4 4.7 4.1Net margin 1.3 1.9 1.9 2.1 1.8ROIC 14.5 12.6 12.4 13.0 13.1ROA 2.9 3.1 3.0 3.1 3.0 Upside case $78.00ROE 10.5 11.6 10.9 11.1 11.0

Balance sheet and cash flow ($mn) CAGRTangible fixed assets 8,823 9,493 10,078 10,638 6.4%Intangible fixed assets 1,554 1,554 1,554 1,554 0.0%Cash and equivalents 1,453 1,121 1,079 1,274 -4.3%Total assets 21,696 20,958 21,531 22,403 1.1%Short and long-term debt 8,198 8,036 8,036 8,036 -0.7% Downside case $57.00Total liabilities 16,472 15,373 15,579 16,027 -0.9%Net debt/(funds) 3,492 5,287 5,329 5,134 13.7%Shareholders' equity 5,224 5,585 5,952 6,376 6.9%Change in working capital 62 (290) (147) (5) NAOperating cash flow 1,741 1,717 1,690 1,961 4.0%Capital expenditure 1,400 1,400 1,400 1,400 0.0%Free cash flow 828 607 437 565 -11.9%

Upside/downside scenarios

Valuation and leverage metrics AverageP/E (x) 15.3 13.6 13.5 12.4 13.7 EV/EBITDA (x) 5.4 5.8 5.4 5.0 5.4 FCF yield (%) 9.6 7.1 5.1 6.6 7.1Price/sales (x) 0.3 0.3 0.3 0.3 0.3 Price/BV (x) 1.6 1.5 1.4 1.3 1.5 Dividend yield (%) 2.2 2.2 2.2 2.2 2.2Total debt/capital (%) 61.1 59.0 57.5 55.8 58.3Total debt/EBITDA (x) 3.7 3.3 3.1 2.9 3.3

Source: FactSet

Selected operating metrics Volume vs. Price GrowthVolume growth (%) -0.1 2.8 2.2 2.7 1.9Price growth (%) -1.9 2.8 1.5 0.6 0.7Inventory growth (%) -0.1 4.8 0.6 2.6 2.0Capex/sales (%) 4.4 4.3 4.3 4.2 4.3


With Loblaw (75% of NAV) struggling to achievevolume growth and Weston Foods fairly valued, wedo not see material upside to WN shares over thenext 12 months. Strategic tuck-ins are a priority forWN's $2B in cash; however, we expect managementto remain patient/prudent on its deployment. Ourimplied target P/E is 14x our F12E EPS.

Our upside scenario reflects a stronger, quicker-than-expected turnaround at Loblaw. In this case, weapply our Upside case for Loblaw of $44, whichgenerates a WN NAV o f $78.

Our Downside case reflects weaker margins atLoblaw due to intensified price competition.Applying our Downside case for Loblaw of $29would yield a $57 NAV for WN.

-3%-2%-1%0%1%2%3%4%

2010A 2011E 2012E 2013E

Volume Growth Price Growth

DownsideCase

$57(-13.7%)

PriceTarget

$71(7.3%)

UpsideCase

$78(17.9%)

2838485868788898

1/27/2011 1/20/2012

DownsideCase

$57(-13.7%)

PriceTarget

$69(4.3%)

UpsideCase

$78(17.9%)

2838485868788898

1/27/2011 1/20/2012


25 January 2012 71

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25 January 2012 72

METRO INC.

Metro Inc.(MRU-A.TO): Quarterly and Annual EPS (CAD)

2011 2012 2013 Change y/y

FY Sep Old New Old New Cons Old New Cons 2012 2013

Q1 N/A 0.89A N/A 0.94E N/A N/A N/A N/A 6% N/A




Year N/A 3.92A N/A 4.29E 4.28E N/A 4.62E 4.65E 9% 8%

P/E 13.2 12.0 11.2




We are initiating coverage of Metro with a 2-Equal Weight/2-Neutral rating and a $54 price target for total return potential of 6% from recent levels. Metro’s consistent earnings growth regardless of market conditions makes it one of the leading “go-to” defensive names in our coverage, in our view. Metro’s share price appreciated 16% in 2011 despite margin risk in the sector (S&P/TSX -11%), as renewed financial crisis concerns and economic slowdown pushed investors back into defensive names. Metro offers investors a long-term track record of consistent earnings growth (20 of the past 21 years saw growth), dividend increases (18 consecutive years) and share buybacks (approximately 4% of float in each of past four years). Despite Wal-Mart’s launch of the Supercenter format in Quebec in 2011, we estimate that proportionately Metro faces the least EPS risk of the CDN Food retailers, and if Target’s temporary closure of the Zellers stores contributes as much of a windfall gain this year as we estimate, Metro’s EPS risk in F2012 (September) could actually be lower than it was in F2011 at only 1.5% to 2%.

Figure 76: Metro’s P/E Valuation Range

YE: Sept 30 Comments

EPS range: $4.25 $4.29 $4.35 $4.55 $4.62 $4.70 NOTE: extra week in f2012y/y % growth 8.5% 9.5% 11.0% 6.1% 7.6% 9.6% adj growth is 7.2%

P/E Multiples

8.0x $34 $34 $35 $36 $37 $38 <= SFWY/Kroger trough fwd P/E's

9.0x $38 $39 $39 $41 $42 $42 <= Metro's avg TROUGH fwd P/E10.0x $43 $43 $44 $46 $46 $47

11.0x $47 $47 $48 $50 $51 $52

11.5x $49 $49 $50 $52 $53 $54 Metro's LT avg. fwd P/E = 11.3x12.0x $51 $51 $52 $55 $55 $56

12.5x $53 $54 $54 $57 $58 $59 <= Barclays Price Target Multiple13.0x $55 $56 $57 $59 $60 $61

13.5x $57 $58 $59 $61 $62 $63

14.0x $60 $60 $61 $64 $65 $66 <= Metro's Avg PEAK fwd P/E15.0x $64 $64 $65 $68 $69 $71

f2012 (extra week) f2013

BarCap est BarCap est

Source: Barclays Capital estimates. EPS range is for illustrative purposes only.

Metro has been perceived as a “go to” defensive stock – for

good reason – and risk to earnings could actually decrease

in 2012

MRU/A CN / MRU-A.TO




Price (20-Jan-2012) CAD 51.58



25 January 2012 73

Our $54 price target is supported by a 12.5x P/E multiple on our F2012 EPS forecast of $4.29, which is above Metro’s long-term smoothed average of 11.3x, but below the most recent cycle peak of 14x. Metro’s share price appreciated 16% in 2011 in part driven by a 7% increase in the forward P/E multiple from 11.5x to 12.4x (S&P/TSX -11%). Unless the Target renovation closures contribute as much EPS offset as we have estimated ($0.07 in 2012 and $0.11 in 2013) we don’t see any other sales/earnings drivers contributing to a material higher earnings outcome in 2012. A more plausible outcome is that investors’ hunger for defensive names lifts Metro’s P/E toward 14x from the current 12.1x FY1; this would generate a very respectable 11% gain on top of the 16% lift the shares achieved in 2011.

Figure 77: Metro Historical Forward P/E

Metro Forward P/E

Note: Avg. PE Normalized to exclude A&P acquisition period from 2005-2007

12.4x

10.0x

14.3x

8.9x

15.8x

9.6x

15.5x

8.9x

15.0x

8.0x

14.3x

9.1x

17.0x

4x

6x

8x

10x

12x

14x

16x

18x

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012


Source: FactSet, Reuters

Overall we recommend that investors minimize their exposure to the food retail space. Within that stance Metro would be our top pick among the Canadian food retailers. We believe that Metro’s growth and cost-containment initiatives and share buybacks from fiscal 2011 and fiscal 2012E can mitigate the estimated EPS risk (impact of $0.05-$0.12, by our estimates) of Wal-Mart’s Supercenter rollout in Quebec, which combined with another dividend increase could provide investors with a relatively respectable return in 2012.

Despite our confidence in Metro’s ability to achieve EPS growth in 2012, for investors looking for relatively defensive investments we prefer Dollarama and Tim Hortons despite their higher valuations because of their superior growth prospects and less intense competitive environment.

Metro has already announced two major initiatives that we estimate could contribute as much as $0.05 to EPS growth in F2012, with the repurchase of 4.5mn shares under the new Normal Course Issuer Bid (NCIB) increasing EPS by another $0.11. Some additional considerations are:

1. Metro has already dealt with Wal-Mart’s impact in Ontario;

2. Wal-Mart has a smaller presence in Quebec (4% share of market vs. 7% in Ontario) and the per store impact so far has been less than Metro experienced in Ontario;

3. Metro’s market position and store network in Quebec is stronger than in Ontario;

Metro is our pick among the Canadian food retailers…

…but within the broader sector we’d suggest DOL & THI as

“defensive” stocks


25 January 2012 74

4. Metro’s exposure to the WMT/TGT Zellers store redeployment will be muted in Ontario by Metro’s urban location skew.

Metro’s estimated sales/EPS risk exposure to Wal-Mart’s grocery growth in 2012 is proportionately the Lowest of the “Big 3”. Despite Metro now facing Wal-Mart’s Supercenter build-out in both Ontario and Quebec with six Supercenter openings (3 expansions, 3 conversions) in Quebec this year, we estimate that the EPS risk in 2012 may only be $0.12, or 2.8% of our F2012 EPS estimate of $4.29. If we include the potential one-time windfall gain that Target’s temporary renovation closures might represent the EPS risk exposure drops to $0.05, which is below the risk level Metro has had to deal with in each of the past four years from Ontario.

Figure 78: Sales and Earnings Risk of WMT & TGT Grocery Sales Growth

Metro 2008 2009 2010 2011 2012E 2013E 2014E 2015E WMT ($M) $51 $52 $53 $58 $90 $117 $73 $67 TGT ($M) $22 $58 $36 WMT/TGT $51 $52 $53 $58 $90 $139 $131 $103 Zellers ($M) -$50 -$76 -$16 $0

Sales at risk ($M) $51 $52 $53 $58 $40 $63 $114 $103


EPS at risk $0.05 $0.06 $0.06 $0.07 $0.05 $0.09 $0.17 $0.16% of EPS 2.1% 1.8% 1.8% 1.9% 1.2% 1.9% 3.3% 2.8%

% of EPS pre Zellers 2.1% 1.8% 1.8% 1.9% 2.8% 4.2% 3.7% 2.8%

Note: Negative figures means a sales/EPS gain Source: Barclays Capital estimates, Company Reports

Corporate Profile: in a word, consistent Metro Inc. is Canada’s third-largest food retailer with an estimated market share of 10% nationally, holding the No. 2 position in Canada’s largest provinces – Quebec and Ontario. Metro is a Quebec-based retailer and wholesaler in the food and drugstore sectors with a mix of corporate and franchise food retail operations in Quebec and a corporate-only network in Ontario. Metro entered the Ontario market in 2007 through the acquisition of A&P Canada. Metro operates food retail banners in the conventional and discount segments and in retail pharmacy as outlined below. McMahon Distributeur is a pharmacy distribution subsidiary which supplies pharmacies, supermarkets and health-care institutions, including hospitals and treatment centres in Quebec. Metro recently acquired Adonis, a Mediterranean specialty retailer and distributor based in Montreal that will be their lead ethnic market platform.

Metro owns 11.3% (20.7 million multiple voting shares; 11% economic interest and 23% voting interest) of Alimentation Couche-Tard (ATD.b-TO, rated 2-Equal Weight/2-Neutral) which it accounts for on an equity income basis. In fiscal 2011, Couche-Tard equity income of $43mn represented 5% of Metro’s EBITDA, 11% of EPS and approximately 18% of Metro’s F2011 EPS growth. The market value of this holding is currently approximately $600mn.

Metro currently has two classes of shares, 99% of which are the single voting class A shares (101.8mn) and the remaining being class B shares (577 shares) which have 16 votes each, or 8% of the votes. Metro will be seeking shareholder approval to a conversion of the class


25 January 2012 75

“B” shares to class “A” shares on a one-for-one basis at their annual meeting on January 31, 2011, which we expect to be approved.

Figure 79: Metro Inc.’s Store Network Profile

Metro Inc. - Store Network Profile

Market Share Revenue EBITDA % Margin Stores

10% $11 bln 794 mln 6.9% 821

Quebec Ontario TotalTotal Sq.

Ft.Primary Banners

Conventional 216 154 370 12.9 mln Metro - Ontario & Quebec

Hard Discount 79 115 194 6.8 mln Food Basics (Ont), Super C (Que)

Total Food stores 295 269 564 19.7 mln

Pharmacies 179 78 257 In-store (Ont), Brunet & Clini Plus (Que)

Owned Food retail square footage (est.) ~ 8%

Owns 20.7 million shares of Alimentation Couche Tard (ATD.B) representing 11% economic interest and 23% voting interest


Growth Strategy & Outlook: Metro can handle the heat in Quebec Metro is known as a company that consistently delivers results driven by a relentless focus on cost reduction/efficiency and a balanced deployment of free cash flow. Metro’s growth strategy sounds so simple that it can make some investors looking for more torque lose interest, but the results speak for themselves. With the exception of the acquisition of A&P Canada in 2007 and the subsequent rebannering of A&P’s conventional stores in Ontario in 2008/09, Metro rarely relies on a silver bullet to deliver earnings growth. Rather, the company prides itself on a culture of continuous improvement and a balanced mix of growth drivers: revenue growth, productivity and efficiency improvements, and innovation.

The results speak for themselves: Metro has one of the best long-term track records of any retail/consumer company in Canada, if not North America. These results have been achieved through a myriad of initiatives over the years. Fiscal 2010 contributions included a new Ontario trucking agreement, a lower-cost collective agreement with the union for its four warehouses in Ontario and the launch of its new proprietary loyalty program in Quebec through its joint venture with Dunnhumby.

Metro has increased earnings every year for 21 years, with the exception of F2008 when Loblaw dropped prices in advance of Wal-Mart’s Supercenter launch.

Return on equity has exceeded 14% for 18 years coming in at 16% in F2011 despite very challenging market conditions.

The dividend has been increased every year for 18 years. In the last two years the company has increased its annualized dividend by 40%.

Metro has repurchased more than 19% of its shares since F2005, or nearly 20mn shares at an approximate cost of more than $650mn.

Metro’s solid results and track record tell the story but are

investors still listening?


25 January 2012 76

Figure 80: Metro: Company-Generated Growth/Returns for Shareholders

Fiscal Year (Sept) 2007 2008 2009 2010 2011 CAGR 2012E 2013E

Net earnings growth 14.6% -4.9% 27.9% 6.5% 6.1% 8.3% 4.6% 2.7%

Share count EPS impact -0.6% 2.9% 2.3% 3.8% 4.0% 3.3% 4.8% 5.0%

Total EPS growth 14.0% -2.0% 30.2% 10.2% 10.1% 11.6% 9.4% 7.7%

Dividend yield 1.2% 1.9% 1.5% 1.6% 1.7% 1.6% 1.7% 2.0%

Company generated returns 15.2% -0.1% 31.8% 11.9% 11.8% 13.2% 11.2% 9.4%

TSX return (incl. dividends) 22.8% -14.4% 0.4% 11.6% -3.6% 3.2%

ROE 16.1% 14.0% 16.6% 16.2% 16.0% 16.0% 15.8%

Net debt to EBITDA 1.4x 1.3x 1.0x 1.0x 1.3x 0.8x 0.8xSource: FactSet, Bloomberg, Company Reports, Barclays Capital estimates

Wal-Mart’s Supercenter concept has arrived in Quebec

WalMart’s rollout of the Supercenter format in Quebec will expose Metro to an additional growth constraint. After dealing with the impact of Wal-Mart’s Supercenter rollout in Ontario, Metro is now facing them in Quebec – the other half of its business. Wal-Mart brought its Supercenter concept to Quebec this year, five years after opening its first Canadian Supercenter in 2006, with the opening of six stores (3 conversions, 3 expansions) out of 55 existing stores in Quebec. In addition to its normal store conversion plan, Wal-Mart has also acquired the leases for eight Zellers stores in Quebec, which we expect to be re-opened as Supercenters toward the end of 2012 if the leases allow the addition of food products. If Wal-Mart sustains the same pace of Supercenter openings in Quebec that we have seen in other parts of Canada, we expect the majority of the conventional stores to be converted within five years.

Of the three major food retailers, Metro faces the greatest exposure to Wal-Mart’s Quebec entry with more than 51% of its sales in that province (17% from discount sales) and an even greater percentage of its profits, which compares to 18% of Loblaw’s total sales and 31% of Sobeys sales. So far Metro has indicated that the impact from Wal-Mart’s Supercenter openings has been more modest than it experienced in Ontario and less than it had expected in most locations. Regardless of the current severity, it is obviously not helpful for the food retailers to be battling for customer traffic when the consumer is already very cautious. As outlined in our sector overview, the competitive environment in Canada remains intense and is expected to remain so for the foreseeable future.

And then there’s Target

Target will enter Quebec with an estimated 27 stores starting sometime in mid- to late 2013 with Metro having 27 stores in proximity to these openings. According to our due diligence, 12 of the predecessor Zeller stores had Neighbourhood Market grocery sections (dairy, dry and frozen grocery) with Metro having lease agreement exclusivity for food in the remaining 15 locations, which could preclude Target from adding food to most of these locations. In addition, with most of these stores being smaller than Target’s average conventional discount stores (83k sq. ft. vs. 122k) in the United States, the amount of space they are likely to commit to food will be very constrained. In the immediate term, as Target has already told investors at its annual investor day, its primary upside is in the apparel and soft home categories. Finally, Target’s opening is expected to materially increase customer traffic at these strip malls, potentially increasing Metro’s customer traffic at the same time. This has been Metro’s experience in Ontario as they dealt with the impact of Wal-Mart’s Supercenter rollout.

Wal-Mart ramp-up in Quebec adds more pressure to an

already intensely competitive landscape...

…but Target entry is a mixed bag


25 January 2012 77

Combining the sales and EPS risk of Wal-Mart and Target’s growth we estimate Metro’s EPS risk exposure to be in the range of $0.12 to $0.19, before taking into consideration the potential reprieve Metro might experience from Target’s closure of the Zellers stores they will be renovating in 2012/13. This EPS risk compares to an estimated run rate of $0.06 in each of the previous four years. If Target’s temporary closure of its acquired Zellers locations contributes as much of a benefit as we have estimated, Metro’s EPS risk drops to $0.05-$0.07 in F2012 which is in line with the risk we estimate it faced in each of the previous four years.

Figure 81: Metro’s Sales and EPS risk to WMT & TGT’s Grocery Sales Growth

Metro 2008 2009 2010 2011 2012E 2013E 2014E 2015E WMT ($M) $51 $52 $53 $58 $90 $117 $73 $67 TGT ($M) $22 $58 $36 WMT/TGT $51 $52 $53 $58 $90 $139 $131 $103 Zellers ($M) -$50 -$76 -$16 $0

Sales at risk ($M) $51 $52 $53 $58 $40 $63 $114 $103


EPS at risk $0.05 $0.06 $0.06 $0.07 $0.05 $0.09 $0.17 $0.16% of EPS 2.1% 1.8% 1.8% 1.9% 1.2% 1.9% 3.3% 2.8%

% of EPS pre Zellers 2.1% 1.8% 1.8% 1.9% 2.8% 4.2% 3.7% 2.8%

Note: Negative figures means a sales/EPS gain Source: Barclays Capital estimates and Company Reports.

3. Metro’s planned offset arsenal in 2012 provides reasonable comfort that it has right sized the risk and has adequate plans to sustain growth. Metro’s revenue and earnings enhancement arsenal for F2012 consists of several larger than usual contributors, which are aptly timed to minimize the negative impact of Wal-Mart’s Supercenter rollout in Quebec: Over the long term Metro’s earnings growth plan remains: achieve top-line growth of 2%-4% per year, EBIT growth of 4%-6% through operating leverage with EPS growth of 8%-10% achieved through share buybacks. Excluding the extra week, F2012 may prove to be slightly below this intended delivery but 6%-8% in this sector is expected to be industry leading.

Restructuring benefit of $2mn, or $0.02/share in F2012, from the closure of non-core assets. Metro announced the 4Q11 closure of a meat processing facility in Quebec and a small satellite Grocery warehouse in Ontario at a cost of $20mn with expected annual savings of $2mn in F2012, or an after tax benefit of $0.01 to $0.02 per share .

Renewal of Normal Course Issuer Bid expected to lift F2012 EPS by $0.11, or 4%. Metro renewed the NCIB program at the beginning of September with intentions to buy back at least 4mn shares out of the 6mn allowed. We are forecasting repurchase of 4.5mn shares in F2012 and again in F2013, which would lift EPS by $0.04 and enhances earnings growth by roughly 4%.

Marché Adonis/Phoenicia acquisition – Metro’s first ethnic venture – could add up to $0.03 to EPS in F2012. In October, Metro announced a 55/45 partnership agreement with Marché Adonis/Phoenicia, an established independent ethnic food retailer with four stores (one more scheduled to open shortly on Montreal’s south shore) located in Montreal that specialize in fresh and Mediterranean products and prepared meals. Net


25 January 2012 78

revenues (after intercompany eliminations) were approximately $200mn – the highest sales productivity Metro has seen for any food retailer. The Adonis stores average 35k square feet with a much heavier skew to fresh sales than a typical grocery store which is believed to generate margins above Metro’s consolidated average. Through this partnership, Metro will own 55% of the Marché Adonis retail operations and its distributor Phoenicia Products.

While this is not a large acquisition it serves several purposes: 1) it provides Metro with access to ethnic food learning that can be applied to its existing store base, 2) it provides Metro with a modest, high-margin new store growth vehicle; Metro plans to open 1-2 new Adonis stores per year in Ontario or Quebec building toward 12-15 locations within five years; 3) it should serve as a slight offset to the sales and earnings drain of Wal-Mart’s Quebec roll-out. The founders will continue to operate the business with Metro providing Adonis with capital to pursue growth and cost savings to enhance profitability where possible. The purchase price was not disclosed. More details will be disclosed as part of the F2Q12 quarterly release.

Pending fresh produce warehouse union contract. Metro is in the midst of completing an early renegotiation of the union contract at it fresh produce warehouse in Quebec with plans to upgrade that facility if it gets the necessary labour concessions.

Eased expense drain as Metro laps Dunnhumby and Metro & Moi start-up costs. Metro will begin to lap extraordinary expenses from the Dunnhumby joint venture start-up and fall 2010 loyalty program roll out in Quebec starting in 1Q12, which should ease y/y SG&A expense growth. Separate from the launch costs Metro has issued $26mn of coupon savings to its 1mn members this year, which if fully redeemed equates to a 25bps expense drain, or in isolation a $0.25 per share EPS investment in F2011.

Roll-out of the fresh produce initiative in F2012 which has been implemented at only 105 of Metro’s 570 or so stores (25 stores in Quebec, 80 stores in Ontario) so far with strong sales gains in the test stores. The fresh initiative involved an extensive reworking of Metro’s fresh supply chain management (e.g., from push to pull system in Ontario), merchandise offering (e.g., 20% to 25% more SKUs, streamlined grades) and in-store presentation of fresh produce (new tables which carry less stock with improved turns).

The Dunnhumby loyalty program – Metro demonstrated its agility and desire for innovation by establishing a Canadian joint venture with Dunnhumby, an industry leader in database management/marketing and loyalty program development in November 2009. Dunnhumby’s experience and sophistication in this area has been developed over many years of working with such leading food retailers as Tesco and Kroger which have achieved significant sales and profit improvement through their work with Dunnhumby, while managing to share the costs with major suppliers. In Kroger’s case it was able to generate sufficient support from its supplier base to cover all of the programs run rate costs within 2-3 years of the program’s startup. As Metro enters F2012, it is now two years into the start-up of the program, having rolled out its proprietary loyalty program, “Metro & Moi” in Quebec in fall 2010. Metro will lap these extraordinary expenses which should ease its drain on earnings growth while it works its way to breakeven through supplier funding over the next 1-2 years. The Metro & Moi program is now up to 1mn members.


25 January 2012 79

Figure 82: Metro Financial Performance Summary

f2009 f2010 2011A f2012e f2013e

Revenue ($ Millions) $11,196 $11,343 $11,431 $12,069 $12,020

Total Revenue Growth (%) 4.4% 1.3% 0.8% 5.6% -0.4%

Square Footage Growth (%) 1.5% 1.9% 0.4% 0.6% 1.0%

Company Reported Food Inflation (%) 2.8% -1.5% 0.2% 1.1% 0.6%

Same Store Sales Growth (%) 4.2% -0.5% 0.9% 1.5% 1.0%

Gross Margin 17.7% 18.3% 18.4% 18.2% 18.4%

SG&A as a % of Revenue 11.3% 11.7% 11.8% 11.7% 11.7%

Retail EBITDA Margin 6.4% 6.6% 6.6% 6.5% 6.6%

Gross Margin Variance 61 bps 58 bps 10 bps -14 bps 15 bps

SG&A Variance 2 bps 38 bps 12 bps -9 bps 5 bps

Retail EBITDA Variance 59 bps 20 bps -2 bps -5 bps 10 bps



Free Cash Flow ($ Millions, After Capex/WC, LTM) $226 $313 $316 $294 $261

Return on Equity 16.6% 16.2% 16.2% 16.0% 15.7%

Return on Invested Capital 11.8% 11.8% 12.1% 12.4% 12.4%Source: Company Reports, Barclays Capital estimates.

Risks Metro is exposed to margin risk driven by increased price/promotion intensity. Factors

that exacerbate this risk include a slowing economy, high unemployment, above-average food commodity inflation and unsustainable square footage growth in the hard discount segment as Wal-Mart builds out its Supercenter stores.

There is also risk of failed union contract negotiations that could delay expected savings, which the company may need to offset increasing competitive pressures.


25 January 2012 80

COMPANY SNAPSHOT

Metro Canadian Consumer & Retail

Income statement ($mn) 2011A 2012E 2013E 2014E CAGRRevenue 11,431 12,069 12,020 12,351 2.6% Stock Rating 2-EQUAL WEIGHTEBITDA 794 830 844 890 3.9% Sector View 2-NEUTRALEBIT 603 631 646 688 4.5% Price (20-Jan-2012) $51.58Pre-tax income 562 588 604 646 4.8% Price Target $54.00Net income 406 424 436 466 4.8% Ticker MRU-A.TOEPS (reported) ($) 3.92 4.29 4.62 5.15 9.5%Diluted shares (m) 104 99 94 91 -4.3% Investment case


Margin and return data (%) AverageEBITDA margin 6.9 6.9 7.0 7.2 7.0EBIT margin 5.3 5.2 5.4 5.6 5.4Pre-tax margin 4.9 4.9 5.0 5.2 5.0Net margin 3.5 3.5 3.6 3.8 3.6ROIC 12.1 12.4 12.4 13.0 12.5ROE 16.2 16.0 15.7 16.1 16.0 Upside case $60

Balance sheet and cash flow ($mn) CAGRTangible fixed assets 1,321 1,337 1,365 1,388 1.7%Cash and equivalents 256 - - - NATotal assets 4,959 4,789 4,884 4,989 0.2%Short and long-term debt 1,035 700 672 614 -16.0%Total liabilities 2,391 2,095 2,080 2,051 -5.0%Net debt/(funds) 779 700 672 614 -7.6% Downside case $43Shareholders' equity 2,568 2,727 2,838 2,971 5.0%Change in working capital (25) 13 (7) (1) NAOperating cash flow 542 593 578 616 4.4%Capital expenditure 148 215 225 225 14.9%Free cash flow 393 378 353 391 -0.2%

Valuation and leverage metrics AverageP/E (x) 13.2 12.0 11.2 10.0 11.6 Upside/downside scenarios

EV/EBITDA (x) 7.7 7.0 6.6 5.9 6.8 FCF yield (%) 7.4 7.4 7.3 8.4 7.6Price/sales (x) 0.5 0.4 0.4 0.4 0.4 Price/BV (x) 2.1 1.9 1.7 1.6 1.8 Dividend yield (%) 1.5 1.7 2.0 2.3 1.9Total debt/capital (%) 28.7 20.4 19.1 17.1 21.4Total debt/EBITDA (x) 1.3 0.8 0.8 0.7 0.9

Selected operating metricsSame store sales growth (%) 0.9 1.5 1.0 2.0 1.3 Source: FactSet

Square footage growth (%) -0.2 0.6 1.0 1.0 0.6 Same Store Sales vs. Sq. Ft. GrowthInventory growth (%) 4.1 2.0 2.0 2.8 2.7Capex/sales (%) 1.3 1.8 1.9 1.8 1.7

Source: Company data, Barclays Capital Note: FY end Sept.

Wal-Mart's Quebec SuperCenter buildout takesmarket share from Metro and increases promotionalintensity even further, straining margins. Ourdownside case would be a P/E multiple of 10x ourF2012 EPS estimate.

Metro consistently delivers earnings growth and mid-teens ROE, despite challenging market conditions.We believe Metro has sufficient revenue growth andcost savings initiatives for 2012 to deliver forecastearnings growth despite WMT's Supercenter rolloutin Quebec. Our target is based on a 12.5x PE on ourF2012 EPS estimate.

Metro successfully passes on COGS inflation whilemaintaining market share vs. Wal-Mart'sSuperCenter buildout in Quebec. Our upside casewould be a P/E multiple of 14x our F2012 EPSestimate.

-1%

0%

1%

2%

3%

2011A 2012E 2013E 2014E


$43(-16.6%)

DownsideCase

$56(8.5%)

PriceTarget

$60(16.3%)

UpsideCase

21

31

41

51

61

71

1/27/2011 1/20/2012

$43(-16.6%)

DownsideCase

$54(4.6%)

PriceTarget

$60(16.3%)

UpsideCase

21

31

41

51

61

71

1/27/2011 1/20/2012


25 January 2012 81



25 January 2012 82

EMPIRE COMPANY

Empire Co., Ltd.(EMP-A.TO): Quarterly and Annual EPS (CAD)

2011 2012 2013 Change y/y

FY Apr Actual Old New Cons Old New Cons 2012 2013

Q1 1.28A N/A 1.26A N/A N/A N/A N/A -2% N/A


Q3 1.36A N/A 1.14E N/A N/A N/A N/A -16% N/A

Q4 1.23A N/A 1.10E N/A N/A N/A N/A -11% N/A

Year 4.98A N/A 4.58E 4.57E N/A 5.10E 5.14E -8% 11%

P/E 11.3 12.3 11.1




We are initiating coverage of Empire Company (EMP-A.TO) with a 2-Equal Weight/2-Neutral rating and a $57 price target, which offers a total potential return of 3% from recent levels. Empire was the second best performer in our food retail coverage in 2011 with a decline of 1% (S&P/TSX -11%). In an environment with little to no volume growth, investors were generally attracted to Sobeys’ industry-leading real CSS growth. However, the shares have fallen nearly 8% since Empire reported its fiscal 2Q12 (October) results on December 15, 2011 (S&P/TSX +8%), as it provided further confirmation of what 4Q11 results are likely to be for the group – greater gross margin pressure. Although Sobeys has announced a number of productivity/cost reduction initiatives, we are concerned that the benefits may not arrive soon enough to offset the earnings drain during the period of maximum margin risk. At 4.9x forward EV/EBITDA, Empire remains attractively valued relative to Metro (7.4x) and Loblaw’s (6.9x); however, we are concerned that pending margin risk combined with Empire’s relatively thin trading volume will impede the valuation. Our NAV is based on the following: 1) $61.70 at Sobeys (5x our F2013 EBITDA, or 85% of NAV), 2) $7.67 for Crombie based on its current market price of $14.28, and 3) a 10% holding company discount.

Figure 83: Empire Co. Net Asset Value F2012 (April year end) and F2013

f2012E f2013E

$M Multiple Value/sh $M Multiple Value/shSobeys - EBITDA $806 5.00x $59.29 $838 5.00x $61.70Theatres & Other - EBITDA $17 6.50x $1.60 $17 6.50x $1.64Genstar (FFO est.) $17 8.50x $2.08 $17 8.50x $2.12Crombie REIT $6.91 $7.67Gross Value $69.89 $73.13

Less: EMP Debt $1,095 $16.12 $1,098 $16.17Less: Preferreds & Min. Int. $40 $0.59 $37 $0.54Add: EMP Cash $638 $9.39 $509 $7.49

Total Net Asset Value $4,251 $62.57 $4,342 $63.91Less: 10% Hold-co Discount $425 $6.26 $434 $6.39

EMP Target NAV / Share $56.31 $57.52

Source: Barclays Capital estimates and Company Reports.

Pending margin risk and Empire’s lower trading volume

may impede valuation

EMP/A CN / EMP-A.TO




Price (20-Jan-2012) CAD 56.43



25 January 2012 83

Empire’s next round of cost reductions is not happening soon enough to offset the increasing challenges of F2H12. Sobeys’ F2Q12 quarterly release on December 15, 2011, which included the month of October, provided investors with a more detailed glimpse of Q4 margin risk. After removing the impact of an accounting change, which was not restated in the prior year, Sobeys’ adjusted gross margin dropped 41bps (-81bps on a reported basis) and that’s just with Thanksgiving in the quarter. Sobeys, consistent with Metro’s commentary, has indicated that the competitive environment was getting more promotional as calendar Q4 progressed (Metro Investor day was held November 24) toward December 25. Unfortunately, after a long run of substantial offsets from the completion of several major productivity and efficiency programs (Ontario and West SAP install, Vaughn DC opening), Sobeys’ next round of initiatives doesn’t kick in until toward the end of F2013. While this is well timed to deal with when we estimate the Wal-Mart/Target grocery drain risk will be peaking, we think it may be too late to provide any meaningful offset to the current price/margin risk period. We do note that our preliminary EPS forecast of $0.07 for the pending 250 store Shell gas station/C-store acquisition could reduce Sobeys’ 2012 EPS risk toward the 2011 level.

Sobeys’ next round of productivity/efficiency initiatives are :

1. “Reset” program involves a streamlining of the organization to capture productivity and efficiency opportunities once the Quebec SAP installation is completed in F2013.

2. Quebec SAP installation to be completed by end of F2013 becomes a major enabler to the pursuit of new cost reduction and productivity improvement projects.

3. New, fully automated Quebec distribution center opening by spring 2013 (F4Q13).

4. Target wholesale supply agreement for frozen, dairy and dry grocery products inclusive of branded and Target’s private label products is expected to begin ramping up in 1Q13 with estimated sales potential of up to $400mn.

5. Increased focus on the convenience store operations to drive growth outside of Wal-Mart’s reach – acquisition of 250 Shell Canada gas station/c-stores and the Needs banners revitalization.

Corporate Profile Empire is a holding company with over 85% of its net asset value derived from Sobeys, its wholly owned food retailer. Sobeys is Canada’s second largest food retailer with a national market share of 17%. Sobeys is based in Nova Scotia but has a national presence through a store network of 1,337 corporate and franchised stores. Of the Big 3 Canadian food retailers, Sobeys is the most concentrated in the conventional segment (92% of sales), though it does operate in the hard discount segment under the FreshCo and Price Chopper banners in Ontario. The company also has a food distribution business and will be the dairy and dry grocery supplier for Target’s Canada stores.

Empire owns 40% (diluted) of Crombie REIT (CRR.UT), a commercial real estate trust which predominantly manages grocery-anchored retail properties in which Sobeys is one of the key tenants. Over 78% of Crombie’s rentable space is comprised of grocery- or drug store–anchored shopping plazas, or freestanding grocery stores. Sobeys represents over 36% of rents generated. During F2011, Empire shifted its property development operations into Sobeys through the sales of 12 properties from ECL Properties. The reorganization gives Sobeys direct control over real estate development. As in the past, future

Sobeys’ next round of initiatives doesn’t kick in until toward the

end of F2013


25 January 2012 84

development projects are expected to be anchored by a Sobeys store with the properties sold to Crombie REIT when they are ready for third-party leasing.

Empire also owns 41% of Genstar Development Partnership, a residential development partnership focused in Ontario and Western Canada. Empire Theatres is wholly owned by the company and is Canada’s second largest movie exhibitor with 386 screens in 51 locations.

Other smaller investments and operations consist of Kepec Resources which, through a JV with APL Oil and Gas Ltd., has ownership interests in various oil and gas properties in Alberta.

Empire has a dual share structure with 33.7mn (49.5%) non-voting class “A” shares and 34.3mn (50.5%) class “B” voting shares. The Sobey family controls approximately 89% of the votes through the ownership of the class “B” voting shares. The class “A” shares are treated equally in the case of a takeover offer.

Figure 84: Sobeys store network in Canada

Empire Co. / Sobeys - Store Network Profile

Market Share Revenue EBITDA % Margin

17% $16 bln $846 mln 5.3%

Corporate Franchise Total Primary Banners

Conventional 584 651 1,235 Sobeys, IGA, Foodland, Thiftys

Hard Discount 45 57 102 FreshCo, Price Chopper

Total 629 708 1,337

Square Footage 12.8 mln 15.8 mln 28.7 mln

Owned square footage 14.8%Source: Company Reports, Barclays Capital estimates

Growth Strategy & Outlook: Sobeys has implemented a significant number of productivity and efficiency initiatives that enhanced earnings power and allowed it to maintain a competitive price position. Since the acquisition of Oshawa Foods (a large, but least-in-class retailer) in December 1998, Sobeys has been working diligently to improve the productivity and efficiency of its operations with the expectation that it would potentially need to reinvest the benefits of these efforts into sustaining, or improving its competitive price position. These productivity and efficiency initiatives involved an extensive ten-year banner consolidation program (from 22 banners to six), benchmarking and operational best practices implementation, a regional rollout of the SAP enterprise system which started in fiscal 2006 and is expected to be completed by fiscal 2013 (started in Ontario, then moved to the West and is now midway through a Quebec rollout) and the opening of Canada’s first fully automated distribution centre in fiscal 2010 which is being followed by the opening of a similar facility in Quebec in fiscal 2013. Sobeys has invested more than $2bn over the last five years in the store and distribution network, which has allowed it to achieve best-in-class results on these critical assets through a balanced deployment of the benefits into price as necessary, or to earnings.

Sobeys has invested more than $2bn over the last five years in

the store and distribution network


25 January 2012 85

Sobeys’ major initiatives have included:

1. An extensive seven-year store upgrade/expansion and banner rationalization program was largely completed in F2011 – over 75% of the network is to standard. Sobeys has significantly rationalized the number of banners it operates, disposing of 16 banners since 2000. The rebannering/upgrade program has provided Sobeys with a significantly simplified network of banners and newer/larger stores that are more productive and cost effective. As shown in Figure 85, Sobeys’ total square footage has increased approximately 9% over the last five years, while total store count has remained fairly stable.

Figure 85: Sobeys’ total sq. ft. has grown while store count has remained flat

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Sobeys’ total square footage has increased approximately 9%

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Source: Company reports

The banner realignment initiative included the rollout of the Sobeys banner into Ontario and Western Canada (replaced IGA Extra) and the conversion of the Sobeys banner to IGA Extra in Quebec complementing its already extensive network of smaller IGA stores. The final piece of the national banner streamlining was put in place in F2001 with the conversion of the IGA franchise agreement to the new Foodland program that caters to smaller communities in Ontario. The IGA legacy agreement was known to have been too favourable to the franchisees economically and operationally, making Sobeys’ Ontario market profitability inadequate.

In F2010, Sobeys tackled the remaining weak link in its store network with the launch of the new FreshCo discount banner. The FreshCo banner was designed to replace the underperforming Price Chopper discount banner in Ontario (~60 stores). The FreshCo banner was differentiated versus the established discount players by promising customers “Fresher. Cheaper”. The conversion rollout was completed over a 12-month period with aggressive grand opening price points to ensure the new banner achieved improved sales productivity versus the underperforming Price Chopper stores. We believe the conversion program has been successful and that the proposition should be defendable. There are currently 64 FreshCo stores in Ontario.

Management now views the core food retailing banners as Sobeys, IGA, IGA extra, Thrifty Foods, Foodland and the new FreshCo. Banner. If the FreshCo stores sustain improved performance we believe that Sobeys may be consider converting the Price chopper stores in Atlantic Canada and then possibly testing them in Western Canada and Quebec. The drawback would be entering as the third player in the market with less store presence.


25 January 2012 86

Figure 86: Sobeys Store Network

Atlantic Quebec Ontario Prairies BC

Sobeys (82) IGA Extra (107) Sobeys (102) Sobeys (105)

Foodland (41) IGA (163) Foodland (152) IGA (50)Conventional Thriftys (27)

DiscountPrice Chopper

(20)FreshCo. (64)

Source: Company reports.

2. Ontario/West business process and IT system upgrades continue to deliver benefits with Quebec on track for F2013 completion: Following the acquisition of Oshawa Group, Sobeys operated a number of different regional legacy information systems and different franchise practices across the country. Following a successful revamping of the IT platform plan in Atlantic Canada, Sobeys began upgrading the IT infrastructure in Ontario in F2006 and then in Western Canada in F2007. These projects were completed in F2007 and F2008. Following each of these implementations, Sobeys achieved some immediate cost savings from headcount reduction and, over time, improved productivity. The Quebec transformation is currently under way with completion expected by 2013, marking the end of a long cautiously implemented systems upgrade. Commensurate with banner rationalization and the IT systems upgrade process Sobeys has also implemented a shared best practices program which has been rolled out across the regions.

3. More recently, Sobeys has begun to add several SAP-enabled productivity tools to improve productivity and lower costs that are expected to impact 2H12 and F2013 such as:

Workforce Management – allows Sobeys to draw upon past shopping behaviour to optimize service levels and control labour costs.

Fresh Item Management – helps reduce shrink and enhances consistency and quality of fresh offering.

Computer Assisted Ordering – forecasting system that helps manage inventory more precisely and improve in-stock performance.

4. Distribution and supply chain upgrades: In F2010, Sobeys opened a state-of-the-art fully automated distribution centre in Vaughan, Ontario. The launch was touted as being highly successful with no reported issues despite the significant technological advancements employed. More importantly, the new automated DC resulted in significant productivity improvements and reduced costs due to lower labour requirements. As a result of the Vaughan DC’s success, Sobeys committed to building a similar facility in Quebec which is expected to open in early F2013. We suspect the same technology will eventually be deployed in Western Canada.

Unfortunately, Empire’s next round of cost reductions is not happening soon enough, or in a material enough way to offset the mounting challenges of 2012:

Unfortunately, after a long run of substantial offsets from the completion of several major productivity and efficiency programs (Ontario and West SAP install, Vaughn DC opening), Sobeys’ next round of initiatives doesn’t kick in until toward the end of F2013 which is well aligned with when we see the Wal-Mart/Target grocery drain risk peaking but too late to provide any meaningful offset to the current price/margin risk period.


25 January 2012 87

1. “Reset” program involves a streamlining of the organization to capture productivity and efficiency opportunities. In mid-October 2011 Sobeys implemented a more streamlined organizational structure that is expected to result in the elimination of functional overlap/redundancy starting in F2013. Sobeys will have two business units: Quebec (IGA - mostly franchised) and Sobeys multi-format versus the previous four regions (Atlantic, Quebec, Ontario and the West) and two business units (Thrifty’s and Lawtons). We expect administrative savings within the next 6-9 months but the larger benefits are not expected for at least another 12-24 months with the major savings occurring in F2014 following the completion of the Quebec SAP installation.

2. Quebec SAP installation to be completed by end of F2013 which brings the entire Sobeys organization onto the same IT platform for the first time. This becomes an enabler for Sobeys to pursue a number of cost reduction and productivity improvement projects that will be outlined as part of the new “Reset” initiative.

3. New, fully automated Quebec distribution center to be operational by spring 2013.

4. Target wholesale supply agreement for frozen, dairy and dry grocery products inclusive of branded and Target’s private label products. We expect shipments will begin in earnest in Sobeys F3Q13. We estimate that once fully ramped Sobeys could achieve annual wholesale revenues from the agreement of at least $400mn.

5. Sobeys convenience store strategy is evolving with the acquisition of 250 Shell Canada gas station/c-store locations in Quebec (80%) and Atlantic Canada (20%). A little over a year ago Sobeys announced that it was initiating a major store renovation program for its126 store Needs C-store business in Atlantic Canada. Now it has announced the acquisition of 250 Shell locations, mostly based in Quebec. We estimate these stores could generate annualized sales of approximately $700mn and EPS of $0.07. These locations will be synergistic with Sobeys’ existing C-store wholesale and retail operations in Quebec and the Atlantic. It will also leverage IGA and Shell’s participation in the Air Miles loyalty program through cross-promotional opportunities.

Sobeys is the leading Conventional segment retailer in Canada. Sobeys is the leading conventional segment retailer in Canada with an estimated market share of almost 40%, or 30% if we include independent retailer sales. Sobeys’ store network is the most heavily skewed to the conventional segment of the “Big 3” with over 92% of system sales in the segment compared to 32% of Loblaw’s sales and 64% of Metro’s.


25 January 2012 88

Figure 87: Conventional Segment Market Share – Major Food Retailers

Atlantic Quebec Ontario West CanadaEmpire 84% 48% 31% 31% 39%

Loblaw 16% 20% 46% 4% 23%

Metro 0% 32% 22% 0% 16%

Safeway Canada 0% 0% 1% 44% 15%

Overwaitea 0% 0% 0% 12% 4%

Other Major Grocers 0% 0% 0% 9% 3%

Conventional - Majors only 100% 100% 100% 100% 100%

Total Conventional 44% 48% 50% 58% 52%Unaffiliated Independents 18% 15% 13% 5% 11%

Total Discount 37% 29% 35% 47% 38%Total CDN Grocery retail 100% 100% 100% 100% 100%

Source: Company reports, Barclays Capital estimates.

Sobeys has performed relatively well despite challenging market conditions over the past three years. Over the past five years, despite discount sales growth dramatically outpacing conventional segment growth, Sobeys has been able to adapt pricing and promotion activity as necessary to sustain its appeal with a cash-strapped consumer and defend its market position despite aggressive square footage growth in the discount segment which has increased competitive price intensity. Sobeys has been able to lower prices, as needed, funded predominantly by the savings and productivity gains it has achieved through the programs outlined above. Over the past 12 quarters Sobeys has achieved some of the strongest results in the group, although there has been a noted relative deterioration over the past year.

Figure 88: Sobeys has generated consistent, industry-leading real CSS

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Loblaw Metro Sobeys



25 January 2012 89

Figure 89: Canadian Food Retailer EBITDA Margins

4.0%

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Loblaw Metro Sobeys


Over the long term, being a big fish in the smaller pond may prove to be a good place to be as an aging population’s preference for smaller, conveniently located stores drives demand. Although Sobeys’ near-term relative performance has weakened, we attribute a significant portion of this to the extraordinary challenges the sector is facing. Over the longer term, we believe that Sobeys’ primary focus on the conventional segment could prove to be an acceptable default strategy as it could be the dominant player in a proportionately smaller segment with less direct competition. As the table below shows, as Wal-Mart’s Supercenter expansion phase in the United States draws to a close, the Chain Supermarket segment (conventional stores) has lost almost seven share points over the past 10 years, but its dollars sales have increased at a 2.7% CAGR. One additional factor to consider is that over the next ten years we could see a meaningful change in shopping habits by the aging baby boomer population as it moves toward retirement. Studies suggest that aging shoppers have shown a tendency toward smaller stores that are conveniently located.

Figure 90: US Grocery Industry Sales – Segment trends 2000 - 2010

Grocery Industry Sales (US$B) Market Share2000 2010 CAGR 2000 2010 Pt Var

Chain Supermarkets $261 $339 2.7% 67.1% 60.2% -6.9Economy Formats $54 $165 11.9% 13.9% 29.4% 15.5Independent Supermarkets $70 $31 -8.0% 18.1% 5.5% -12.7Other $4 $28 22.7% 0.9% 5.0% 4.0All Grocery sales $388 $563 3.8% 100.0% 100.0% 0.0

Source: TD Linx, Progressive Grocer, Barclays Capital estimates

Genstar – 2012 rebound in demand will help but margins are under pressure. Empire owns 41% of Genstar which is a residential housing development company focussed primarily on development in Western Canada. At only 2% of Empire’s NAV, Genstar’s performance does not typically move the needle on Empire’s valuation. Canada’s strong housing market has supported generally favourable earnings trends at Genstar with the exception of the pullback in 2008-2009 and more recent trends. Given the decline in single unit starts over the past year it has not been a surprise that Genstar’s results have weakened. Single unit starts (LTM) in Alberta are down approximately 14% as of December 2011. CMHC is forecasting a strong recovery of 15% in 2012. Lower oil prices and the lowest migration growth in Alberta in over 15 years cooled demand for homes in 2011. CMHC expects demand to improve in 2012 aided by a rebound in oil prices and related job creation. Given recent developments in the economic outlook we are not as optimistic

Aging shoppers shop smaller, closer to home


25 January 2012 90

about the degree of rebound in Alberta. Margin pressure is expected to continue even if demand improves as Genstar cycles into the development of more expensive properties. Over the past 10+ years Genstar has cycled through significantly lower cost land purchases made prior to Alberta’s housing boom. As these inventories have been used, Genstar has been accumulating land at higher costs, which is currently impeding margins given weakened housing demand and a related constraint to higher sale prices. We believe a cautious forecast stance is warranted.


25 January 2012 91

Figure 93: Empire Financial Performance Summary

GAAP GAAP IFRS IFRS IFRS

F2009 F2010 2011A 2012F 2013F

Total Revenue ($ Millions) $15,016 $15,519 $15,960 $16,125 $16,321

Total Revenue Growth (%) 3.3% 2.8% 1.0% 1.2%

Sobeys Revenue ($Millions) $14,765 $15,243 $15,750 $15,912 $16,103

Sobeys Revenue Growth (%) 7.2% 3.2% 3.3% 1.0% 1.2%


Same Store Sales Growth (%) 5.2% 1.9% 0.2% 1.5% 0.2%

Other Revenue ($Millions) $251 $276 $210 $214 $218

Other Revenue Growth (%) 9.7% -23.7% 1.7% 3.7%

Sobeys Gross Margin 23.9% 23.8% 24.2% 23.8% 24.0%

Sobeys SG&A as a % of Sobeys Revenue 19.0% 18.9% 18.9% 18.8% 18.8%

Sobeys EBITDA Margin 4.9% 5.0% 5.3% 5.1% 5.2%

Sobeys Gross Margin Variance -8 bps 44 bps -36 bps 20 bps

Sobeys SG&A Variance -11 bps 34 bps -10 bps 5 bps

Sobeys EBITDA Variance 24 bps 4 bps 10 bps -26 bps -11 bps

Total EBITDA Margin 5.2% 5.2% 5.0% 5.1% 5.3%

Total EBITDA Variance -26 bps 0 bps -17 bps 5 bps 10 bps



Free Cash Flow (OCF ex WC/Capex) $229 $343 $133 -$69 $247

Return on Equity 4.7% 4.8% 5.2% 4.7% 5.0%

Return on Invested Capital 7.4% 7.8% 10.9% 7.8% 8.0%Source: Company Reports, Barclays Capital estimates. Note: Growth rates/ variances comparing 2011/ 2010 use GAAP figures, while 2010 raw figures are presented in IFRS

Figure 91: Single Unit Alberta Housing Starts, All Centres 10k+,LTM

Figure 92: Calgary Home Price Index

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Y/Y Growth (Right Axis)

Source: CMHC Source: NB Teranet House Price Index


25 January 2012 92

Risks Empire is exposed to margin risk driven by increased price/promotion intensity. Factors

that exacerbate this risk include a slowing economy, high unemployment, above-average food commodity inflation and unsustainable square footage growth in the hard discount segment as Wal-Mart builds out its Supercenter stores.

The company’s investments in residential real estate (Genstar Partnership) exposes it to the Canadian housing market and could impact earnings should the housing market further deteriorate.

Upside risk to our valuation could be driven by greater-than-expected cost savings from the first round of Empire’s new Reset program expected to be announced as part of Empire’s 4Q12 release which could increase our comfort with Sobeys margin risk offsets.


25 January 2012 93

COMPANY SNAPSHOT

Empire Canadian Consumer & Retail

Income statement ($mn) 2011A 2012E 2013E 2014E CAGRRevenue 15,957 16,114 16,310 17,295 2.7% Stock Rating 2-EQUAL WEIGHTEBITDA 814 817 870 932 4.6% Sector View 2-NEUTRALEBIT 477 474 510 561 5.6% Price (20-Jan-2012) $56.43Pre-tax income 561 467 491 543 -1.1% Price Target $57.00Net income 401 322 342 382 -1.6% Ticker EMP-A.TOEPS (reported) ($) 4.98 4.58 5.10 5.81 5.3%Diluted shares (m) 68 68 67 66 -1.2% Investment case


Margin and return data (%) Average

EBITDA margin 5.1 5.1 5.3 5.4 5.2EBIT margin 3.0 2.9 3.1 3.2 3.1Pre-tax margin 3.5 2.9 3.0 3.1 3.1Net margin 2.5 2.0 2.1 2.2 2.2ROIC 10.9 7.8 8.0 8.8 8.9ROA 6.2 4.8 4.9 5.2 5.3 Upside case $63.00ROE 5.2 4.7 5.0 5.3 5.0

Balance sheet and cash flow ($mn) CAGR

Tangible fixed assets 2,398 2,675 2,815 2,945 7.1%Intangible fixed assets 449 446 446 446 -0.3%Cash and equivalents 616 385 509 705 4.6%Total assets 6,477 6,723 6,999 7,401 4.5%Short and long-term debt 1,140 1,104 1,104 1,104 -1.0% Downside case $52.00Total liabilities 3,309 3,290 3,212 3,250 -0.6%Net debt/(funds) 524 720 596 399 -8.7%Shareholders' equity 3,168 3,391 3,662 3,943 7.6%Change in working capital 8 (78) (0) 23 40.4%Operating cash flow 687 631 747 818 6.0%Capital expenditure 554 700 500 500 -3.4%Free cash flow 133 (69) 247 318 33.9%


Valuation and leverage metrics Average

P/E (x) 11.3 12.3 11.1 9.7 11.1

EV/EBITDA (x) 5.4 5.6 5.0 4.4 5.1 FCF yield (%) 3.4 -1.8 6.5 8.6 0.0 Price/sales (x) 0.2 0.2 0.2 0.2 0.2 Price/BV (x) 1.2 1.1 1.0 0.9 1.1 Dividend yield (%) 1.6 1.6 1.8 1.8 0.0 Total debt/capital (%) 26.5 24.6 23.2 21.9 0.2 Total debt/EBITDA (x) 1.4 1.4 1.3 1.2 1.3

Source: FactSet

Selected operating metrics Same Store Sales vs. Square Ft. GrowthSame store sales growth (%) 0.2 1.5 0.2 0.7 0.6

Square footage growth (%) 2.1 2.0 1.5 1.5 1.8Inventory growth (%) -7.9 -1.2 0.7 5.9 -0.6Capex/sales (%) 3.5 4.3 3.1 2.9 3.4

Source: Company data, Barclays Capital Note: FY end Apr.

Sobeys has had industry leading SSS and squarefootage growth over the past year. Productivity andcost savings initiatives are expected to support EPSgrowth; however, the benefits may not materializesoon enough to help offset near-term gross marginpressures. Our target is based on an NAV whichincorporates a 5x EV/EBITDA on Sobeys.

Promotional intensity eases and the company is ableto pass along COGS inflation and expand marginsthrough its concentration in conventional grocerystores. Applying a 5.5x EV/EBITDA on Sobeys wouldyield an Upside case of $63.

Competition continues to increase the level ofpromotional activity, shrinking margins. Residentialreal estate declines, lowering the income of theGenstar Development Partnership. Applying a 4.5xand 7x multiple on Sobeys and Genstar, respectively,generates a Downside case of $52.

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25 January 2012 94

NORTH WEST CO.

North West Co., Inc.(NWC.TO): Quarterly and Annual EPS (CAD)

2011 2012 2013 Change y/y

FY Jan Actual Old New Cons Old New Cons 2012 2013





Year 1.43A N/A 1.23E 1.21E N/A 1.32E 1.34E -14% 7%

P/E 14.0 16.2 15.1


Consensus figures are from Thomson Reuters

Recommendation & Valuation – a fairly valued defensive investment

We are initiating coverage of North West Co. (NWC.TO) with a 2-Equal Weight/2-Neutral rating and $20 price target. Our price target provides a total potential return of 5% from current levels, including NWC’s dividend yield of 4.8%. Our 12-month price target of $20 is supported by an 8.5x EV/EBITDA multiple applied to our F2013 (January) earnings forecast, which has an implied P/E valuation of 15x. These valuation multiples carry a premium to the Metro and Empire of 40% on an EV basis and 30% on a P/E basis, which we feel adequately reflects NWC’s superior defensive characteristics while recognizing the company’s near-term earnings growth constraints.

The shares are trading at an EV/EBITDA multiple of 8.2x which is above NWC’s long-term average of 7.7x on consensus earnings and at a 34% premium to the average for Metro/Empire of 6.1x, which is in line with NWC’s historical premium to these peers. We are forecasting EBITDA growth of only 1.5% for NWC this year and 5.4% next year. As NWC struggles with profit pressures at Giant Tiger and Cost-U-Less while digesting new initiative costs we do not believe the shares warrant a higher valuation multiple. NWC is pursuing corrective action and implementing initiatives to improve the earnings power of its core food business, but these efforts will take time.

Figure 94: North West Company EV/EBITDA Valuation Range

f2013E f2014E CommentsBarCap est BarCap est

EBITDA ($M) $122 $134 $142 $130 $141 $150y/y growth -5% 5% 11% -3% 5% 12%

EV/EBITDA Multiple7.0x $14 $16 $17 $15 $17 $187.5x $15 $17 $19 $17 $18 $20 <=== NWC LT Average8.0x $17 $19 $20 $18 $20 $218.5x $18 $20 $21 $19 $21 $23 Barcap valuation multiple9.0x $19 $21 $23 $21 $23 $249.5x $20 $23 $24 $22 $24 $26

10.0x $22 $24 $26 $23 $26 $27Source: Company Reports, Barclays Capital estimates. EBITDA range is for illustrative purposes only.

Our forecast is for 1.5% EBITDA growth this year; 5.4% next year

NWC CN / NWC.TO




Price (20-Jan-2012) CAD 19.95



25 January 2012 95

Corporate Profile: North West Co. – Canada’s retailer to the north Established in 1668, the North West Company is one of Canada’s oldest companies and is the leading retailer to remote/underserved rural and urban markets in Northern Canada, Western Canada, rural Alaska, and the South Pacific/Caribbean with population bases from 500 to 7,000 people. These small, remote markets and unique logistics requirements provide NWC with above-average barriers to entry. NWC offers a broad range of products (food, general merchandise) and services (e.g., post offices, tax returns, cheque cashing, money transfers) with grocery sales representing 76% of sales through several formats and banners (e.g., Canada: Northern-126, Northmart-7; Alaska: AC Value centers-30, Pacific/Caribbean: 12 Cost-U-less stores).

Figure 95: North West Company Corporate Profile

North West Co. - Store Network Profile

Grocery Mkt. Share Revenue EBITDA % Margin Stores

<1% $1.4 bln $130mln 9.3% 233

Canada US Other Total Primary Banners

Food Focused 133 30 - 163 Northern, AC Value

General Merch. Focused 34 - 12 46 Giant Tiger, Cost-U-Less

Other 19 4 1 24Includes Art, Fur, Pharmacy, Convenience, and Food Distributor stores

Total 186 34 13 233

Retail Square Footage 1.5 0.3 0.3 2.1 mln

Owned stores 58%


North West Company converted from an income trust structure back to a corporation in January 2011. Partly due to a relatively conservative payout ratio, NWC was able to establish its annual dividend at an after tax value that has maintained an attractive yield of 4.8%. Several well-known attributes of the company’s markets have made it a go-to defensive name over the past five years:

High barriers to entry and low price elasticity. NWC’s primary customer base is located in remote markets in the northern parts of Canada’s provinces and Alaska. Many of its markets can be as small as 500 people, requiring unusual distribution approaches to deal with extended harsh winter conditions. This limits inroads by competitors and allows NWC to pass on COGS inflation with more certainty than a typical retailer.

Population growth at nearly twice the rate of more populated markets. NWC’s organic growth capacity is aided by forecast average population growth of 1.3% versus 0.7% in the rest of Canada (source: StatsCan population forecast estimates).

Resource development is supporting above-average local market growth. Mine exploration/development and related resource royalties have bolstered spending capacity in many remote markets.

More than 75% of sales are in grocery products, providing investors with relatively stable earnings/cash flow support to dividends.

NWC is a modest-growth company offering investors relatively stable earnings and an above-average yield (currently 4.8%) versus other food retailers, supported by its core Canadian and Alaskan operations. The company has attempted to enhance growth

NWC has been a go-to defensive name over the past five years


25 January 2012 96

prospects through the rollout of franchised Giant Tiger stores (starting in 2001) in western Canada and through the 2007 acquisition of Cost-U-Less (a Pacific Island warehouse club style retail format), with mixed results partly due to the prolonged economic slowdown.

Over the past five years, NWC has been able to materially improve its food performance, which represents the majority of sales (72% in Canada; 86% in International Operations), through better sourcing, increased private label and improved store-level capabilities (best practices and new technology). This has been augmented by the opportunistic addition of complementary everyday products and services such as financial services, post offices, fuel and pharmacies. Modest new store growth has been achieved by acquiring independent stores in northern Canada and Alaska, Giant Tiger store growth in western Canada (from 20 to 34) and the acquisition of Cost-U-Less (CUL) in late 2007.

Growth Strategy & Outlook – More growth “in store” Like many retailers that are facing the prospect of slowed consumer demand, NWC has shifted its earnings growth focus toward improving the productivity and efficiency of core operations while working to improve the profitability of the underperforming Giant Tiger and CUL operations. Productivity opportunities include improved labour scheduling, reduced energy usage and reduced inventory shrinkage. NWC’s major initiatives include:

1. Improve perishable food performance (produce, meat, chilled and frozen foods). NWC started its produce improvement program in 2010 with new assortment and waste management plans following an extensive review of past practices and products. It has achieved good results on a reduced produce assortment and is now working on the meats program (shelf ready), with plans to work on food service next year. The company expects to see a sales lift of more than $3mn this year from these initiatives.

2. Optimize in-stock position and shrink – As with many retailers, the company’s efforts at maintaining consumer-friendly in-stock positions to maximize sales and keeping shrink at acceptable levels are ongoing battles. In 2010, as part of the company’s increased focus on getting better returns out of its existing assets, NWC initiated a major by-store push on these two measures. After just six months, NWC was achieving material improvement in its in-stock positions as it continued to roll the initiative out to the rest of the northern store network and it has targeted a 92% in-stock rate with management bonuses tied to achievement. It has also made significant progress on better shrink control over the past year.

3. Increase store team stability – Recognizing the performance benefits of maintaining strong management teams in one location for extended periods of time, NWC has made a concerted effort to encourage greater longevity in its store management teams, which has involved incentives, better pay and more extensive training. This program will take several years to establish its success.

4. Build supply chain advantage – NWC is on track with planned savings and operational improvements but this year’s savings were reinvested into Nutrition North as part of the program agreement. Its aspirational intentions of leveraging its logistics skills as a third-party provider will take time to explore.

Fixing the problems: Giant Tiger (GT) and Cost-U-Less (CUL)

These two newer businesses were supposed to be growth contributors. Instead they have become a drain to growth and returns as the weak economy, Wal-Mart’s Supercenter

Productivity opportunities include improved labour

scheduling, reduced energy usage and reduced inventory

shrinkage


25 January 2012 97

rollout in western Canada and poor performing softgoods at GT have eroded sales and profit margins, while CUL is struggling with weakened tourism in its markets.

Giant Tiger – not a quick fix. Giant Tiger’s sales were approximately $285mn in F2011, just under 30% of the Canadian operation’s sales. Although the first 15 locations achieved strong results, the next five were just to plan and the next 14 have done considerably worse. GT’s softgoods business has been struggling for a while now and needs a revamp. As part of its Master franchise agreement, NWC pays GT a fee for general merchandise assortment selection and buying. Industry sources suggest that GT is struggling in the east to a similar degree as it is in the west. It will potentially take 6-12 months for GT to execute a new approach to these categories before we see any material improvement. GT’s food business has also been hurt by Wal-Mart’s Supercenter rollout with 20 of GT’s 35 locations in similar trading areas. Lapping weakened sales and becoming more promotionally aggressive seem like the only solutions to this problem. If NWC doesn’t get a reasonable effort from GT to fix the softgoods problem, we could see the relationship deteriorate further, but a more far-reaching solution feels a ways off yet.

Cost-U-Less – the core problem is weak tourism, which is unlikely to achieve any material improvement for at least another year or longer given worldwide economic circumstances. The good news is CUL is beginning to turn the corner on drained sales and is implementing a number of strategies to improve profits (using Alaskan turnaround as template – expanding food offering to attract non warehouse club customers, opportunity buys). Unfortunately, these elements won’t allow the business to get back to previously expected growth for some time but at least an end to the drain on earnings may be close at hand.

Figure 96: Same Store Sales by Banner

Northern Banners* Giant Tiger Cost-U-Less

Q1 2011 3.2% -1.7% 1.2%

Q4 2010 4.3% -2.1% -1.8%

Q3 2010 5.7% -0.2% -4.1%

Q2 2010 4.8% 1.4% -4.5%

Q1 2010 8.0% 5.3% -5.9%

Q4 2009 2.5% 6.1% -4.9%

Q3 2009 -2.6% 6.9% -3.8%

Q2 2009 -1.2% 3.9% 0.6%

*Includes Northern, NorthMart, and AC Value stores


Investing in the future is constraining immediate term earnings

As they say “timing is everything” and right now North West Company is in the midst of investment spending SG&A and Capex dollars on longer term payback programs that are not expected to generate any meaningful lift in sales, or earnings until at least late next year.

SG&A has ramped up to support several of the company’s strategic initiatives such as a change to incentive programs (transition from a loan program to stock based compensation with significant payouts expected this year in Canada and Alaska), store team recruitment and retention programs, consulting fees to explore the supply chain advantage opportunity and transportation management software expenses.


25 January 2012 98

Higher than usual capex spending expected over the next two years, above the depreciation run rate, is likely to increase depreciation expense. We estimate capex at $54mn for F2012 and expect it could possibly be as high as $65mn in F2013 versus a run rate of $35-$45mn. NWC expects to spend $8-$9mn on upgrading staff housing and replacing two stores that were destroyed by fire versus a more typical run rate of $3-$3.5mn per year, plus $6mn for the opening of a new CUL store in Barbados late next year. IT spending will be higher than usual by $4-$6mn for the implementation of transportation management software which should deliver immediate benefits once installed.

Risks 1. Government policy changes that impact the funding of aboriginal communities.

2. Reduction of resource development in the north. NWC experiences a meaningful lift in sales during the exploration phase of major resource development and a sustained lift if the projects become viable. The aboriginal communities also benefit from the royalties that mining companies pay to access the land.

3. Unseasonable weather that can interfere with NWC’s distribution capability; i.e., warm weather that makes the ice roads inoperable.

4. An upside risk to our valuation could be faster-than-expected earnings recovery at Giant Tiger and/or Cost-U-Less.

Figure 97: North West Company Financial Performance Summary

GAAP GAAP IFRS IFRS IFRS

2009A 2010A 2011A 2012E 2013E

Total Revenue ($M) $1,393 $1,444 $1,448 $1,483 $1,516

growth (%) 30.8% 3.7% 0.3% 2.4% 2.3%

Total Same Store Sales (%) 2.7% 0.1% 2.7% 2.7% 2.3%

Canadian Revenue ($M) $899 $922 $979 $1,022 $1,054 growth (%) 5.5% 2.5% 6.2% 4.5% 3.1%

Canadian Same Store Sales (%) 2.2% 0.8% 4.2% 3.1% 3.1%

International Revenue ($M) $493 $523 $469 $460 $462 growth (%) 133.0% 5.9% -10.2% -2.0% 0.4%

International Same Store Sales (%) 7.3% -1.4% -0.3% 2.0% 1.7%

International GM Same Store Sales (%) 7.9% -15.1% -1.0% -4.9% 0.0%

International Food Same Store Sales (%) 7.1% 0.7% -0.1% 3.1% 2.0%

Total Gross Margin 28.9% 28.7% 28.5% 27.6% 0.0%

Total SG&A as a % of Total Revenue 20.1% 19.7% 20.5% 19.0% 0.0%

Total EBITDA Margin 8.8% 9.0% 8.7% 8.6% 8.9%

Total Gross Margin Variance -17 bps 79 bps 20 bps 0 bps

Total SG&A Variance -42 bps 116 bps -143 bps 0 bps

Total EBITDA Variance -123 bps 24 bps -7 bps -8 bps 25 bps



Free Cash Flow (after WC/Capex) $43 $65 $76 $26 $34

Return on Equity 28.4% 29.1% 24.3% 19.8% 21.7%Source: Company reports, Barclays Capital Note: Growth rates/variances comparing 2011/2010 use GAAP figures, while 2010 raw figures are presented in IFRS


25 January 2012 99

COMPANY SNAPSHOT

North West Company Canadian Consumer & Retail

Income statement ($mn) 2011A 2012E 2013E 2014E CAGRRevenue 1,448 1,483 1,516 1,562 2.5% Stock Rating 2-EQUAL WEIGHTEBITDA 126 128 134 141 4.0% Sector View 2-NEUTRALEBIT 90 91 98 104 4.9% Price (20-Jan-2012) $19.95Pre-tax income 84 85 92 98 5.2% Price Target $20.00Net income 70 59 64 69 -0.5% Ticker NWCEPS (reported) ($) 1.43 1.23 1.32 1.41 -0.3%Diluted shares (m) 49 49 49 49 -0.2% Investment case

Dividend per share ($) 1.42 1.05 1.16 1.27 -3.6%

Margin and return data (%) AverageEBITDA margin 8.7 8.6 8.9 9.1 8.8EBIT margin 6.2 6.2 6.4 6.7 6.4Pre-tax margin 5.8 5.8 6.0 6.3 6.0Net margin 4.8 4.0 4.2 4.4 4.4Payout as % net income 85.5 85.7 87.3 89.9 87.1Payout as % CFO 61.3 64.0 56.5 60.7 60.6 Upside case $22.00Payout as % EBITDA 53.4 39.9 41.7 43.6 44.7

Balance sheet and cash flow ($mn) CAGRTangible fixed assets 260 274 305 318 7.0%Cash and equivalents 31 39 - - NATotal assets 617 659 656 677 3.2%Short and long-term debt 193 203 203 203 1.8%Total liabilities 330 358 367 380 4.8% Downside case $18.00Net debt/(funds) 161 164 209 219 10.7%Shareholders' equity 286 301 289 296 1.1%Change in working capital (0) (16) (2) (5) NAOperating cash flow 113 96 101 106 -2.2%Capital expenditure 37 54 65 50 10.4%Free cash flow 76 26 34 51 -12.2%

Valuation and leverage metrics Average Upside/downside scenarios

P/E (x) 14.0 16.3 15.1 14.1 14.9 EV/EBITDA (x) 9.0 8.9 8.8 8.4 8.8 FCF yield (%) 7.8 2.6 3.5 5.3 4.8Price/sales (x) 0.7 0.7 0.6 0.6 0.6 Price/BV (x) 3.4 3.2 3.3 3.3 3.3 Dividend yield (%) 7.1 5.3 5.8 6.4 6.1Total debt/capital (%) 40.2 40.3 41.3 40.7 40.6Total debt/EBITDA (x) 1.5 1.6 1.5 1.4 1.5

Selected operating metrics Source: FactSet

Same store food growth (%) 2.9 3.5 3.0 3.0 3.1 Same Store Food Sales vs. General Merch.Same store merch growth (%) 1.8 0.3 1.6 2.2 1.5Inventory growth (%) 12.2 13.4 13.3 13.3 13.1Capex/sales (%) 2.6 3.6 4.3 3.2 3.4

Source: Company data, Barclays Capital Note: FY end Jan.

North West Company has superior defensivecharacteristics than other food retailers that deservea premium multiple. The company is focused onbetter in-stock and improving the generalmerchandise business, which will take time. Ourtarget is based on an 8.5x EV/EBITDA multple.

Our upside case reflects a quick turnaround in theGM business with better inventory leading to highersales and stronger margins off of fewer markdowns.In this scenario, we estimate potential 2013E EBITDAto be $138mln and would apply a 9x EV/EBITDAmultiple.

Our downside case reflects further deterioration ofthe GM business with lower sales and margins dueto markdowns. In this scenario, we estimatepotential 2013E EBITDA to be $130mln and wouldapply an 8x EV/EBITDA multiple.

0.0%

1.0%

2.0%

3.0%

4.0%

2011A 2012E 2013E 2014E

Same Store Food Same Store Merch

DownsideCase

$18(-8.76%)

PriceTarget

$20(1.3%)

UpsideCase

$22(11.5%)

9

14

19

24

1/27/2011 1/20/2012

DownsideCase

$18(-9.77%)

PriceTarget

$20(0.2%)

UpsideCase

$22(10.2%)

9

14

19

24

1/27/2011 1/20/2012


25 January 2012 100

Figure 98: SNAPSHOT: North American Drugstore Industry – Canada vs. US

NORTH AMERICAN DRUG RETAIL INDUSTRY

Pharmacy Sales ($CDN M) Market Share Pharmacy Sales ($USD M) Market Share

Drug Store Chains $16,251 70.5% $106,582 40.0%Katz Group $5,380 23.3% Walgreens $43,823 16.5%

Shoppers Drug Mart $4,847 21.0% CVS $38,994 14.6%Jean Coutu $2,381 10.3% Rite Aid $17,086 6.4%

Other $3,644 15.8% Other $6,679 2.5%

Grocery/Mass $2,858 12.4% $52,497 19.7%Wal-Mart $892 3.9% Wal-Mart $15,616 5.9%

Loblaw $354 1.5% Kroger $7,886 3.0%HBC Pharmacies $288 1.2% Safeway $3,695 1.4%

Costco $223 1.0% Target $3,033 1.1%Sobeys (ex Lawton) $82 0.4% Sam's Club $1,781 0.7%

Metro $46 0.2% Costco $1,449 0.5%

Other $974 4.2% Other $19,037 7.1%

Independents/Mail Order $3,942 17.1% $107,316 40.3%

Total $23,051 $266,395Source: NACDS, CACDS, Chain Drug Review, StatsCan, Company Reports, Barclays Est. Note: Based on fiscal year 2010

Canada United States

North American Drug Retail Market Share

Shoppers Jean Coutu Walgreens CVS

12 Months Ending Jan-11 Feb-11 Aug-10 Dec-10National Rx Market share est. 21.0% 10.3% 16.5% 14.6%

Store Count 1,238 389 7,562 7,182Retail Square Footage (mlns) 12.5 2.8 84.5 75.5

Script Volume (mlns) 106 68 695 636

Average store size (sq. ft.) 10,097 7,198 11,174 10,512

Revenue per store ($M) $8.4 $9.7 $8.9 $8.0Front end sales per store ($M) $4.4 $3.6 $3.1 $2.6

Rx sales per store ($ Millions) $4.0 $6.1 $5.8 $5.4Avg. scripts/store (k's) 86 174 92 89

Average script value $46.86 $35.21 $63.25 $61.31

Revenue ($ Millions) $10,376 $2,613 $67,420 $57,345Revenue Growth (3Yr CAGR) 7.0% 15.5% 7.8% 8.3%Total SSS Growth (%) 2.1% 1.6% 1.7% 2.2%

Front-End SSS (%) 2.5% 0.3% 0.5% 0.5%Rx SSS (%) 1.7% 1.9% 2.3% 2.9%

Front End Sales as % of Total 52.0% 37.0% 34.8% 32.0%Generic RX as a % Total RX 55.5% 54.0% - 73.0%

Gross Margin (%) 38.6% 19.9% 28.4% 29.7%EBITDA Margin (%) 11.5% 11.1% 6.7% 9.9%

Operating Margin (%) 8.7% 9.8% 5.1% 8.0%

Capex as a % of Revenue 4.0% 1.7% 1.5% 2.1%*

Net Debt to EBITDA 1.0x 0.7x 0.5x 1.1x*Free Cash Flow ex Capex ($M) $405 $170 $3,146 $2,480*

FCF Yield (%) 4.7% 7.3% 9.1% 5.4%*ROE (%) 14.2% 32.4% 14.8% 9.5%*

ROIC (%) 11.9% 23.8% 14.3% 7.5%*

Source: StatsCan, NACDS, CACDS, Company reports, Barclays Capital estimates *Includes PBM business

Source: NACDS, CACDS, Chain Drug Review, StatsCan, Co. Reports, Barclays Capital est. Note: Based on fiscal year 2010


25 January 2012 101

CANADIAN DRUGSTORE SECTOR OVERVIEW

Canada’s Prescription drug market – A brief overview

Canada is known internationally for its virtually universal healthcare system, which, although not as universal as some Canadians might like it to be, is a very generous, all-encompassing program funded and controlled by the federal and provincial governments. The problem is that government cannot afford the “promise,” as the already rapidly escalating cost of healthcare meets with an aging baby boomer population which threatens to significantly increase the cost of healthcare over the coming decade. Something has to give: First it was service levels (extended wait times) and late, or no, adoption of new technology and then it was prescription drug “reform” – a kind word for reduced reimbursements from government to the providers.

Rx sales growth of 5%-6% over the past three years has shifted into 1% decline in 2011 due to drug reform. We estimate total sales of drugstore type merchandise in Canada were $41bn in 2010, up approximately 5% versus 2009 with prescription drug sales representing 56%, or $23bn, up 6.6% in 2010. Prescription drug sales have historically grown at an above-average rate (5%-10%) relative to most retail categories. Drug Reform by the provincial governments, which pay for more than 40% of all prescription drugs, to ease the growth curve (called drug reform) has resulted in Rx sales declining 1.1% so far in 2011.

Figure 99: Canadian Drugstore Retail Prescription Sales

2000 - 05 CAGR

2005 2006 2007 2008 2009 20102005 - 10

CAGR

Patented RX (M) 213 223 223 221 221 217

% growth 10.8% 17.9% 4.6% -0.3% -0.8% 0.0% -1.9% 0.3%

Generic RX (M) 161 175 205 237 262 288

% growth -2.3% -9.6% 8.9% 17.1% 15.3% 10.7% 9.9% 12.4%

RX Scripts (M) 374 399 428 458 483 505% growth 3.9% 4.0% 6.4% 7.4% 6.9% 5.6% 4.5% 6.2%

Patented RX ($) $64.84 $66.10 $67.62 $69.23 $71.91 $72.12

% growth 5.7% 7.0% 1.9% 2.3% 2.4% 3.9% 0.3% 2.2%

Generic RX ($) $24.56 $24.95 $25.99 $26.38 $26.59 $26.77

% growth 3.8% 3.4% 1.6% 4.2% 1.5% 0.8% 0.7% 1.7%

Avg. $ / script $42.90 $44.46 $45.74 $44.97 $44.84 $45.73% growth 5.8% 1.3% 3.7% 2.9% -1.7% -0.3% 2.0% 1.3%

Patented RX ($B) $13.8 $14.8 $15.0 $15.3 $15.9 $15.6

% growth 12.8% 4.7% 6.6% 2.0% 1.6% 3.9% -1.6% 2.5%

Generic RX ($B) $2.2 $3.0 $4.5 $5.3 $5.8 $7.5

% growth -9.7% -47.5% 33.4% 52.5% 17.3% 8.9% 29.1% 27.4%

Prescription drug sales ($B) $16.1 $17.7 $19.6 $20.6 $21.7 $23.1% growth 9.9% 5.4% 10.3% 10.5% 5.2% 5.2% 6.6% 7.5%

Source: PMPRB, IMS Health, StatsCan, Barclays Capital estimates

So far, Drug Reform = decreased Rx sales


25 January 2012 102

Drug reform has been a bitter pill to swallow Phased-in drug reform will continue to curtail sales growth in 2012 and 2013, but the pain is easing. The first round of changes occurred in 2005/06, with the Ontario government demanding and ultimately legislating that it get its fair share of the sizeable rebates (estimated at 40%-80%) called “education support funds” that generic drug manufacturers paid to pharmacists to encourage generic substitution. The rebates made the lower priced generic as, or often more, profitable to the pharmacist on a per script basis than the higher-priced patented drug.

Phased-in drug reform allows pharmacists to adapt, but it’s a slow and painful transition. In 2010, Ontario and Quebec finalized and began the implementation of phased-in changes to the reimbursement model of generic drugs, which dramatically lowered the selling price and profitability of generic drugs to pharmacists. The following table provides a summary of the announced plans for Ontario, Quebec, Alberta and British Columbia (BC).

Figure 100: Provincial Drug Reform Summary: Phase-in

2009 2010 2011 2012 2013 2014

OntarioGeneric reimbursement rate 50% 25% 25% 25% 25% 25%

Private sector rate 50% 50% 35% 25% 25% 25%

Professional allowances 65% 50% 35% 25% 0% 0%

Dispensing fees $7.00 $8.00 $8.20 $8.40 $8.62 $8.83Professional service fees $50M $150M

Private label generics Banned - Supreme Court ruling overturned lower court

QuebecGeneric reimbursement rate 50% 37.5% 37.5% 30% 25% 25%

Wholesale markup on generics 5.0% 6.0% 6.3% 6.5%

Dispensing fees $7.89 $7.89 increases expected - but none announced

Professional allowances 20% 20% 16.5% 15%Private label generics no restrictions

British Columbia - Under Review Generic reimbursement rate 65% 50% 40% 35% 35% 35%

Allowable markup 7% 8%

Dispensing fees $8.60 $8.98 $10.00 $10.50 $10.50 $10.50

Professional allowances no restrictionsPrivate label generics no restrictions

Note: BC is considering reducing generic reimbursement rate to 25% immediately

AlbertaGeneric reimbursement rate 75% 51% 51% 51% 51% 51%

Dispensing fee $10.93 $10.93 $10.93 $10.93 $10.93 $10.93

Transitional allowance $3.00 $2.00 $1.00 $0.33Professional allowances no restrictions

Private label generics no restrictions

Source: Provincial government filings


25 January 2012 103

The good news is the earnings drain of drug reform for Shoppers Drug Mart is estimated to be much less in 2012 and almost insignificant by 2013.

Figure 101: Shoppers Drug Mart and Jean Coutu Average Rx Price Drain

-6%

-5%

-4%

-3%

-2%

-1%

0%

3Q-10

4Q-10

1Q-11

2Q-11

3Q-11

4Q-11

1Q-12

2Q-12

3Q-12

4Q-12

1Q-13

2Q-13

3Q-13

4Q-13

Shoppers Drug Mart Jean Coutu

Source: Company Reports, Barclays Capital estimates.

Figure 102: Canadian Drug Reform – Estimated Impact on EPS by Year

Estimated drug reform impact on EPS2010 2011 2012 2013 2014 Total

Jean Coutu EPS impact -$0.01 -$0.02 -$0.02 -$0.01 $0.00 -$0.06

Shoppers EPS impact -$0.21 -$0.23 -$0.05 $0.00 $0.00 -$0.48 Source: Barclays Capital estimates

Still uncertainty on the table Unfortunately, several factors are expected to maintain a certain amount of earnings risk for Shoppers Drug Mart, albeit less than before.

1. The BC government is expected to follow Ontario’s lead; we estimate the EPS risk to Shoppers at $0.05. Recently, the BC government announced that the plan it had previously announced was not generating the expected savings so it is re-opening discussions with various industry segments, which we suspect will result in BC implementing a similar plan to Ontario’s. We estimate that if BC implements these changes, it would represent an incremental $0.05 of EPS risk to Shoppers Drug Mart once fully implemented. This does not include the banning of private label generic drugs.

2. The federal government’s plan to reduce healthcare funding could become another catalyst that forces the smaller provinces to follow Ontario’s drug reform lead. Most of the provinces are already scrambling to find ways of reducing their deficits which have ballooned under the pressures of the extended economic slowdown. The federal government’s surprise announcement that it intends to change the healthcare funding formula, when the current agreement expires in 2013/14, appears to make things worse for most provinces. What the final funding formula is going to be remains uncertain as the provinces are in the midst of reviewing the federal government’s announced changes and trying to see if they can influence some modifications. In the meantime this adds more uncertainty to the drug reform outlook.


25 January 2012 104

3. Ontario will begin negotiations with the doctors this year; the end result could have some implications for pharmacy. According to the Canadian Institute for Health Information (CIHI), healthcare expenditures on doctors represents 14% of total healthcare spending versus 16% for prescription drugs. One area that the provincial governments and the pharmacists seem to agree on is that pharmacy can play a significant role in reducing the cost of healthcare; highly educated/trained retail pharmacists are ultimately one of the government’s lowest-cost contact points for patient care in a number of areas. The challenge is how to get there, as most of the savings involve transferring responsibilities from the doctors to pharmacists at a lower reimbursement rate. Implementing this type of transition obviously takes revenue away from the doctors and often introduces an incremental transition expense for the government as the pharmacists would require some upfront training/qualification process. The doctors, sometimes for ethical reasons, but also for financial reasons, are not open to giving up any services they currently provide unless the government can find ways to replace those revenues. Given how aggressive the Ontario health ministry was with drug reform, it will be interesting to see how tough it is with the doctors. We might get some indication of how aggressively the government is prepared to pursue this transition of services as negotiations with the doctors unfold.

Figure 103: Canadian Healthcare Spending

Capital5%

Administration3%

Public Health6%

Other Health Spending

6%

Other Institutions10%

Other Professionals

11%Physicians

14%

Drugs16%

Hospitals29%

Source: CIHI

Longer term the risk of more reform will remain despite the logic; the “wall of worry” could start as early as 2013, creating a valuation overhang on the sector. We are hopeful that once all of the provinces have taken as big a bite out of pharmacy profits as Ontario has, they won’t come back for more. Unfortunately, pharmacists are an easy target; they have a tough time winning the PR battle, and squeezing them more doesn’t carry the same risk as going after the generic manufacturers (they can close plants, which doesn’t win votes). Regardless of whether we are right or not, by the time 2013 rolls around, the level of focus and uncertainty around the issue will likely increase, resulting in a potential overhang on valuations in the sector.

By 2013, the level of focus and uncertainty around drug reform will likely increase, resulting in a

potential overhang on valuations in the sector


25 January 2012 105

Increased focus on improving Rx counter productivity Government drug reimbursement reform is expected to increase the major pharmacies’ sense of urgency to capture improved Rx counter productivity through consolidation, expanded services and technology. Government price controls and a more saturated/less densely populated market make Canada’s pharmacy counter 35% less productive than the United States. Patented drugs in Canada are subject to price controls under the Patented Medicines Prices Review Board (PMPRB), which according to IMS Health results in Canada’s average patented prescription drug price being almost 60% less than the average U.S. patented drug price (source: IMS Health $72.12 vs. $166.68 in 2010). This combined with lower script volume per store in Canada makes the Canadian Rx counters much less productive than they are in the United States. Excluding Quebec’s average script volume per store, which is significantly higher than the rest of the country (71/store vs 48/store) due largely to Quebec’s 30-day script rule on “first time prescriptions” and more extensive universal coverage, Canada’s average script volume per store is 20% lower than the United States.

Figure 104: Canada vs. US Pharmacy Productivity Comparison Rx Scripts Rx Sales Average Script Prices

per store (000s) per store ($M) Average Branded Generic

Canada 56.4 $2.6 $42 $72 $27Canada ex Que 47.1 $2.8 $56 $88 $33US 60.2 $4.4 $72 $167 $44CN:US Index (ex Que) 0.78 0.63 0.77 0.53 0.75

Shoppers 85.8 $4.0Jean Coutu 173.8 $6.1

Walgreens 91.9 $5.8CVS 88.6 $5.4

Sources: IMS Health/Brogan, CACDS, NACDS, Company Reports, Barclays Capital estimates

Rx Script acquisition appears to be the only immediate term lever the major competitors can rely on. Shoppers and Jean Coutu already have significantly more productive and profitable front-end businesses than the U.S. pharmacies due largely to their success in high-end prestige cosmetics and related health/wellness offerings such as derma care. Their focus over the next few years is expected to be the pursuit of expanded service revenues and improved Rx counter productivity (more scripts/hour, filled at a lower cost):

1. Expanded services: meaningful gains require significant changes in the public and private sectors that will take time. Making changes to healthcare provision is a delicate subject regardless of whether it’s in the public or private sector. We doubt that we will see any major progress beyond currently approved professional services before the current provincial drug reform agreements near the end of their term in 2014. Over the long term we expect government affordability constraints to force changes in public healthcare delivery that will ultimately create a meaningful revenue/profit stream for pharmacies who offer a lower cost, high quality patient contact point.

2. Technology and process changes can improve script throughput and reduce handling costs, but to get an acceptable payback the major pharmacies need more volume. Rx script fulfilment in Canada is significantly more labour intensive than it is in the United States and Europe. There are many process changes and technologies that Canadian pharmacies could employ to reduce handling costs and increase script fill rates but many of these require government policy changes that support more productive approaches (e.g., increased technician handling, centralized filling of chronic disease script renewals). Lower Rx sales productivity makes it difficult for the industry to cost justify adoption of some of

Canada’s average patented prescription drug price is almost

60% lower than the average U.S. patented drug price


25 January 2012 106

the productivity technologies employed in the United States and Europe. Industry consolidation appears the most likely way for pharmacies to achieve acceptable payback levels.

Figure 105: Drugstore Revenue Metrics – Canada vs. US

CN:USUS Canada US Canada INDEX US CN

Chain Drug Stores 20.8 3.0 22.6 3.9 1.3% 4.4%Food / Mass Rx counters 16.6 1.5 17.6 1.8 1.0% 2.2%Independents 20.8 3.3 20.8 3.3 0.0% 0.0%Total RX counters (k"s) 58.3 7.9 61.0 8.9 0.8% 2.2%Population per store 5,322 4,224 5,058 3,867 -0.8% -1.5%Independents share 34% 37%Top 3 retailers' share of RX 35% 59% 1.7

RX sales $217 $15 $266 $23 3.5% 7.3%FE sales $60 $14 $61 $18 0.4% 3.9%Drugstore sales ($B) $276 $29 $327 $41 2.9% 5.7%Rx sales as % of DSTM 78% 52% 81% 56%Prescriptions (mlns) 3,274 361 3,676 505 1.9% 5.7%Generic penetration 48% 43% 71% 57% 24 14

Branded Price/script $92 $62 $167 $72 0.4 10.5% 2.5%Generic Price/script $28 $23 $44 $27 0.6 7.7% 2.3%Avg. RX Price / script $66 $42 $72 $42 0.6 1.5% 0.2%

RX Scripts / capita 11.1 11.3 11.9 14.8 1.2 1.2% 4.6%Rx sales / capita $735 $472 $863 $677 0.8 2.7% 6.2%Front-end sales / capita $202 $442 $197 $523DSTM sales / capita $938 $914 $1,060 $1,199 1.1 2.1% 4.6%

Rx scripts / store (000s) 56.2 45.9 60.2 56.4 0.9 1.2% 3.5%Rx sales / store ($M) $3.7 $1.9 $4.4 $2.6 0.6 2.7% 5.0%Front-end sales / store ($M) $1.0 $1.8 $1.0 $2.0 2.0 -0.4% 1.7%DSTM sales / store ($M) $4.7 $3.7 $5.4 $4.6 0.9 2.1% 3.5%

2004 2010 6 Year CAGR

Source: NACDS 2011 Chain Pharmacy Industry profile, CACDS 2010 Industry report, Barclays Capital estimates

3. Industry consolidation is needed to improve Rx counter productivity; so far we have not seen much activity. Shoppers Drug Mart, Jean Coutu and Katz Group are all eager to lead industry consolidation. The hope is that as the independents digest the reality of the second phase of reimbursement cuts (April 2011), they will become more motivated to sell. Our concern is that true independents won’t sell – at least not this year. We have seen something similar occur in the Canadian home improvement sector and in the U.S. convenience store industry; tough times did not shake out as much consolidation activity as we would have expected. Shoppers Drug Mart has indicated that it is starting to see more acquisition files, but a company of Shoppers’ size needs scale acquisitions – doing transactions with one-store operations is a lot of work for what it’s worth.


25 January 2012 107

Figure 106: Smaller Canadian Drugstore Chains and Independents

Atlantic Quebec Ontario West CanadaDrug Store Chains

London Drugs - - - 74 74 Lovell Drugs - - 11 - 11 Main Drug mart - - 45 - 45 Medical Pharmacies Group - - 34 - 34 People's Drug Mart - - - 48 48 Paragon Pharmacies - - - 22 22 Prince Theodore - - 21 - 21 Super Thrifty - - - 17 17 Total Health - - 37 - 37 Value Drug Mart - - - 56 56

Total Stores - - 148 217 365 Independent

Familiprix 5 293 - - 298 Pharmasave 73 - 148 200 421 Proxim 6 235 11 - 252 Uniprix - 366 - - 366 Unidentified Independents 112 53 862 955 1,982

Total Stores 196 947 1,021 1,155 3,319 Source: Company reports, CACDS, IMS Health, Barclays Capital estimates.

We estimate that independents represent at least 37% of the total Canadian pharmacy store count, which includes Uniprix. IMS Health estimates the independent store count at 1,691, or 19% of total pharmacies in Canada. Some industry sources have suggested the number is between 40% and 50%. Defining an independent in Canada is not clear cut, as many independents are members of buying groups, or loosely defined cooperatives, or minimally contractual affiliated programs. In our view, the key measure is determining the independents financial/legal ability to leave their current membership agreement if and when they choose to. In general, this adds many pharmacies to the definition of independents (e.g., many of Uniprix and Katz Group’s pharmacy members) as in many cases these pharmacies are not corporate, or “true” franchise agreement relationships. With required notice either through the year, or at year end after receiving their share of group rebates, these members can leave and take their deposited capital with them (plus or minus the group’s return).

Of equal importance, with respect to consolidation is that in many of these organizations (e.g., Uniprix) each member has a vote regarding any major policy, or strategy changes. The aforementioned flight risk and the fragmented voting structure of these organizations has proven to be a major hurdle to acquirers’ interest and ability to pursue a merger with these organizations as has been seen with McKesson’s failed attempt to acquire Uniprix (2009) and the opposition to Jean Coutu’s toe-hold acquisition of three Pharmasave stores in 2003 (subsequently sold back to Pharmasave in 2006).


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Figure 107: Canadian Pharmacy Store Count by region and segment

Atlantic Quebec Ontario West CanadaCHAIN:

Shoppers Drug Mart 110 174 612 345 1,241 Katz Group 132 - 1,129 474 1,735 Jean Coutu 20 359 10 - 389 McMahon Dist. (Metro) - 179 - - 179 Lawton's (Sobeys) 68 - - - 68 Other - - 103 161 264

TOTAL CHAIN 330 712 1,854 980 3,876 % of Total Stores 41% 40% 53% 34% 43%

FOOD RETAIL:Loblaw 71 40 224 159 494 Metro - - 78 - 78 Sobeys 140 - 47 47 234 Canada Safeway - - 5 194 199 Overwaitea Food Group - - - 94 94 Other - - 1 34 35

TOTAL FOOD RETAIL 211 40 355 528 1,134 % of Total Stores 26% 2% 10% 18% 13%

MASS RETAILWal-Mart 40 53 120 111 324 Costco 5 10 25 31 71 The Bay / Zellers 25 12 117 71 225

TOTAL MASS RETAIL 70 75 262 213 620 % of Total Stores 9% 4% 8% 7% 7%

TOTAL INDEPENDENT 196 947 1,021 1,155 3,319 % of Total Stores 24% 53% 29% 40% 37%

TOTAL PHARMACIES 807 1,774 3,492 2,876 8,949 Source: Company reports, CACDS, IMS Health, Barclays Capital estimates.

Generics are expected to continue to grow in importance as there are several major patents set to expire over the next few years and benefit payers want cheaper generics. One of the motivations for the provincial governments to get reform in place in 2010 was the pending patent expiry of Lipitor, which was one of the largest generic conversions in years.

Figure 108: Patent Expiration Schedule for Major Branded Drugs in Canada

Canadian Patent Expiries ($B) - 2011 thru 2014

2011 2012 2013 2014Lipitor Cozaar Crestor Aricept

Norvasc Micardis Oxycotin Celebrex

Spiriva Arthrotec Plavix Gleevec

Diovan Hyzaar Atacand WellbutrinLupron Singulair Arimidex

Caduet Cosopt

Femara Prograf

$3.3

$0.3

$1.5

$0.6

-$0.5

$0.5

$1.5

$2.5

$3.5

$4.5

2011 2012 2013 2014

Source: ODB expiry listings, Barclays Capital estimates

Baby Boomers are expected to lift annual script growth by as much as 2%. Adults age 60+ order more than 3x the per capita script volume of the 40- to 59-year-old cohort. With the mean age of the baby boomer population nearing 60, we expect this age group shift to begin driving a meaningful increase in average annual script volume. We estimate that the

Per capita script count has increased at an average annual

CAGR of 5% over the past five years


25 January 2012 109

shift of the aging baby boomer population into the 60+ cohort could drive script count growth up by as much as 2% over the next five years, just based on expected population trends and the heavier usage of the 60+ age group. We note that per capita script count has increased at an average annual CAGR of 5% over the past five years and 4.7% over 10 years.

Figure 109: Rx Growth due to Demographic Shifts

RX per Capita2011 Population

(M)Total RX (M)

2016 Population (M)

Total RX (M)

Age 0-39 4.21 17.3 72.9 18.0 75.8Age 40-59 13.51 10.2 137.7 10.2 138.1Age 60+ 41.82 7.0 293.3 8.3 345.6

Total (M) 34.5 503.9 36.5 559.5CAGR Growth (%) 0.3% 2.1%

Source: CACDS, StatsCan, Barclays Capital estimates

Despite drug reform, the Canadian drugstore sector continues to achieve above-average growth versus many other retail sectors (e.g., food, specialty retail and home improvement) as evidenced by square footage growth and the continued outperformance of front-end comp-store sales.

Figure 110: Drugstore vs. Food Retail square footage growth

2007 2008 2009 2010 2011e 2012e 2013e

Food retail 1% 1% 2% 1% 1% 2% 2%Drug Retail 10% 10% 10% 6% 5% 5% 4%

Source: Company reports and Barclays Capital estimates

Figure 111: Canadian Retail Comp -Store-Sales – weighted averages

Q1-09 Q2-09 Q3-09 Q4-09 Q1-10 Q2-10 Q3-10 Q4-10 Q1-11 Q2-11 Q3-11

Food Retail - CSS 4.7% 3.4% 1.2% 0.4% 0.1% -0.1% -0.2% -0.8% -0.1% 0.2% 1.3%

Drug Retail - FE CSS 2.3% 4.8% 3.4% 4.6% 2.0% 1.6% 1.4% 3.2% 5.1% 2.3% 1.8%

Specialty retail - CSS 0.9% -0.3% 0.3% 1.1% 3.9% 3.0% 1.0% 1.2% -1.1% -0.1% 0.6%

Home Improvement - CSS -6.6% -5.6% -2.3% 6.4% 8.5% 0.6% -4.0% -6.3% -9.6% -5.3% -5.1%

Food & Drug CSS - wtd avg. 4.5% 3.6% 1.5% 0.8% 0.3% 0.1% 0.0% -0.4% 0.4% 0.4% 1.3%

Discretionary CSS - wtd avg. -0.8% -1.5% -0.3% 2.4% 4.9% 2.4% -0.2% -0.5% -3.1% -1.3% -0.7%

TOTAL Group CSS 2.1% 1.4% 0.7% 1.5% 2.3% 1.1% -0.1% -0.5% -1.1% -0.3% 0.4%Source: Company reports, Barclays Capital estimates

Leaders in their respective markets – Shoppers Drug Mart & Jean Coutu Shoppers Drug Mart (SC-TO) and Jean Coutu Group (PJC.a-TO) are Canada’s only publicly traded drugstore retailers. Shoppers Drug Mart is Canada’s only national drugstore chain and the largest drug store retailer by total sales (estimated Rx market share of ~21%), the largest player by store count is Katz Group. Jean Coutu is the market leader in Quebec (national Rx share of 10%, Quebec Rx share estimated at 38%), on a total sales basis, followed by Uniprix, a large cooperative independent also based in Quebec.


25 January 2012 110

Shoppers Drug Mart operates an Associate dealer model in which the company generates earnings through a share of store profits and service fees charged to the Associate dealer, whereas Jean Coutu is a pure franchise model earning a royalty (3%-4%) plus fees for shared services they provide to the franchise members.

Jean Coutu is a franchisor and distributor of prescription drugs and front-end merchandise to its network of Jean Coutu franchisees. The company also generates rental income where it either owns the site, or holds the lease. The franchisees are responsible for store fixtures, inventory and day-to-day operation of the store for which they get to keep the profits after paying Jean Coutu for product, shipment, rent where applicable, royalties and services. In Quebec, the revenue generated by the sale of a prescription drug must be received by a pharmacist; this includes payments such as generic rebates.

Jean Coutu is also a vertically integrated generic drug supplier to its franchise network. In addition to this franchise/wholesale business, Jean Coutu also has a generic manufacturing/distribution company called Pro Doc which it acquired at the end of 2007, immediately following drug reform in 2006. Pro Doc facilitates the approval, packaging and sale of generic molecules predominantly on behalf of third-party generic manufacturers. Since being acquired by Jean Coutu, the majority of Pro Doc’s customers are Jean Coutu franchisees. The move to vertical integration of generic drug supply was well timed as it provided a significant buffer to the drain of drug reform over the past two years.

Figure 112: Shoppers Drug Mart vs. Jean Coutu – a Financial Comparison

Store count Atlantic Quebec Ontario West Canada

Shoppers 110 174 612 342 1,238

Jean Coutu 20 359 10 0 389

Jean Coutu ShoppersSystem sales ($M) $3,778.5 $10,376.0Reported revenue ($M) $2,613.0 $10,376.0

Franchise EBITDA ($M) $237.5 -

Pro Doc / Generic EBITDA ($M) $58.1 -Total EBITDA ($M) $288.5 $1,184.0

EBITDA margin % 11.0% 11.4%

Franchise margin (%) 9.1% -

Pro Doc / Generic margin (%) 35.4% -

AVG per store metrics% front end 36.8% 52.0%Generic penetration % 54.0% 55.5%

Avg. RX scripts / store (ooo's) 174 86

Average script value / store $35.34 $46.86

Front end sales /store ($M) $3.6 $4.4

RX sales / store ($M) $6.1 $4.0

System sales /store ($M) $9.7 $8.4

Average store size - sq. ft. 7,303 10,097

System sales / square foot $1,330 $830 Source: Company Reports, Barclays Capital estimates Note: Shoppers is based on Fiscal 2011 (Jan) and Jean Coutu Fiscal 2011 (Feb) data


25 January 2012 111

Shoppers Drug Mart’s Associate dealer model provides more corporate control than a typical franchise model. Shoppers’ licenses the operation of each store to a pharmacist owner receiving fees for services (e.g., operational support, purchasing/distribution, information technology, marketing, accounting) and a share of store profits up to an “agreed to” capped level in exchange for Shoppers providing working capital loans and loan guarantees. Fixtures, leasehold improvements and equipment are purchased by the company and leased to Associates over periods ranging from two to 15 years. In addition to the fees for services, Shoppers receives a substantial share of Associate store profits in return for their financial backing of the Associates operations. The share of store profits is reflective of Shoppers’ investment in, and commitment to, the operations of the Associates’ stores. In 3Q11 Shoppers disclosed that it has increased the Associate dealers’ share of store profits in response to complaints following the negative impact of drug reform.

Shoppers felt proportionately more pain from drug reform than Jean Coutu. Partly due to their different business models and their different market jurisdictions, Jean Coutu had less of a negative impact on its earnings from drug reform than Shoppers Drug Mart. We are still waiting for an announcement about a possible dispensing fee increase in Quebec, which could reduce PJC’s EPS risk by as much as $0.01-$0.02 depending on the size of the increase.

Jean Coutu’s exposure to drug reform in Quebec was proportionately less than Shoppers’ due to its franchise structure (lower prices reduced royalty payments and wholesale sales, no impact from the reduction/elimination of rebates that hit the franchisees) and due to Pro Doc (PJC received profits from increased generic sales and the benefit of reduced professional allowances). Shoppers’ business model outside of Quebec was fully impacted by the reduced profitability of generic drugs, including lower professional allowances. It has been able to mitigate some of this exposure through the launch of its Sanis private label, but the Ontario private label ban has significantly impeded the financial benefit.

Figure 113: Canadian Drug Reform – Estimated Impact on EPS by Year

Estimated drug reform impact on EPS2010 2011 2012 2013 2014 Total

Jean Coutu EPS impact -$0.01 -$0.04 -$0.01 -$0.01 $0.00 -$0.07

Shoppers EPS impact -$0.21 -$0.23 -$0.05 $0.00 $0.00 -$0.48Source: Barclays Capital estimates

Shoppers Drug Mart launched the Sanis private label generic program to offset some of drug reform’s profit drain. In 2010, Shoppers Drug Mart launched a private label generic called Sanis Health, essentially its version of Pro Doc, to provide its associate network with access to lower-cost generics to mitigate some of the lost profitability from drug reform. As part of drug reform, the Ontario government banned private-label generics, a move specifically designed to stop one of Shoppers’ primary drug reform offsets. Within the markets where Sanis is sold, Shoppers is on track to achieve a 50% penetration of generic scripts in its network excluding Ontario (55% of store count) by the end of this year and is targeting 70% penetration by the end of 2012.

Unfavourable Ontario Supreme court private label generic ruling at minimum extends period of uncertainty and distantly introduces risk in other provinces. Immediately after the Ontario government passed legislation to ban private label generics, Shoppers and Katz Group moved to challenge the Ontario government’s legal right to implement the ban. The Ontario District court ruled in February 2011 that the Ontario government had overstepped


25 January 2012 112

its legislative/regulatory powers and disallowed the ban. The Ontario government requested an appeal which was reviewed in June 2011.

On December 23, 2011, the Ontario Court of Appeal overruled (supported by 2 of 3 judges) the lower District court’s findings, resulting in the reinstatement of the private label generic ban in Ontario. Shoppers’ share price dropped $1.28, or 3% on the first trading day following the decision but has since recuperated some of the loss (S&P/TSX -1.7%). This decline is materially less than the implied impact of the $0.15 to $0.20 EPS we estimate could be generated by Ontario private label – a 5%-7% share price impact assuming a 14x PE multiple.

We expect Shoppers and Katz Group to seek a Supreme Court of Canada appeal. Given that the decision 1) was not unanimous; with a strongly worded dissenting argument presented by Judge Epstein, and 2) hinges on a delicate subject: the government’s legal right to dictate “public and private sector commercial trading terms,” we expect Shoppers and Katz to seek an appeal with the Supreme Court of Canada. They have 60 days to file for an appeal following the Ontario appeal decision.

The appeals court decision appears to conclude that: 1) the Ontario Drug Benefit Act (ODBA) and Drug Interchangeability and Dispensing Fee Act (DIDFA) are collectively a “specialized legislative scheme” that provides the government with sufficient “regulation-making powers” to ban private label generics as they circumvent the intent of the 2010 changes (elimination of special funding) and could over the longer term impede the government’s ability to achieve further cost reductions; 2) public health’s importance and the effective use of significant tax payers dollars provides the government with some latitude in how it legislates health care expenditures; 3) responsibility for the management of public funds rests with the government and not the courts.

This decision introduces a potential risk that other provincial governments may choose to pursue a similar ban once we have a final decision, as the Ontario case will have established a precedent. The EPS downside risk of a ban by the remaining provinces would be approximately $0.15-$0.20, or an approximate share price risk of $2.10-$2.80, by our analysis.


25 January 2012 113

Drugstore Recommendation & Valuation Summary

We prefer the Drugstore Retailers over the Food Retailers despite the impact of drug reforms. While drug reform has constrained earnings growth, more so at Shoppers than at Jean Coutu, we believe the worst of the pain is in the past. Both are defensive names with limited downside risk at their current valuations, fuelled by the prescription drug growth of an aging population. We expect Jean Coutu to deliver over 10% EPS growth this fiscal year, while Shoppers is on track to delivering within its EPS guidance for F2011 (+3%) with growth accelerating as 2012 (+7%) unfolds toward what we expect will be a sustainable level of 10% earnings growth in 2013.

Despite our comfort with Jean Coutu and Shoppers’ near-term earnings outlook the risk of further drug reform is expected to remain an overhang on valuations. This uncertainty is expected to be more of an issue for Shoppers than Jean Coutu due largely to their different business models. Some of the potential changes include:

Another round of reform in BC: British Columbia is currently revisiting its generic drug reimbursement rate. There is a possibility that reimbursement rates could be lowered to 25% (from the current 35% level).

Revised federal formula lowering health care distributions to provinces: This could add pressure on provinces to control health expenses.

Other provinces implementing new drug reforms.

Resolution of the legality of private label generic drugs sold by retailers: The banning on private label generic drugs in Ontario can set a precedent for other provinces to follow suit.

While we see Jean Coutu and Shoppers’ earnings growth reaccelerating as the earnings drain from drug reform eases, in light of the risks we’ve highlighted, we are hard pressed to see any material upside potential to current valuations. At current levels, Jean Coutu is the most expensive drugstore stock in North America at a forward P/E of 14.3x. Shoppers Drug Mart is only modestly lower at 13.7x. This represents on average a 7% premium on CVS and 19% premium on Walgreens.

Figure 114: Drugstore Retailer Recommendation Summary


DRUGSTORE RETAILERS

Jean Coutu PJC-A.TO 2-EW Feb-28 $3,003 $0.76 $0.88 $0.98 15.1x 13.5x $0.24 1.8% $13.27 $14.00 7.3%

Shoppers DM SC.TO 2-EW Dec-31 $8,974 $2.75 $2.83 $3.04 14.6x 13.6x $1.00 2.4% $41.45 $43.00 6.2%


Source: FactSet, Company Reports, Barclays capital estimates. Pricing is as of January 20, 2012 1-OW = 1-Overweight; 2-EW = 2-Equal Weight; 3-UW = 3-Underweight. Sector rating is 2-Neutral.


25 January 2012 114

Figure 115: Shoppers Drug Mart vs. Jean Coutu Historical Fwd. P/E

0x

5x

10x

15x

20x

25x

30x

35x

40x

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011



Figure 116: Shoppers Drug Mart vs. Jean Coutu Historical Fwd. EV/EBITDA

0x

5x

10x

15x

20x

25x

30x

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011




25 January 2012 115

Figure 117: Canadian Drug Reform Summary by Province

* British Columbia is renegotiating their reimbursement for further reductions (estimated to end up at 25% like Ontario and Quebec) Source: Company and Government Ministry Reports

Province Nova Scotia Quebec Ontario Alberta British Columbia

Date July 2011 November 2010 May 2010 April 2010 October 2010

Reform Type Public Plans Only Public Plans Only Public and Private Plans Public Plans Only Public Plans Only

Generic Drug Reimbursement Rate

Generic drug prices lowered to 45% of the branded drug price July 1, 2011.

- Reduces to 40% 1/1/12 - Reduces to 35% 7/1/12

Generic drug price was lowered to 37.5% of the branded drug price Dec/10

- Reduced to 30% 4/1/11 - Reduces to Lowest price in Canada on 4/1/12 i.e. Ont. rate of 25%

Public plans were lowered to 25% of the branded drug price immediately Private plans were lowered to 50% of the branded drug price immediately

- Reduced to 35% 4/1/11 - Reduces to 25% 4/1/12

Existing generic drugs lowered to 56% of the branded drug price 4/1/10 New generic drugs reimbursed at 45% of the branded drug price as of 4/1/10

Generic drugs introduced prior to Nov. 08 lowered to 50% of the branded drug price 10/1/10 (42% for drugs introduced after Nov. 08)

- Reduced to 40% 7/1/11 - Reduces to 35% 4/1/12*

Dispensing Fees & Transitional Allowance

The magnitude of the increase in dispensing fees is currently being negotiated by the government and pharmacists

Negotiations for a dispensing fees increase are ongoing between the government and pharmacists – a positive decision is expected in the near term

Dispensing fees increased from $7 to $8 for most pharmacies immediately

- Increased to $8.20 4/1/11 - Increases to $8.40 4/1/12 - Increases to $8.62 4/1/13 - Increases to $8.83 4/1/14

Rural pharmacies can qualify for a dispensing fee as much as $5 above the published level

Transitional allowance of $3 paid in addition to dispensing fees for all prescriptions (branded and generic) under $75

- Reduced to $2 4/1/11 - Reduces to $1 4/1/12 - Eliminated 4/1/13

Dispensing fees were increased to $9.10 on 7/1/10

- Increased to $9.60 10/1/10 - Increased to $10 7/1/11 - Increases to $10.50

4/1/12

Professional Allowances

The government gained the authority to limit professional allowances paid to pharmacies in the future

Capped at 20% of generic drug price

- Reduced to 16.5% 4/20/11 - Reduces to 15% 4/20/12

Eliminated immediately for public plans Private plans reduced to 50% of sales immediately

- Reduced to 35% 4/1/11 - Reduces to 25% 4/1/12 - Eliminated 4/1/13

Not addressed Not addressed

Other

Maximum profit margin on pharmacy/wholesaler produced generic drugs capped at 6%

- Increased to 6.25% 4/1/11- Increases to 6.50% 4/1/12

Ordinary commercial trading terms capped at 10% of the generic drug price Private label generics banned for pharmacies and wholesalers

Minimum drug mark-up increased to 8% on 10/1/10 (from 7%)


25 January 2012 116

SHOPPERS DRUG MART

Shoppers Drug Mart Corp.(SC.TO): Quarterly and Annual EPS (CAD)

2010 2011 2012 Change y/y






Year 2.75A N/A 2.83E 2.83E N/A 3.04E 3.01E 3% 7%

P/E 15.1 14.6 13.6




We are initiating coverage of Shoppers Drug Mart (SC.TO) with a 2-Equal Weight/2-Neutral rating and $43 price target, which offers a potential total return of 4% from recent levels. Our price target is supported by a 14x target multiple applied to our 2012 EPS forecast of $3.04. Within the Consumer group, we currently prefer the drugstore stocks over the food retailers, with Shoppers preferred over Jean Coutu. Despite the earnings drain from drug reform, Shoppers has delivered on its promise of renewed earnings growth in 2H11 and is on track to meet its 2011 guidance. Although we estimate 2012 EPS growth of 7% y/y, the rate of EPS growth should improve through 2012 as drug reform drain eases and ongoing share buybacks increase EPS growth toward what we expect will be the new sustainable EPS growth rate of 10%. With lower capex spending and increasing free cash flow, further dividend increases are expected. In the immediate term, we expect the uncertainty of further provincial drug reform (i.e., British Columbia) and an expected private label appeal to the Supreme Court of Canada will act as overhangs on the valuation. A lack of extraordinary positive catalysts also keeps us on the sidelines for now.

Figure 118: Shoppers Drug Mart P/E Valuation Range

f2012E f2013E CommentsBarCap est BarCap est

EPS range $3.00 $3.04 $3.10 $3.25 $3.33 $3.40Y/Y % chg 6.0% 7.3% 9.6% 7.0% 9.6% 11.9%

P/E Multiples10.0x $30 $30 $31 $33 $33 $3411.0x $33 $33 $34 $36 $37 $37 <= WAG fwd P/E12.0x $36 $36 $37 $39 $40 $41 <= SC's trough P/E13.0x $39 $39 $40 $42 $43 $44 <= CVS fwd P/E14.0x $42 $43 $43 $46 $47 $48 <= BarCap multiple14.5x $44 $44 $45 $47 $48 $4915.0x $45 $46 $47 $49 $50 $5116.0x $48 $49 $50 $52 $53 $5418.0x $54 $55 $56 $59 $60 $6119.0x $57 $58 $59 $62 $63 $65 <= SC's LT avg Fwd P/E21.0x $63 $64 $65 $68 $70 $71 <= SC's 5 Year Max P/E


Uncertainty around Drug Reform is likely to weigh on the shares

SC CN / SC.TO




Price (20-Jan-2012) CAD 41.45



25 January 2012 117

Despite more tepid earnings growth, Shoppers is trading at 13.7x forward P/E, which is 5% above CVS Caremark and 17% above Walgreen’s P/E multiple. Shoppers is only modestly cheaper than Jean Coutu at 14.3x, which is currently the most expensive stock in the drug store space. There are limited indications that with a new CEO just coming on board, we should expect a sudden step-up in earnings growth in 2012. The unfavourable private label generic ruling in Ontario has transformed an EPS upside opportunity into a potential downside risk depending upon whether Shoppers appeals the decision, or not, to the Supreme Court of Canada. If this process ends up with private label generics still banned in Ontario other provinces may opt to implement a ban as well using Ontario’s case precedent as their justification. We estimate the share price downside risk at $2-$2.50 per share, or 5%-7%.

Based on the retail sector’s average PEG ratio range of 1.1x-1.5x, Shoppers’ current valuation suggests the market is anticipating EPS growth of approximately 10%. Shoppers EPS growth potential has been significantly reduced by drug reform. Gone are the heady days of 15% EPS growth quarter after quarter which supported a forward P/E multiple of more than 20x. The earnings drain of known drug reform changes will ease materially in 2012 versus 2011 and continue to decline over the following two years but we are challenged to see EPS growth in 2012 of more than 10% versus our forecast of 6%. Once Shoppers is able to establish a consistent trend of earnings growth in the 10% area we believe the market will pay up for that certainty/consistency toward the 15x P/E level. In our view, attainment of this P/E level will be partly a function of Shoppers’ superior liquidity versus most other Canadian retail sector stocks. We note that Shoppers commands the largest market cap (free float) and has the highest liquidity within our coverage universe.

For now, however, Shoppers still faces several meaningful earnings drain hurdles from the remaining cuts in generic reimbursement rates, professional allowances, or temporary transition fees that are scheduled over the next two-plus years. This will make it difficult to achieve any sequential earnings growth consistency until 2013. By that time we are somewhat concerned that investors will start to worry anew about the next leg of drug reform which could create a valuation overhang.

Figure 119: Shoppers Drug Mart’s forward P/E and EPS growth

0.0x

5.0x

10.0x

15.0x

20.0x

25.0x

30.0x

2003

2004

2005

2006

2007

2008

2009

2010

2011

-20%

-10%

0%

10%

20%

30%

40%

50%

Forward P/E earnings growth


The unfavourable private label generic ruling in Ontario has

transformed an EPS upside opportunity into a potential

downside risk

Shoppers commands the largest market cap (free float) and has the highest liquidity within our

coverage universe


25 January 2012 118

Corporate Profile Shoppers Drug Mart is Canada’s largest public drug retailer with an estimated 21% prescription sales market share. The company is Canada’s only national drugstore retailer operating under the Shoppers Drug Mart banner, with the exception of the Pharmaprix banner in Quebec, and has 1,238 stores and 12.5 million retail square feet. Shoppers Drug Mart derives a greater proportion of its sales from the front of the store (52%) compared to North American peers. This is partly due to its industry-leading cosmetics business and prestige BeautyBOUTIQUES, which offer high-end cosmetics similar to the assortments found in department stores. The company currently has 303 stores with BeautyBOUTIQUES with a goal of 350 stores. (See the drugstore sector overview for more details about Shoppers and the Associate dealer business model.)

Shoppers’ new CEO, Domenic Pilla, brings extensive wholesale pharmacy experience and a “can do attitude” to Shoppers. Shoppers Drug Mart’s previous CEO Jurgen Schreiber left the company in February 2011 after five years at the helm to become CEO of Edcon Holdings, a leading retailer in South Africa. Mr. Pilla, Shoppers’ new CEO as of November 2011, was most recently president of McKesson Canada – the Canadian division of McKesson Corporation, a leading pharmacy distributor/provider. Given the top two challenges/opportunities Shoppers faces over the next 3-5 years (government/industry consensus building and driving industry consolidation) Mr. Pilla’s experience and credentials seem well aligned. It will take time for Mr. Pilla to formalize his plans for Shoppers Drug Mart but the opportunity path seems fairly clear; getting the job done is the real challenge.

Growth Strategy & Outlook Shoppers delivered on its promise of returning to EPS growth by the second half of 2011 despite the second phase of Ontario drug reform kicking in April 1, 2011. In our view, the company has done an admirable job offsetting what is estimated to have been a $0.23 EPS drain in 2011 from drug reform across the country. Unfortunately, unless it wins the Ontario private label appeal, which we estimate could add as much as $0.15-$0.20 to EPS on an annualized basis, and starts to achieve meaningful acquisition benefits from industry consolidation, we are concerned that establishing consistent +10% EPS growth in 2012, or 2013, will be difficult to achieve.

In the immediate term we expect new CEO Domenic Pilla to stick with Shoppers’ current growth and drug reform offset plans. We believe that some of his immediate to longer-term strategic priorities are: 1) ensuring that Shoppers is the biggest beneficiary of industry consolidation, 2) establishing a more cooperative, proactive dialogue with the provincial governments to increase the likelihood that the pharmacy industry benefits from the next round of healthcare changes, 3) exploring private sector exclusivity arrangements that leverage Shoppers’ national store network. In the meantime, Shoppers has an extensive array of earnings growth initiatives, which we have outlined below, that has allowed the company to re-establish earnings growth despite the onerous drain of drug reform.

1. Square footage growth of 4% to 5% remains a solid assist to sales growth. Shoppers reduced its square footage growth plans immediately following the confirmation of drug reform plans in Ontario providing square footage growth guidance for 2011 of 4.5% versus 8%-10% in previous years to conserve free cash flow for other needs. Shoppers is on track to open 50-55 new stores this year and expects to open approximately the same number of stores next year.

Shoppers has an extensive array of earnings growth initiatives


25 January 2012 119

Figure 120: Shoppers Drug Mart Store Population Density

Shoppers Drug Mart ATL QUE ONT WEST CANADA

Store count 110 174 612 345 1241000's of people / store (k's) 22.4 45.4 21.6 30.5 27.5People / sq. ft 2.2 4.5 2.1 3.0 2.7

Population 2464 7906 13228 10529 34126Square footage (mlns) 1108 1753 6164 3475 12500Average store size 10.1 10.1 10.1 10.1 10.1

Source: Statistics Canada, Company reports, Barclays Capital estimates.

2. Small store renovation program provides faster payback on capex. Shoppers continues to roll out its renovation program for smaller stores (7-8k sq. ft.) adding a greater selection of convenience food and beauty products to enhance sales productivity and margins. Sales in original prototype stores increased on average 17-22%. Shoppers is on track to complete 40 of these renovations this year and expects to complete a total of 150 over the next 2-3 years. Each conversion requires an investment of approximately $300k/store, and should generate a faster payback on capex than what the company achieves on bigger projects.

3. Beauty Boutique expansion continues toward 350 locations. Shoppers’ industry-leading prestige cosmetics offering still has lots of runway from its current 303 locations. Shoppers continues to gain share in the category, up another 40bps in 3Q11. The Murale stores, although not a growth focus, have served one of their primary purposes, which, in our view, was to convince more of the higher-end prestige brands to become part of the beauty boutique network.

4. Cost reduction efforts – Project Infinity. Over the past two years Shoppers has completed productivity and efficiency initiatives under the Project Infinity program that we estimate have reduced operating costs by as much as $100mn. Project Infinity involved a complete review of procurement, supply chain and in-store operations for the front-end and Rx portions of the business, which generated sustainable reductions that are now largely reflected in the company’s cost run rate. These savings were a meaningful contributor to offsetting the negative profit impact of drug reform. While we expect that Shoppers’ new CEO will continue to press the organization for cost reductions Project Infinity’s contributions are now in place.

5. Shoppers’ Optimum program is one of the largest loyalty programs in Canada. Launched in 2000, Shoppers’ Optimum loyalty program now has more than 10 million active members. The Optimum program is an important part of the company’s overall value proposition and a key driver of sales growth. Optimum cardholders frequent the stores more often and have an average basket size that is over 60% greater than non-cardholders. Typically, a member earns 10 Optimum points for each dollar spent in-store. Members can redeem points for dollar value rewards toward store purchases according to a rewards grid (i.e., $10 for 8,000 points; up to $170 for 95,000 points). Shoppers also implements promotional campaigns that offer bonus points (i.e., 20x bonus points). To further leverage the success of the program, Shoppers introduced the Optimum MasterCard in 2009 which enables cardholders to earn points on all purchases made with the MasterCard (not just in Shoppers Drug Mart stores). On January 17, 2012, Shoppers and Royal Bank of Canada announced a co-branded RBC Shoppers Optimum banking account and debit card. Similar to the Optimum MasterCard, the new bank account allows members to earn Optimum points at Shoppers and other retailers on purchases made with the new debit card.


25 January 2012 120

Figure 121: Shoppers operates one of the largest loyalty programs in Canada

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6. Front-end private label penetration gains continue to offer margin upside. Shoppers continues to make significant progress increasing the penetration of its more profitable private label products in front-end categories. Since 2000 Shoppers has almost doubled its private label penetration from 10% to 19.3% (3Q11), with the Q3 rate up 26bps versus 3Q10 last year. Management expects private label penetration to reach 25% over the next three to five years. We estimate that each 50bp increase in front-end private label penetration can increase Shoppers’ consolidated gross margin by 10bps.

7. Sanis private label generic drug sales nearing 50% penetration level. Shoppers launched its private label generic program in 2010 under the Sanis label. Outside of Ontario, Sanis has achieved a penetration rate of 46% of generic drugs dispensed with a goal to reach 70% by the end of next year. The unfavourable Ontario appeals court ruling seems to end Shoppers’ ability to expand the current program into Ontario. It appears that Shoppers will have to consider becoming a generic manufacturer to qualify for formulary listing in Ontario. This seems like a possibility but not a preferred route unless the other provinces also move to ban, or outlaw, private label generics.

8. Consolidation remains a major opportunity for improved growth. Shoppers’ new CEO sees consolidation as a must and expects the number of opportunities to increase between now and the next phase of drug reform, which for Ontario is April 2012. He sees consolidation as an important driver to future growth and will be stepping up the organization’s efforts in this area. He has said the organization can do a better job of making the platform more receptive to independents that join the organization.

A major step toward demonstrating that the organization can be more receptive to independent entrepreneurs appears to be some concessions by Shoppers regarding shared earnings with its current Associate dealers. After some strained relations and an attempted class action lawsuit by a few dealers, Shoppers appears to have responded by increasing the Associates’ earnings as noted in the 3Q11 press release as an increased expense in the quarter. As Associates are front-line ambassadors in Shoppers’ efforts to attract new independents, we see this as a prudent and necessary move.

9. Shoppers has begun to actively buy back shares to augment EPS growth, repurchasing 2.7mn shares in 3Q11 out of an approved buyback program of 8.7mn shares. With a cut back in new store growth capex, Shoppers has been able to increase the dividend and maintain a clean balance sheet by limiting funds use to available free cash flow. In 2012


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Shoppers has indicated that total capex spending will remain in the $350mn area with a considerably larger portion committed to acquisition activity. With a net debt/EBITDA ratio of only 1.0x, the company has considerable leverage capacity if it chooses to use it. If Shoppers utilizes all of the 8.7mn share buyback capacity, we estimate it would increase annualized earnings by 0.5%. We are assuming a buyback in 2011 of 5mn shares and 8.7mn in 2012 and 2013 contributing 3% to EPS growth per year.

Figure 122: Shoppers Drug Mart Free Cash Flow Summary ($ mn)

Fiscal Year (Dec) 2006 2007 2008 2009 2010 2011E 2012E 2013E

Operating Cash Flow $569 $676 $772 $835 $894 $910 $963 $1,028Change in W/C -$27 -$138 -$325 -$178 -$82 -$66 -$56 -$64

Cash from Operations $542 $539 $447 $657 $812 $844 $907 $964Capex -$293 -$396 -$516 -$443 -$415 -$343 -$260 -$250

Free Cash Flow $249 $143 -$69 $214 $397 $501 $647 $714

Dividends -$99 -$130 -$175 -$187 -$194 -$211 -$220 -$232

Net Change in Share Capital -$41 $14 $7 $5 $1 -$191 -$361 -$414

Acquisitions -$94 -$122 -$238 -$98 $1 -$18 -$100 -$100

Net Change in Debt -$23 $41 $143 $220 -$133 -$96 $0 $150

Remaining cash flow -$8 -$54 -$331 $154 $72 -$15 -$34 $118

Free Cash Flow per share -$0.04 -$0.25 -$1.52 $0.71 $0.33 -$0.07 -$0.16 $0.59

Free Cash Flow Yield -0.1% -0.5% -3.0% 1.6% 0.9% -0.2% -0.4% 1.4%

ROE 16.5% 16.9% 16.9% 16.1% 14.2% 14.1% 14.4% 15.1%Source: Company Reports, Barclays Capital estimates

Figure 123: Shoppers Drug Mart Financial Performance Summary

GAAP IFRS IFRS IFRS IFRSf2009A f2010A f2011E f2012E f2013E


Total Revenue Growth (%) 6.0% 2.1% 2.1% 2.7% 4.1%


Front End Same Store Sales Growth (%) 4.0% 2.5% 2.6% 1.2% 3.0%

Prescription Same Store Sales Growth (%) 5.7% 1.7% 0.4% 1.1% 2.9%

Prescription Same Store Count Growth (%) 3.0% 3.7% 3.5% 3.5%

Gross Margin 37.5% 38.2% 38.6% 38.8% 39.0%


EBITDA Margin 11.5% 11.6% 11.6% 11.8% 12.0%

Gross Margin Variance 43 bps 106 bps 45 bps 18 bps 20 bps

SG&A Variance 36 bps 101 bps 45 bps 1 bps -3 bps

EBITDA Variance 8 bps 16 bps 0 bps 17 bps 23 bps



Free Cash Flow ($ Millions, After Capex/WC) $152 $418 $490 $547 $614

Return on Equity 16.1% 14.6% 14.1% 14.4% 15.1%

Return on Invested Capital 12.4% 12.1% 12.1% 12.5% 12.8%Source: Company Reports, Barclays Capital estimates. Note: Growth comparisons between 2011/2010 are presented in GAAP, raw figures/margins are presented in IFRS


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Risks The unfavourable appeal ruling in Ontario could become precedent for other provinces

to move to banning private label generics. We expect Shoppers to make an appeals request to the Supreme Court of Canada which it must submit within 60 days of the Ontario appeals court ruling. If it does not proceed or loses the appeal, other provinces may consider banning private label generics. We estimate the downside could be as much as $2.80/share, or 3% (14x EPS of $0.20).

More government policy changes that reduce pharmacy profitability. An aging baby boomer population is expected to significantly increase the rate of health care cost inflation over the next ten years which is likely to dramatically outpace the government’s tax revenue growth which is the primary funding source. This disconnect is expected to result in continued significant reform of the Canadian Health care delivery system. While we see the opportunity for some positive outcomes (i.e., expanded professional services by pharmacists) it would be naive to assume that government won’t look at the prescription drug channel again as a source of cost reduction.

Further economic weakness that leads to intensified price competition. About 50% of Shoppers Drug Mart’s sales are done in the front end of the store which involves more discretionary purchases. Given our expectations that consumers will remain tight fisted through 2012 there is some risk that Shoppers’ front end sales growth could be slowed and margins put at risk due to increased promotion intensity.

A favourable Supreme Court ruling could materially increase Shoppers’ earnings outlook and its valuation.


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COMPANY SNAPSHOT

Shoppers Drug Mart Canadian Consumer & Retail

Income statement ($mn) 2010A 2011E 2012E 2013E CAGRRevenue 10,193 10,403 10,688 11,130 3.0% Stock Rating 2-EQUAL WEIGHTEBITDA 1,184 1,208 1,259 1,337 4.1% Sector View 2-NEUTRALEBIT 907 911 932 978 2.5% Price (20-Jan-2012) $41.45Pre-tax income 847 847 872 917 2.7% Price Target $43.00Net income 598 613 637 669 3.8% Ticker SCEPS (reported) ($) 2.75 2.83 3.04 3.33 6.6%Diluted shares (m) 218 217 210 201 -2.6% Investment case



Balance sheet and cash flow ($mn) CAGRTangible fixed assets 1,690 1,777 1,810 1,801 2.1%Intangible fixed assets 272 274 274 274 0.2%Cash and equivalents 64 132 98 66 0.9%Total assets 7,044 7,193 7,282 7,349 1.4%Short and long-term debt 1,280 936 1,186 1,186 -2.5% Downside case $39.00Total liabilities 1,528 1,624 1,654 1,696 3.5%Net debt/(funds) 1,216 1,054 1,088 1,120 -2.7%Shareholders' equity 4,093 4,361 4,417 4,440 2.8%Change in working capital (82) (66) (56) (64) NAOperating cash flow 832 851 907 964 5.0%Capital expenditure 415 343 260 250 -15.5%Free cash flow 405 807 547 614 14.8%


Valuation and leverage metrics AverageP/E (x) 15.1 14.7 13.6 12.4 14.0 EV/EBITDA (x) 8.6 8.3 7.8 7.1 7.9 FCF yield (%) 4.5 9.0 6.3 7.4 6.8Price/sales (x) 0.9 0.9 0.8 0.7 0.8 Price/BV (x) 2.2 2.1 2.0 1.9 2.0 Dividend yield (%) 2.2 2.4 2.5 2.8 2.5Total debt/capital (%) 23.8 17.7 21.2 21.1 20.9Total debt/EBITDA (x) 1.1 0.8 0.9 0.9 0.9

Source: FactSet

Selected operating metrics Same Store SalesFront-end same store sales (% 2.5 2.6 1.2 3.0 2.3RX same store sales (%) 1.7 0.4 1.1 2.9 1.5Rx as % of sales 47.8 46.8 46.3 46.3 46.8Capex as % of sales 4.1 3.3 2.4 2.2 3.0


Shoppers Drug Mart is Canada's only nationaldrugstore chain with an estimated 21% share of Rxsales. Shoppers has done a good job at offseting theEPS drain from drug reforms; however, it will be hard-pressed to get back to +10% EPS growth in 2012 or2013. Our price target is supported by a 14.5x P/Emultiple on our 2012E EPS of $3.04.

Our Upside case reflects a favourable decision inShoppers' private label case with the Ontario court ofappeal, which we see annualized EPS upside of up to$0.20. Applying a 15x P/E multiple to a potential2012E EPS of $3.19 would generate an Upside caseof $48.

Having received an initial favourable ruling,Shoppers' premium valuation could be at risk if itloses the Ontario court of appeal review of its privatelabel case. Applying a 13x P/E multiple on our 2012EEPS of $3.04 derives a $39 Downside case.

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25 January 2012 125


25 January 2012 126

JEAN COUTU GROUP.

Jean Coutu Group(PJC-A.TO): Quarterly and Annual EPS (CAD)

2011 2012 2013 Change y/y

FY Feb Actual Old New Cons Old New Cons 2012 2013





Year 0.78A N/A 0.88E 0.87E N/A 0.98E 0.94E 13% 11%

P/E 17.0 15.1 13.5




We are initiating coverage of Jean Coutu (PJC-A.TO) with a 2-Equal Weight/2-Neutral rating and $14 price target, which offers a potential total return of 6% from recent levels. Our $14 price target reflects a target P/E multiple of 14.5x on our fiscal 2013 (February) EPS of $0.98. Jean Coutu’s share price appreciated 38% in 2011 versus -11% for the TSX index as investors were attracted to its relatively modest exposure to drug reform (franchise model and Pro Doc); strong free cash flow, which is being used to buy back stock; and continued commitment to strong new store growth (+4% to 5%), which has helped offset the drain of drug reform through above-market volume growth (+7% in F3Q12). Unfortunately, as a result of this sector-leading price appreciation, we view the shares as being fairly valued.

Figure 124: Jean Coutu P/E Valuation Range

f2013 f2014 Comments

EPS range $0.90 $0.98 $1.10 $1.00 $1.09 $1.20growth vs PY -7.9% -0.2% 12.6% 2.6% 11.6% 23.1%

P/E Multiples9.0x $8 $9 $10 $9 $10 $11

10.0x $9 $10 $11 $10 $11 $12 <= Jean Coutu trough P/E multiple11.0x $10 $11 $12 $11 $12 $1312.0x $11 $12 $13 $12 $13 $1413.0x $12 $13 $14 $13 $14 $1614.0x $13 $14 $15 $14 $15 $1714.5x $13 $14 $16 $15 $16 $17 <= Barclays Capital Target Multiple15.0x $14 $15 $17 $15 $16 $1816.0x $14 $16 $18 $16 $17 $19 <= Jean Coutu all-time avg Fwd P/E17.0x $15 $17 $19 $17 $19 $2018.0x $16 $18 $20 $18 $20 $2219.0x $17 $19 $21 $19 $21 $23 <= Shoppers all-time avg Fwd P/E

BarCap Est. BarCap Est.


At 14.3x forward P/E, Jean Coutu currently commands the highest valuation in the North American drugstore sector, although we note that PJC is trading versus its historical average of 15.8x. We believe this discount is warranted as we see some potential short- to medium-term headwinds that could limit further valuation upside. In the near term, we

Jean Coutu stock is trading at fair value, in our view

PJC/A CN / PJC-A.TO




Price (20-Jan-2012) CAD 13.27



25 January 2012 127

expect a weak flu season to negatively impact OTC and pharmacy sales, which also reduces traffic in other areas of the front store. Further, in the absence of any major drug patent expiries in 2012 and 2013, we believe Pro Doc’s contribution to Jean Coutu’s margin growth will become more muted as the savings from mandated lower professional allowances is unlikely to be enough to offset the sales and earnings drain of lower generic drug prices.

Figure 125: Jean Coutu Historical Forward P/E

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On an EV/EBITDA basis, PJC also commands the highest multiple at 9.8x FY2 EBITDA. Excluding the value of Rite Aid, we estimate that PJC Canada is currently trading at an EV/EBITDA multiple of 8.6x, which is still at a premium to Shoppers and CVS at 7.9x and 7.3x, respectively. Our $14 price target would imply a 9.0x EV/EBITDA multiple for PJC Canada on our F2013 EBITDA forecast of $324mn.

Figure 126: North American Drug Stores Comparable Valuations – EV/EBITDA

Price EV Fiscal EBITDA ($M) EV/EBITDA EBITDA GrowthTicker 20/01/2012 ($M) PY FY1 FY2 PY FY1 FY2 PY-FY1 FY1-FY2 PY-FY2

Shoppers SC $41.45 $10,013 $1,184 $1,212 $1,269 8.5x 8.3x 7.9x 2% 5% 4%

Jean Coutu PJC.A $13.27 $3,124 $291 $307 $318 10.7x 10.2x 9.8x 5% 4% 5%

Walgreens WAG $33.48 $30,660 $5,131 $4,972 $5,258 6.0x 6.2x 5.8x -3% 6% 1%

CVS CVS $42.77 $64,522 $7,634 $7,945 $8,701 8.5x 8.1x 7.4x 4% 10% 7%

Rite Aid RAD $1.38 $7,403 $644 $903 $913 11.5x 8.2x 8.1x 40% 1% 19%

Average $23,144 9.0x 8.2x 7.8x 10% 5% 7%Average (ex. RAD) $27,080 8.4x 8.2x 7.7x 2% 6% 4%

Source: FactSet.

Corporate Profile The Jean Coutu Group is Quebec’s leading drugstore retailer and the fourth-largest player in Canada. The company operates 394 stores predominantly in Quebec. Jean Coutu is a franchisor and distributor of prescription drugs and front-end merchandise to its network of Jean Coutu franchisees. It also generates rental income where the company either owns the site, or holds the lease. The franchisees are responsible for store fixtures, inventory and day-to-day operation of the store for which they get to keep the profits after paying Jean Coutu for product, shipment, rent where applicable, royalties and services. In Quebec, the


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revenue generated by the sale of a prescription drug must be received by a pharmacist; this includes payments such as generic rebates.

Rite Aid stake provides potential windfall upside if it ever materializes; for now PJC has become a seller. For the first time since selling the Eckerd stores to Rite Aid in 2007 Jean Coutu reduced its stake in Rite Aid by selling 17.6mn shares for total consideration of $22mn. As of the end of F2Q12, Jean Coutu held a 26.1% equity interest in Rite Aid, which is down from 28.3% at the beginning of the year. Jean Coutu has written off its investment in Rite Aid.

Jean Coutu has two classes of shares outstanding: 1) Class “A” Subordinated Voting Shares which are entitled to one vote each, and 2) Class “B” shares which are each entitled to ten votes. Mr. Jean Coutu, founder, maintains 100% interest of the Class “B” shares, which represents over 90% of the company’s total voting rights.

Growth Strategy & Outlook: keeping it simple Since exiting the U.S. drugstore sector through the sale of its Eckerd stores to Rite Aid in June 2007 for $2.36bn in cash and 250mn RAD shares, Jean Coutu has embraced the simpler life of growing its business in Canada. The earnings growth strategy has been built on a few basic strategies: 1) increased square footage growth, 2) Pro Doc generic drug vertical integration, 3) selective share buybacks, and 4) dividend increases. This simple formula has contributed to a share price gain of 216% since the lows in November 2008, with most of this gain occurring in 2011(+38% versus a TSX decline of 11% ).

Smaller average store size continues to be a growth opportunity. Jean Coutu’s average store size as of year-end F2010 was approximately 7.3k sq ft vs. Shoppers Drug Mart at 10.1k sq ft. Although the pace of square footage growth has slowed following the recent drug reforms in Quebec, PJC has continued to pursue square footage growth (4%-4.5% per year versus an initial 8%-9%). This in part is achieved through upgrading and expanding its materially smaller stores compared to its competitors. The sale of the Brooks Eckerd stores to Rite Aid has also resulted in a much improved balance sheet for PJC, which put the company in a good position to invest in its store network.

Acquisition of Pro Doc enabled PJC to have a greater participation in growing generics penetration. In addition to its franchise/wholesale business, Jean Coutu also has a generic manufacturing/distribution company called Pro Doc which it acquired at the end of 2007, immediately following the drug reform in 2006. Pro Doc facilitates the approval, packaging and sale of generic molecules predominantly on behalf of third-party generic manufacturers. Since being acquired by Jean Coutu, the majority of Pro Doc’s customers are Jean Coutu franchisees. As a generic drug manufacturer/supplier, Pro Doc has helped PJC partially mitigate the negative impacts from the Quebec drug reforms. More specifically, the mandated reductions in professional allowances results in some cost savings for Pro Doc.

Pro Doc’s growth prospects look more limited post F2012. The Pro Doc acquisition was a “home run” for Jean Coutu. Pro Doc has been a major contributor to top-line and margin growth over the past two years. With Pro Doc’s sequential revenues having peaked a year ago (F3Q11) it appears that the year-over-year PJC franchise network penetration gains and molecule expansion do not have enough upside to offset the generic price drain. This may limit earnings growth to the contribution of professional allowance cuts, which in Quebec will have been fully deployed by spring 2013.


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Figure 127: Quebec drug reform phase-in schedule

2009 2010 2011 2012 2013 2014

QuebecGeneric reimbursement rate 50% 37.5% 37.5% 30% 25% 25%

wholesale markup on generics 5.0% 6.0% 6.3% 6.5%

Dispensing fees $7.89 $7.89

Professional Allowances 20% 20% 16.5% 15%

private label generics no restrictions

Source: Quebec government filings

When fully deployed, we expect the mandated professional allowance cuts to result in $32mn in savings for Pro Doc. However, this will largely be offset by the loss in gross profit due to lower generic selling prices.

Figure 128: Estimated drug reform impact on Pro Doc ($M)

F2011E F2012E F2013E F2014E CumulativeOIBA ImpactLost Gross Profit due to lower generic drug selling price -$3.7 -$14.9 -$13.6 -$7.8 -$40.0Reduced professional allowances $2.1 $10.2 $13.9 $6.0 $32.1Total -$1.7 -$4.7 $0.2 -$1.8 -$7.9

Net Income ImpactLost Gross Profit due to lower generic drug selling price -$2.6 -$10.7 -$9.8 -$5.6 -$28.7Reduced professional allowances $1.4 $7.3 $10.0 $4.3 $23.1Total -$1.2 -$3.4 $0.2 -$1.3 -$5.6

EPS Impact - Net -$0.01 -$0.02 $0.00 -$0.01 -$0.03Source: Company reports, Barclays Capital estimates.

Specific details regarding Pro Doc’s penetration rate are limited; however, the most recent data point provided by management (in 2Q11) indicated that Pro Doc offered over 300 molecules or roughly 80% of generics available in the market. Management has also indicated that Pro Doc will not carry every molecule in the market. As such, we do not see material growth remaining in Pro Doc’s offering (beyond new drugs coming off patent). As shown in Figure 129, Pro Doc’s revenue growth has slowed over the past four quarters. While the price reductions were largely driven by drug reforms, we would have expected this to be partly mitigated by volume growth (total script growth in 3Q12 was up 7%, which would imply even stronger growth for generic drugs).


25 January 2012 130

Figure 129: Pro Doc Gross Sales ($ mn)

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Sharing the pain of drug reforms. In response to the 2006 drug reform and subsequent recession, PJC has materially lowered its royalty rate. Management has indicated that the company has temporarily lowered royalty rates on new or expanded stores as a form of support to the franchisee given that they had to invest in the leasehold improvement, increased inventory and are paying more on rent (in the case of an expanded store).

Figure 130: PJC royalty rates have fallen dramatically

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Increasing returns to shareholders through share buybacks. PJC continues to generate strong free cash flow. In addition, the company has recently reduced its holdings of Rite Aid (26.1%, down from 28.3%) which generated additional liquidity. In 2Q12, PJC sold 17.6mn RAD shares for total consideration of $22mn.

PJC’s solid financial position and strong free cash flow generation has enabled the firm to actively repurchase shares, which has generated incremental EPS growth. PJC’s current NCIB permits the company to repurchase up to 10.4mn Class “A” shares (10% of outstanding), expiring May 3, 2012. Since initiation of the program, PJC has bought back 8.7mn shares. Management has indicated that it intends to fully execute on the NCIB. We note that the company has stepped up its buyback activity as it had only repurchased

Reducing its holding of RAD shares has increased free cash

flow…

…which can be used to buy-back shares


25 January 2012 131

6.8mn of the 11.1mn shares permitted under its previous NCIB which expired on May 3, 2011.

Figure 131: Jean Coutu Free Cash Flow Summary ($ mn)

Fiscal Year (Feb) 2009 2010 2011 2012E 2013E 2014E

Operating Cash Flow $175 $215 $221 $288 $241 $256Change in W/C -$31 -$8 -$8 -$7 -$9 -$9

Cash from Operations $144 $207 $213 $281 $232 $248Capex -$49 -$47 -$44 -$45 -$45 -$45

Free Cash Flow $95 $160 $169 $236 $187 $203

Dividends -$39 -$43 -$51 -$61 -$63 -$66

Net Change in Share Capital -$91 $3 -$61 -$124 -$141 -$152

Acquisitions $0 -$7 -$5 -$5 -$20 -$20

Net Change in Debt $103 -$75 -$15 -$56 -$61 -$63

Remaining cash flow $68 $38 $37 -$10 -$98 -$98

Free Cash Flow per share $0.28 $0.16 $0.16 -$0.04 -$0.46 -$0.48

Free Cash Flow Yield 3.5% 1.7% 1.7% -0.4% -3.4% -3.6%

ROE (ex-RAD) 12.4% 33.9% 32.8% 32.1% 32.8% 35.1%Source: Company reports, Barclays Capital estimates.

Risks Due to Quebec’s “Lowest Price in Canada” statute on drug prices, further government

policy changes affecting pharmacy profitability from any province in Canada will negatively impact the majority of Jean Coutu’s pharmacies.

Further economic weakness would lead to intensified price promotion.

An expected increase in Quebec’s Rx dispensing fees could be supportive of the share price.


25 January 2012 132

Figure 132: Jean Coutu Financial Performance Summary

GAAP GAAP IFRS IFRS IFRSf2009 2010A 2011A 2012E 2013E

Revenue ($ Millions) $2,377 $2,556 $2,613 $2,671 $2,749 Total Revenue Growth (%) 7.5% 2.2% 2.2% 2.9% Square Footage Growth (%) 7.5% 6.3% 7.3% 5.0% 4.5% Total Same Store Sales (%) 3.8% 4.5% 1.6% 1.8% 2.5% Front End Same Store Sales Growth (%) 1.2% 2.8% 0.3% 2.0% 1.9% Prescription Same Store Sales Growth (%) 5.4% 5.7% 1.9% 1.6% 2.9%

Gross Margin 18.2% 19.0% 19.9% 20.3% 20.7%SG&A as a % of Revenue 8.4% 8.5% 8.8% 8.8% 8.9%EBITDA Margin 9.8% 10.5% 11.1% 11.5% 11.8%

Gross Margin Variance -16 bps 74 bps 97 bps 32 bps 45 bpsSG&A Variance 19 bps 2 bps 34 bps -4 bps 14 bpsEBITDA Variance -35 bps 72 bps 63 bps 36 bps 31 bps

Net Debt/EBITDA (LTM) 1.2x 0.8x 0.7x 0.7x 0.7xCapex as a % of Sales (LTM) 2.1% 1.8% 1.5% 1.7% 1.6%Free Cash Flow ($ Millions, After Capex/WC) $95 $160 $160 $172 $189Return on Equity (ex RAD) 12.4% 33.9% 31.3% 32.1% 32.8%Return on Invested Capital (ex-RAD) 10.0% 23.5% 23.2% 24.2% 24.1%

Source: Company Reports, Barclays Capital estimates Note: Growth comparisons between 2011/2010 are presented in GAAP, raw figures/margins are presented in IFRS


25 January 2012 133

COMPANY SNAPSHOT

Jean Coutu Group Canadian Consumer & Retail

Income statement ($mn) 2011A 2012E 2013E 2014E CAGRRevenue 2,613 2,675 2,753 2,891 3.4% Stock Rating 2-EQUAL WEIGHTEBITDA 289 307 324 345 6.1% Sector View 2-NEUTRALEBIT 261 277 292 310 5.9% Price (20-Jan-2012) $13.27Pre-tax income 259 275 290 308 5.9% Price Target $14.00Net income 181 219 209 221 7.0% Ticker PJC.AEPS (reported) ($) 0.77 0.88 0.98 1.09 12.1%Diluted shares (m) 234 224 214 203 -4.5% Investment case


Margin and return data (%) AverageEBITDA margin 11.0 11.5 11.8 11.9 11.6EBIT margin 10.0 10.3 10.6 10.7 10.4Pre-tax margin 9.9 10.3 10.5 10.6 10.3Net margin 6.9 8.2 7.6 7.7 7.6ROA 17.4 20.6 18.9 19.5 19.1ROE 31.3 35.7 32.8 35.1 33.7 Upside case $15.00

Balance sheet and cash flow ($mn) CAGRTangible fixed assets 362 386 419 449 7.4%Total assets 1,060 1,094 1,122 1,156 2.9%Short and long-term debt 201 199 232 264 9.5%Total liabilities 461 456 484 511 3.5%Net debt/(funds) 201 199 232 264 9.5%Shareholders' equity 598 639 638 645 2.5% Downside case $12.00Change in working capital (8) (5) (7) (9) NAOperating cash flow 214 283 234 247 5.0%Capital expenditure 44 45 45 45 0.8%Free cash flow 118 182 129 139 5.5%

Valuation and leverage metrics AverageP/E (x) 17.2 15.1 13.6 12.2 14.5 EV/EBITDA (x) 11.5 10.4 9.5 8.6 10.0 Upside/downside scenarios

FCF yield (%) 3.8 6.1 4.5 5.1 4.9Price/sales (x) 1.2 1.1 1.0 0.9 1.1 Price/BV (x) 5.2 4.7 4.5 4.2 4.6 Dividend yield (%) 1.7 1.9 2.1 2.3 2.0Total debt/capital (%) 25.2 23.8 26.6 29.1 26.2Total debt/EBITDA (x) 0.7 0.7 0.7 0.8 0.7

Selected operating metricsFront-end SSS (%) 0.3 2.0 1.9 2.6 1.7Rx SSS (%) 1.9 1.6 2.9 3.9 2.5 Source: FactSet

RX as a % of sales 63.0 63.1 63.4 63.6 63.3 Same Store SalesCapex as % of sales 1.7 1.7 1.6 1.6 1.6

Source: Company data, Barclays Capital Note: FY end Feb.

PJC has relatively modest exposure to drug reform;strong FCF, which is being used to buy back stock;and commitment to new store growth, which hashelped offset the drain of drug reform throughstrong script growth. However, as a result of sectorleading price appreciation, we view PJC as fullyvalued at 14.5x P/E.

Our Upside case reflects increased sales andprofitability at Pro Doc driven by higher loyalty rateby franchisees. In this scenario, we estimatepotential 2013E EPS of $1.03. Applying a 15x P/Ewould generate an Upside share price of $15.

Increasing economic weakness could lead tointensified price promotion. In this scenario, weexpect lower wholesale sales of front-endmerchandise and lower royalty rates to supportfranchisees. Our downside case is based on 12xpotential 2013E EPS of $0.89.

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

2011A 2012E 2013E 2014E

Front-End Rx

DownsideCase

$12(-8.46%)

PriceTarget

$14(6.7%)

UpsideCase

$15(14.4%)

4

9

14

19

1/27/2011 1/20/2012

DownsideCase

$12(-9.57%)

PriceTarget

$14(5.5%)

UpsideCase

$15(13.0%)

4

9

14

19

1/27/2011 1/20/2012


25 January 2012 134

DISCRETIONARY RETAILERS


25 January 2012 135

CANADIAN TIRE CORP.

Canadian Tire Corp., Ltd.(CTC-A.TO): Quarterly and Annual EPS (CAD)

2010 2011 2012 Change y/y






Year 4.89A N/A 5.24E 5.47E N/A 6.14E 6.17E 7% 17%

P/E 13.0 12.2 10.4


FactSet

Recommendation and Valuation

We are initiating coverage of Canadian Tire (CTC) with a 1-Overweight/2-Neutral rating and $74 price target, offering a total potential return of 18% from recent levels. Despite our cautious macro outlook and bias toward defensives, we believe Canadian Tire’s attractive valuation offers investors an attractive risk/reward play on the eventual turn in consumer discretionary spending. Canadian Tire is the least expensive stock in our coverage trading at 10x forward P/E, which is at 23% discount to its long-term average of 13x. We are applying a conservative target multiple of 12x on our F2013 EPS estimate to reflect the earnings uncertainty of the recent consumer spending pullback which is expected to constrain sales growth. We have reflected the potential drain of unseasonably warm/dry winter weather on CTC’s seasonal sales/margins at all three retail banners in our below consensus 4Q11 forecast and expect consensus to drop as we get closer to the quarterly release. While we acknowledge the immediate-term downside risk of a Q4 earnings miss and the patience required while waiting for an improved consumer spending outlook (2H12) we believe the risk/reward at 10x P/E is attractively weighted.

Figure 133: Canadian Tire Forward P/E Valuation

YE Dec. 31 2012 2013 CommentsBarCap est BarCap est

EPS range $6.06 $6.14 $6.21 $6.73 $6.81 $6.88Growth vs PY 15.6% 17.1% 18.4% 9.6% 10.9% 12.1%P/E Multiples:

8.0x $48 $49 $50 $54 $54 $55 <= Trough multiple9.0x $55 $55 $56 $61 $61 $62

10.0x $61 $61 $62 $67 $68 $69 <= Current multiple11.0x $67 $68 $68 $74 $75 $7612.0x $73 $74 $75 $81 $82 $83 <= BarCap target multiple13.0x $79 $80 $81 $88 $89 $89 <= Long-term Avg P/E14.0x $85 $86 $87 $94 $95 $9615.0x $91 $92 $93 $101 $102 $10316.0x $97 $98 $99 $108 $109 $11017.0x $103 $104 $106 $114 $116 $117 <= Peak multiple


We believe the risk/reward at 10x P/E is attractively weighted

CTC/A CN / CTC-A.TO

Stock Rating 1-OVERWEIGHT



Price (20-Jan-2012) CAD 63.70



25 January 2012 136

Figure 134: Canadian Tire (CTC-A.TO) Forward P/E Multiple Trend

8x9x

10x11x12x13x

14x15x16x

17x18x

2005 2006 2007 2008 2009 2010 2011 2012

Avg 12.7x

Max 16.7x

Min 8.3x


Canadian Tire’s share price has typically moved in lockstep with the U.S. department store stocks. As shown in Figures 135 and 136, Canadian Tire’s share price and valuation have exhibited similar trading patterns over an extended period. Since 2005, Canadian Tire’s forward P/E traded at an 8% average discount to a select group U.S. department stores (Macy’s, JC Penney and Nordstroms). Currently, Canadian Tire trades at a 32% discount relative to the group. Should Canadian Tire’s valuation discount revert back to its long-term mean versus the U.S. department stores, this would imply a forward P/E multiple of 14x which is more reflective of a recovery multiple. We believe a 13x-14 x P/E multiple for Canadian Tire is achievable once investors are convinced that a resurgence in consumer discretionary spending is imminent. We believe Canadian Tire’s shares will move quickly once a sense of recovery takes hold so it’s important to establish a position well in advance.

Shares could move quickly once a sense of recovery takes hold

Figure 135: CTC vs. US Dept. Stores Price Change since 2000

Figure 136: CTC vs. US Dept. Stores Forward P/E since 2005

-100%

-50%

0%

50%

100%

150%

200%

250%

2000 2002 2004 2006 2008 2010 2012

Canadian Tire Department Stores

0x

5x

10x

15x

20x

25x

2005 2006 2007 2008 2009 2010 2011 2012

Canadian Tire Department Stores

Source: Factset (US Dept. Stores consists of Macy’s, JC Penney and Nordstroms) Source: FactSet.


25 January 2012 137

Figure 137: Specialty Retailers Comparison Valuation

Price Market Fiscal EPS PE EPS GrowthTicker 20/01/12 Cap ($M) FY0 FY1 FY2 FY0 FY1 FY2 FY0-FY1 FY1-FY2 FY0-FY2

Home Improvement RetailersRONA RON $9.55 $1,215 $ 1.03 $ 0.74 $ 0.93 9.3x 12.9x 10.3x -28.0% 24.9% -10.1%

Home Depot HD $44.51 $68,615 $ 2.01 $ 2.39 $ 2.74 22.1x 18.6x 16.2x 18.8% 14.7% 36.3%

Lowe's LOW $26.53 $33,230 $ 1.42 $ 1.61 $ 1.78 18.7x 16.4x 14.9x 13.6% 10.5% 25.5%

Home Improvement Retailer Average 14.8x 15.5x 13.0x -7.4% 21.0% 10.0%

General Merchandise

Canadian Tire CTC/A $63.70 $4,970 $ 5.56 $ 5.47 $ 6.15 11.5x 11.6x 10.4x -1.6% 12.5% 10.7%

Wal-Mart WMT $61.01 $208,941 $ 4.18 $ 4.49 $ 4.91 14.6x 13.6x 12.4x 7.4% 9.3% 17.4%

Target TGT $50.17 $33,694 $ 4.00 $ 4.24 $ 4.30 12.5x 11.8x 11.7x 5.9% 1.4% 7.4%

Sears Holdings SHLD $49.00 $5,237 $ 1.19 $ (5.10) $ (4.86) 41.2x na na -528.2% -4.6% -508.5%

Kohl's KSS $47.37 $12,005 $ 3.66 $ 4.24 $ 4.95 12.9x 11.2x 9.6x 15.9% 16.6% 35.2%

Nordstroms JWN $50.02 $10,475 $ 2.75 $ 3.13 $ 3.58 18.2x 16.0x 14.0x 13.7% 14.5% 30.3%Dillards DDS $46.21 $2,136 $ 2.67 $ 3.91 $ 4.65 17.3x 11.8x 9.9x 46.3% 19.1% 74.3%

Macy's M $35.38 $14,853 $ 1.98 $ 2.79 $ 3.23 17.9x 12.7x 11.0x 41.0% 15.7% 63.2%

JC Penney JCP $35.09 $7,493 $ 1.59 $ 1.25 $ 1.66 22.1x 28.1x 21.2x -21.5% 32.9% 4.3%

General Merchandise Average 18.0x 14.3x 12.3x -42.5% 13.5% -25.3%Source: FactSet, Barclays Capital estimates. EPS estimates are consensus from FactSet.

Company Profile Canadian Tire Corp. (CTC) is a unique multi-line retailer that operates a total of over 1,700 store locations across Canada under four major business units: Canadian Tire (a Dealer structure), Mark’s, CT Petroleum and Forzani Sports (Corporate and franchised), which it acquired in August 2011. CTC also operates a Financial Services business as a Schedule One bank and a credit card issuer.

Figure 138: Canadian Tire – Store Network

East Quebec Ontario West Total Sq. Ft. (M)

Canadian Tire 54 98 200 134 486 19.5

Forzani 30 177 147 174 528 6.5

Mark's 41 48 147 149 385 3.3

CT Gas 33 59 161 38 291 -

PartSource 3 - 59 25 87 0.3


Canadian Tire is Canada’s No. 1 retailer of auto parts through its 486 Canadian Tire retail stores and 87 Part Source (specialty stores for serous DIYers) locations. Canadian Tire also services Canadian’s auto needs through a network of 5,500 service bays across Canada (predominantly located in CTR stores) and a network of 291 gas stations across Canada.

Canadian Tire’s recent acquisition of sporting goods market share leader Forzani Group (roughly 20% market share) has made Canadian Tire the dominant leader in the category with an estimated combined share of 32%

Mark’s is Canada’s largest specialty retail apparel banner with an estimated market share of 4%-5% of total apparel sales. CTC acquired Mark’s in 2002.


25 January 2012 138

Founding family member controls 61% of the votes, but only 4% economic interest. Canadian Tire has a dual class share structure that primarily restricts voting to the 3.4mn common voting shares that are predominantly controlled by Martha G. Billes, daughter of the founder (61.4% voting control, but only 3.5% total economic interest). Class A shares are restricted to voting on the election of three of the 16 directors.

Figure 139: Canadian Tire – Company Snapshot

Canadian Tire Corp.

Total Retail Segment Financial Services

F2012E CTR Mark's Forzani Petroleum

Retail Sales $12,800 $7,828 $1,055 $1,653 $2,264

% of total 100% 61% 8% 13% 18%

Operating Revenue* $11,441 $5,869 $1,011 $1,446 $2,066 $993

% of total 100.0% 51.3% 8.8% 12.6% 18.1% 8.7%

EBITDA $1,155 $842 $313

% of total 100% 73% 27%

Products/CategoriesGeneral retailer;

automotive parts/services

Industrial apparel, Men's & Women's

casual wear

Specialty sporting goods; footwear;

apparel

Gasoline; c-stores; car washes

MasterCard; high-interest savings accounts; GICs

*net of eliminations and adjustments Source: Company reports, Barclays Capital estimates.

A brief background Canadian Tire’s core retail business is Canadian Tire Retail (CTR) which is one of Canada’s best-known and often-shopped retailers. Canadian Tires appeal and resilience in the face of growing competition is its status as a trusted brand, its unique product offering, its modern store network and global sourcing capabilities. Canadian Tire retail operates 486 stores across Canada under a dealer structure (see details later in this report). Canadian Tire’s store network reach is more extensive than most of its Big Box competitors such as Wal-Mart Canada (330 stores), Zellers (273 stores), Home Depot (179 stores), and Rona (80 Big box stores). Typically, over 80% of Canadian consumers have shopped the store in a 12-month period and 50% to 60% shop there every month. The average consumer lives 12 minutes away from a Canadian Tire. Canadian Tire’s retail banner carries a unique merchandise mix with auto parts representing approximately 26% of CTR’s approximately $7bn of retail sales, Home products (Living & Fixing), about 38%; and Leisure (Playing; includes sporting goods), roughly 36%. Canadian Tire is the dominant auto-parts retailer in Canada, and more recently following the acquisition of Forzani Group, Canada’s leading sporting goods retailer.

Just when you thought it couldn’t get any tougher, Wal-mart and Target turn up the heat. Over the past 20 years Canadian Tire’s core retail banner has been under siege as a flurry of “best in class” U.S. retailers entered and aggressively expanded its footprint in Canada offering customers compelling, often industry-leading consumer propositions in many of Canadian Tire’s established core categories (e.g., housewares and hardware/tools). From 1994 to 2010 these retailers have opened over 500 stores.

As if the economy wasn’t making things challenging enough for Canadian Tire, in January, through two separate transactions, the ownership of 188 Zellers locations was transferred to Wal-Mart (39) and Target (149) marking the latter’s entry into Canada. This change of

Over 80% of Canadian consumers have shopped the

store in a 12-month period and 50%-60% every month


25 January 2012 139

ownership of almost 15mn sq. ft. of retail space is expected to have significant implications for many of Canada’s leading retailers as it places underperforming square footage in the hands of two “best-in-class” retailers which are expected to generate substantially higher sales productivity in several categories that represents a material threat to many established retailers in Canada.

Figure 140: Estimated sales productivity lift of redeployed Zellers’ locations

TGT WMT Remaining Increase

Zellers Canada Canada Zellers TOTAL vs Zellers

Store count 273 135 39 85 259 -5%

Avg store size - sf 78 83 83 68 78 1%

Sales / selling sf. $189 $440 $545 $189 $385 104%

Sales estimate $4,000 $4,930 $1,764 $1,092 $7,786 95%


For Wal-Mart the 39-store acquisition represents almost a doubling of its Supercenter banner rollout pace from 40 per year to 73 in 2012. As for Target, fortunately for Canadian Tire, Target’s core category strengths do not have a significant overlap with Canadian Tire’s key categories. Small appliances, kitchenware, storage and ready-to-assemble furniture appear to be the most at risk categories.

Wal-Mart’s (and maybe one day, Target’s) focus on food sales growth is the real risk to Canadian Tire through a change of shopping habits. Over time, Canadian Tire’s biggest risk is a shift of shopping habits and customer traffic due to Wal-Mart’s growing food sales. As Wal-Mart establishes the Supercenter banner across Canada they benefit from securing the significantly greater shopping frequency of weekly food shopping. Over time these more regular trips to Wal-Mart can erode a customer’s need, or interest, in going to Canadian Tire for commonly available merchandise. This scenario could gradually erode Canadian Tire’s ranking on consumers’ short list of retail destinations for household needs.

With the landscape changing, Canadian Tire needs to bolster its uniqueness and category dominance in sectors that can remain differentiated versus Wal-Mart and Target’s core offerings. It is also why we believe Canadian Tire will continue to explore its own entry into food sales. While initially Target will not be placing a major emphasis on food sales, as the Zellers stores are materially smaller than Target’s U.S. conventional stores, we do expect them to, eventually. Once Target’s initial sales ramp-up slows 2-3 years after it first opens it will get a better handle on what its optimal merchandise mix is and what space allocation is required. Once it has that figured out we expect it to begin looking for incremental sales growth opportunities – at that time we expect food to take on a greater priority.

For now, to say that Canadian Tire survived the onslaught of the past 20 years would be an understatement as in many respects it has remained top of mind and relevant as a retail destination. Unfortunately, one of the casualties of the successful defence of its home turf has been a deterioration of the company’s profitability and return on equity in its core retail operations. This has occurred despite the successful and very accretive acquisition of Mark’s Work Wearhouse in 2002. As the Figure below demonstrates, the earnings growth at Mark’s and Financial Services has more than doubled the core Retail performance.

Not a lot of overlap with Target..

...for now, but Target’s focus and consumer shopping habits could

change


25 January 2012 140

Figure 141: Canadian Tire segmented EBITDA growth

2003A 2004A 2005A 2006A 2007A 2008A 2009A 2010A7-yr

CAGRAdj. EBITDA* ($millions)CT Retail $403.5 $472.1 $517.8 $523.8 $509.1 $524.7 $533.4 $565.2 4.9%Marks $41.0 $54.8 $83.5 $112.8 $118.4 $115.9 $91.7 $89.4 11.8%Petroleum $10.5 $10.5 $21.8 $10.4 $39.9 $44.3 $42.9 $41.7 21.8%Financial Services $123.5 $149.4 $171.4 $212.3 $200.5 $221.6 $218.7 $269.4 11.8%

*Cdn. GAAP basis (pre-IFRS and new company segmentation presentation) Source: Company Reports, Barclays Capital estimates

Growth Strategy & Outlook: improve retail performance & returns In November 2008 Canadian Tire announced the appointment of Stephen Wetmore as CEO replacing Tom Gauld, a long-standing Canadian Tire employee, who had previously run the company’s Financial Services business. Mr. Wetmore had previously been CEO of Bell Alliant, a large Canadian telecommunications company. Prior to his appointment as CEO of Canadian Tire he had been a Canadian Tire board member for six years.

In short order, Mr. Wetmore confirmed that his strategic priority was to strengthen the Canadian Tire retail business and to improve the profitability/returns of the company’s retail operations. Canadian Tire’s management team provided details of this strategy to investors when they presented their new five-year strategic plan in April 2010.

The top priority is to strengthen the Canadian Tire retail business and generate higher returns on the total retail business. The company’s primary objective is to strengthen the core retail business and improve productivity. CTC’s financial aspirations are shown below. Unfortunately, the extended economic slowdown has already hampered Canadian Tire’s achievement of these aspirational targets, but the company has made respectable progress on a number of its objectives and strategies.

Figure 142: Canadian Tire’s Financial Aspirations

Financial Measure Aspirations

CTR retail sales annual growth 3% - 5%

Adj. EPS annual growth 8% - 10%

Retail ROIC 10%+

Financial Services return on receivables 4.5% - 5.0%

Total return to shareholders 10% - 12%


The strategy’s key priorities are as follows:

1. Increase the company’s focus on the core retail business to ensure its long-term relevance and success.

2. Improve the customer experience to bolster the brand and attract more customers.

3. Increased focus on Automotive – the company is aggressively working to improve the quality and breadth of its automotive relationship with customers across a broad spectrum of initiatives. Key programs include the roll-out of a new, more robust auto-parts IT software platform, an expanded tire offering and a commercial on-line website program.


25 January 2012 141

4. The Financial services operations will place an increased focus on developing products and services that support the strengthening of Canadian Tire retail such as in-store financing, customer loyalty, the introduction of insurance products such as extended product warranties and potentially auto insurance.

5. Execution…execution…execution – Canadian Tire needs to execute better and faster.

6. Aggressively pursue productivity and efficiency programs that improve profitability and financial performance.

Improve the customer experience & investment returns

Since the unveiling of the new strategic plan Canadian Tire has made real progress on a number of these objectives/strategies.

1. A September 2010 reorganization along more functional lines resulted in headcount reductions and other synergies that were estimated to generate cost savings of $0.11 at EPS in F2011.

2. Critical Automotive software upgrade is being rolled out with completion targeted for 1Q12. This new IT platform is a key enabler of many other initiatives that Canadian Tire would like to pursue in its auto parts and service business.

3. Canadian Tire retail expects to retrofit 170 stores to the improved “Smart store” concept by the end of F2011 with another 100 planned for 2012 which would bring over 55% of the store network “on prototype”.

4. The Forzani acquisition significantly enhances Canadian Tire’s market position in this sector and inevitably the profitability of the category. We also believe that this increased market dominance may create a permanent deterrent to the potential entry of a U.S. retailer.

5. Expanded/enhanced CTR’s retail tire offering and launched an on-line tire order website.

6. Initiated the development of a new loyalty program with Dunnhumby Canada, one of the world’s best retail loyalty program consulting companies, which is expected to be tested in early 2012.

While financial services achieved a faster-than-expected recovery of elevated net write-off rates which significantly improved CTC’s earnings growth and profitability, the sluggish economy has been more of a headwind than tailwind in many of the company’s more discretionary retail categories.

Smart stores are designed to improve productivity and the shopping experience. The Canadian Tire store concept continues to evolve with the “Smart” store representing the latest iteration of the Canadian Tire Retail box. First launched in November 2008, the Smart store was designed to build off the previous Concept 20/20 design with more focus on improving productivity. The concept, so far, has proven successful, with positive feedback from customers and Canadian Tire dealers. In addition to driving incremental sales, a Smart store retrofit is capital-light (costing less than $300k per store) which is positive from an ROIC perspective. As improving ROIC remains a top priority for the company, management has set an aggressive growth target of retrofitting 170 stores by the end of 2011 and completing approximately 100 capital-light projects in 2012.


25 January 2012 142

Small Market stores also require less capital. Launched in summer 2008, the Small Market store was developed to meet the needs of underserved rural markets. Ranging from 14,000 to 19,000 sq. ft., the small market stores represent another capital-light concept offering strong returns with minimal capital outlay. Where feasible, a small market store may include a Mark’s outlet and/or Petroleum gas bar. As of 3Q11, there were 13 small market stores.

Automotive: refocusing on growing this cornerstone business. Canadian Tire’s automotive business is one of its most profitable categories, partly due to the company’s dominance of the retail DIY segment in Canada. The retail automotive aftermarket in Canada is estimated to be a $22bn market consisting of a DIY segment of approximately $6bn and “do-it-for-me” (DIFM) sales of $16bn. Canadian Tire’s automotive parts sales are estimated be in the range of $1.8-$2 billion, which excludes the dealers’ auto bay service sales, making Canadian Tire the industry leader in DIY parts, auto accessories and installed tires. After a surprisingly slow Fall 2010, the retail auto sector in Canada has experienced robust sales aided by: 1) tight-fisted consumers who have shifted from DIFM to DIY, 2) more cars on the road are driving volume growth, and 3) longer average miles driven per car require more maintenance.

Figure 143: Automotive parts sales trends have improved in 2011

Canadian Auto Parts/Accessories/Tire Store Sales Growth (NSA)

-10%

-5%

0%

5%

10%

15%

20%

1Q-0

52Q

-05

3Q-0

54Q

-05

1Q-0

62Q

-06

3Q-0

64Q

-06

1Q-0

72Q

-07

3Q-0

74Q

-07

1Q-0

82Q

-08

3Q-0

84Q

-08

1Q-0

92Q

-09

3Q-0

94Q

-09

1Q-1

02Q

-10

3Q-1

04Q

-10

1Q-1

12Q

-11

3Q-1

1

Source: StatsCan, Retail trade data.

The company is committed to securing Canadian Tire’s position as Canada’s authority in Automotive. One of the first steps toward this goal has been the Automotive Infrastructure initiative that was launched in 2008, which was intended to improve the automotive customer experience at Canadian Tire and PartSource stores. This initiative involves three components:

1. Significantly expand the auto parts assortment and replace aging IT with a commercially available, decision rule and predictive modelling based solution;

2. Upgrading CTR’s legacy “green screens” with Windows-based automotive management software and data management software to establish a more interactive customer experience;

3. Create a network of PartSource hub stores across Canada to enhance supply of auto parts at the local market level.

Canadian Tire is the industry leader in DIY parts, auto

accessories and installed tires


25 January 2012 143

The final roll-out of the Automotive Infrastructure project is expected to be completed by 1Q12. In addition to the Auto Infrastructure initiative, Canadian Tire has recently launched an online tire website and opened four Automotive concept stores.

The company has not provided an update of the financial benefits from the Automotive Infrastructure investment. However, we note management’s initial expectations when the project was announced which projected the program to generate $120-$130mn in incremental auto parts sales by 2010 and increasing to over $200mn by 2014. The associated pre-tax earnings contribution was estimated to be $15-$20mn by 2010, growing to an estimated $45-$50mn by 2014. While it seems that the economy and system rollout timing has probably delayed the achievement of the targeted sales gain if this program does generate the intended sales lift it could increase CTC’s EPS by $0.36 to $0.40 to EPS by 2014.

Forzani Sports provides Canadian Tire with increased category dominance, which means significant synergies and improved retail profitability. Canadian Tire completed the acquisition of Forzani in August 2011. CTC paid $26.50 per FGL share (a 45% premium to FGL’s prior 10-day VWAP) for an aggregate purchase price of $771mn (excluding FGL net debt/shares already owned). The acquisition was financed with $500mn in cash and the balance in short-term financing. While CTR already participates in the sporting goods category with an estimated share of 12%, the Forzani acquisition significantly increases Canadian Tire’s market share and sector dominance with a very complementary product mix. We expect both CTR and Forzani’s retail operations to benefit from this merger. Forzani’s profitability will benefit from Canadian Tire’s superior transportation, marketing and real estate clout. Both organizations offer some potentially powerful imported product sourcing expertise – Canadian Tire through its direct import operations and Forzani through its ownership stake in the European based Intersport organization.

Figure 144: Canadian Tire Category Importance

Category Importance Market Footwear Clothing Equipment Total share

Forzani 31% 40% 29% 100% 22%

Canadian Tire 4% 2% 94% 100% 12%

Combined CTC 21% 27% 52% 100% 34%

Source: .Barclays Capital estimates, Company Reports, Sports Vision

Preliminary synergy target set at $25mn in 2012, increasing to a run rate of $35mn in 2014 – we expect the final number to be materially higher. Management expects to capture synergies in areas like supply chain, marketing and global sourcing. Annualized synergies are expected to be approximately $25mn in 2012, increasing to a run-rate of approximately $35mn in 2014. We believe this number could prove to be substantially higher as Forzani management was already well down the path of planning banner rationalization and related centralized services overhead reductions prior to the CTC takeover. At a valuation of 7.3x EV/LTM EBITDA, we believe CTC paid a hefty premium for Forzani; however, the deal is expected to be accretive to earnings. Including synergies, we estimate that the acquisition could add $0.48 to EPS (~8% accretion) with a strong possibility that the synergies will come in above the company’s preliminary estimate.

Of equal, or greater, importance we believe that CTC’s new combined purchasing power scale could be a major deterrent to new entrants as it will be difficult for them to achieve

Including synergies, we estimate that the Forzani acquisition

could add $0.48 to EPS


25 January 2012 144

comparable expense rates in areas such as domestic sourced product costs, rent, transportation and marketing expenses.

Figure 145: Forzani acquisition is earnings accretive to CTC

F2012E

$ millions Forzani adj. Total

Revenues $1,446.3 $1,446.3

Synergies $25.0 $25.0

EBITDA $87.2 $112.2

Net Income $39.1

EPS $0.48 Source: Company reports, Barclays Capital estimates.

Enhancing customer loyalty. Canadian Tire money is already one of Canada’s best known and most successful loyalty programs. Unfortunately, the paper currency does not allow Canadian Tire to capture valuable customer information from the over one million points of customer transaction data and feedback it receives each day.

In early 2012, Canadian Tire will begin piloting a new loyalty program that is expected to provide deeper customer insight. Canadian Tire has retained Dunnhumby Canada (Metro’s JV partner), a leader in customer insights and analytics to develop the program. Management has not provided specific details of the new program but we expect it to involve an evolution of Canadian Tire money through electronic collection of points.

Financial Services remains a key strategic business unit and has been a major contributor to CTC’s earnings rebound. Management views Canadian Tire Financial Services (CTFS) as a key strategic business segment that supports the core retail unit. CTFS is expected to grow through cross-promotional activity with Canadian Tire Retail including broadening of in-store financing offers, instant in-store credit, and integration with the pending launch of a new loyalty program. While the Canadian Tire MasterCard remains the core product, CTFS is pursuing new product and service offerings such as home services (i.e., garage door opener installations), auto and home insurance, and product warranties.

Figure 146: Canadian Tire Financial Services Summary

2007A 2008A 2009A 2010A YTD 2011Revenue ($M) $760.3 $823.3 $917.7 $953.7 $711.7

Revenue (as % of GAR) 24.78% 24.39% 25.14% 23.60% 23.56%

EBITDA ($M) $200.5 $221.6 $218.7 $274.7 $217.5

EBITDA margin 26.4% 26.9% 23.8% 28.8% 30.6%

Avg. active credit card accounts (000's) 1,816 1,819 1,768 1,716 1,728

Y/Y Growth 0.2% 0.2% -2.8% -2.9% 0.7%

Avg. account balance $1,899.0 $2,031.0 $2,179.0 $2,334.0 $2,341.0

Y/Y Growth 9.4% 7.0% 7.3% 7.1% 0.3%

Net credit card write-off rate 5.76% 6.34% 7.58% 7.51% 7.33%

Gross avg. receivables (GAR) $M $3,650.4 $3,913.0 $4,071.5 $4,041.2 $4,061.1

Return on receivables 5.10% 4.93% 3.57% 4.96% 5.10% Source: Company reports, Barclays Capital estimates.

In early 2012, Canadian Tire will begin piloting a new loyalty

program


25 January 2012 145

Dealer contract set to expire in 2014. In conjunction with the launch of the Automotive Infrastructure initiative in 2008, the company announced a new dealer agreement that expires in 2014. The new agreement included financial adjustments on cost sharing of marketing expenses, shared savings from store-based energy initiatives and participation by Canadian Tire in the growth of dealer profits. At the time of the announcement, management estimated that the new agreement would generate $15-$20mn of incremental pre-tax earnings ($0.13 to $0.17 at EPS), growing to an estimated $80-$100mn by 2014 ($0.68 to $0.85 at EPS). Unfortunately, we believe these benefits have not been as significant as originally expected as a result of the recession.

We have mixed views about this round of negotiations. It really hinges on the quality of the dealer relations as the negotiations begin and what each party is willing to give up. We are encouraged by the fact that previous management was able to negotiate the 2008 deal with some financial benefits to the company, especially when the existing deal was not anywhere near its expiry. We are concerned that perhaps the recession eroded most, or all, of the upside for either party, creating the potential for a less cooperative stance in this round of discussions.

Increasing returns to shareholders. In conjunction with its 3Q11 earnings release, Canadian Tire announced a 9% increase in its quarterly dividend to $0.30 per share following a 31% increase in November 2010. We note that in 2010, Canadian Tire also increased its dividend payout ratio to a range of 20%-25% from 15%-20%.

Risks Canadian economic slowdown would lower sales and financial performance.

Wal-Mart's current build-out and the 2013 entry of Target will increase the competitive intensity of the market, potentially leading to lower sales and margins as promotions increase to drive traffic.

The recent acquisition of Forzani poses integration risks.


25 January 2012 146

Figure 147: Canadian Tire Financial Summary

Canadian Tire - Financial Statement SummaryIFRS IFRS IFRS IFRS2010 2011E 2012E 2013E

Revenue ($ Millions) $9,213 $10,352 $11,371 $11,612 Total Revenue Growth (%) 6.0% 12.4% 9.8% 2.1% CTR Same Store Sales (%) 0.8% 0.8% 1.5% 2.0% MWW Same Store Sales (%) 1.9% 2.1% 2.0% 3.0%

Total Sq. Ft. Growth (%) 0.9% 1.2% 1.5% 1.4% CTR Sq. Ft. Growth (%) 1.6% 1.5% 2.0% 1.9% MWW Sq. Ft. Growth (%) -0.5% 0.8% 1.3% 1.3%

Gross Margin 30.3% 29.6% 30.8% 30.9%SG&A as a % of Revenue 19.3% 19.6% 20.7% 20.9%EBITDA Margin 11.0% 10.0% 10.2% 9.9%

Gross Margin Variance -69 bp 120 bp 5 bpSG&A Variance 32 bp 101 bp 28 bpEBITDA Variance -100 bp 19 bp -24 bp

Net Debt/EBITDA (LTM) 4.2x 4.5x 3.2x 2.6xCapex as a % of Sales (LTM) 2.6% 2.4% 2.8% 2.6%Free Cash Flow ($M, After Dividends/Capex/WC, LTM) $656 $775 $344 $703Return on Equity 10.4% 9.0% 8.1% 7.7%Return on Invested Capital 6.9% 5.7% 5.2% 4.5%



25 January 2012 147

COMPANY SNAPSHOT

Canadian Tire Corp. Ltd. Canadian Consumer & Retail

Income statement ($mn) 2010A 2011E 2012E 2013E CAGRRevenue 9,213 10,352 11,371 11,612 8.0% Stock Rating 1-OVERWEIGHTEBITDA 1,011 1,032 1,155 1,152 4.5% Sector View 2-NEUTRALEBIT 736 748 853 834 4.2% Price (20-Jan-2012) $63.70Pre-tax income 583 601 708 785 10.4% Price Target $74.00Net income 400 429 502 557 11.7% Ticker CTC.AEPS (adjusted) ($) 4.89 5.24 6.14 6.81 11.7%Diluted shares (m) 82 82 82 82 0.1% Investment case



Balance sheet and cash flow ($mn) CAGRTangible fixed assets 3,232 3,353 3,353 3,353 1.2%Intangible fixed assets 361 1,092 1,092 1,092 44.6%Cash and equivalents 569 340 689 1,380 34.4%Total assets 11,049 12,244 12,641 13,070 5.8%Short and long-term debt 3,525 2,471 2,471 2,471 -11.2% Downside case $68.00Other long-term liabilities 137 190 190 190 11.5%Total liabilities 7,044 6,945 5,563 5,596 -7.4%Net debt/(funds) 2,956 2,131 1,782 1,091 -28.3%Shareholders' equity 4,005 5,299 7,078 7,474 23.1%Change in working capital 171 (134) (85) 234 11.1%Operating cash flow 792 1,249 850 875 3.4%Capital expenditure (238) (247) (320) (300) NAFree cash flow 962 1,114 766 1,109 4.8% Upside/downside scenarios

Valuation and leverage metrics AverageP/E (x) 13.0 12.1 10.4 9.4 11.2 EV/EBITDA (x) 8.1 7.1 6.1 5.5 6.7 FCF yield (%) 18.5 21.4 14.7 21.3 19.0Price/sales (x) 0.6 0.5 0.5 0.4 0.5 Price/BV (x) 1.3 1.0 0.7 0.7 0.9 Dividend yield (%) 1.4 1.8 2.0 2.0 1.8Total debt/capital (%) 46.8 31.8 25.9 24.8 32.3

Source: FactSet

Selected operating metrics CTR Same Store Sales vs. Sq. Ft. GrowthCTR Same store sales (%) 0.8 0.8 1.5 2.0 1.3MWW Same store sales (%) 1.9 2.1 2.0 3.0 2.3FGL Same store sales (%) 5.5 -6.2 5.4 3.1 2.0


At 10x f2012 P/E, Canadian Tire is attractively valued compared to its long run average of 13x P/E. Webelieve CTC's valuation will benefit from a modesteconomic recovery in H2/12, as historically, cyclicalstocks experience multiple expansion roughly 6months in advance of an economic rebound. Ourprice target is supported by a 12x P/E.

Stronger-than-expected economic rebound couldsupport more robust CSS and increased grossmargins due to lower price promotions. Under thisscenario, we estimate potential 2012E EPS of $6.85.Applying our 12x P/E multiple would generate anUpside scenario of $82.

Weaker consumer expenditure could constrain retailCSS and pressure margins due to increasedpromotional pricing. In addition, credit card write-offs could rise as consumer debt increases. OurDownside scenario is predicted on 12x P/E on apotential 2012E EPS of $5.67.

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

2010A 2011E 2012E 2013E

Same Store Sales

DownsideCase

$68(2.1%)

PriceTarget

$74(11.1%)

UpsideCase

$82(23.1%)

26

46

66

86

1/27/2011 1/20/2012

DownsideCase

$68(6.7%)

PriceTarget

$74(16.1%)

UpsideCase

$82(28.7%)

26

46

66

86

1/27/2011 1/20/2012


25 January 2012 148

Figure 148: SNAPSHOT: North American Dollar Store Industry – Canada vs. US

As of Jan-11 DollaramaDollar Store with

MoreGreat Canadian

Dollar StoreDollar Giant

Everything for a Dollar

Buck or Two

Established 1992 1998 1993 2001 1985 1990Total Store Count 652 130 112 88 61 58Ownership Structure Corporate Franchise Franchise Corporate Franchise FranchiseStore Size Range 2,500 - 10,000 8,000 - 15,000 2,000 - 10,000 8,000 - 15,000 1,600 - 8,000 3,500 - 5,000Price Point $1 - $2 $1 - $3 $1 - $3 $1.25 Up to $1 Up to $2.00

Source: Company documents, BarCap estimates

Canadian Dollar Store Competitor Profiles

Dollarama Dollar Tree 99 Cents Only Family Dollar Dollar General12 Months Ending Jan-11 Jan-11 Mar-11 Aug-10 Jan-11

Store Count 652 4,101 (85 in CAD) 285 6,785 9,372

Price point range $1 - $2 $1 or less $0.99 $10 or less $10 or lessAverage store size (sq. ft.) 9,862 8,559 16,702 7,104 6,989

Retail Square Footage (Millions) 6.43 35.1 4.8 48.2 65.5Sales per Store ($ Millions) $2.2 $1.4 $5.0 $1.2 $1.4

Average sales per sq. ft. $221 $168 $299 $163 $199

Dedicated DC Yes Yes Yes Yes Yes

POS Yr 1 of rollout Yes Yes Yes YesOffshore Sourcing 54% 43% na 9% 13%

Private label 54% Yes Yes 22% 22%Consumables mix 37% 48% 65% 64% 71%


Revenue growth (3Yr CAGR) 13.5% 11.5% 5.9% 4.8% 11.1%

Same Store Sales Growth (%) 7.6% 6.3% 0.8% 4.8% 4.9%Gross Margin (%) 36.1% 35.9% 40.8% 35.7% 32.0%

EBITDA Margin (%) 16.5% 13.9% 10.2% 9.5% 11.9%Operating Margin (%) 14.5% 11.2% 8.3% 7.3% 9.8%

Net Margin (%) 8.7% 7.0% 5.2% 4.6% 5.0%

Inventory Turns 3.3x 4.3x 4.6x 5.0x 5.4x

Capex as a % of Revenue 3.0% 3.0% 4.3% 2.7% 3.2%Net Debt to EBITDA 1.3x -0.3x -1.4x -0.1x 1.8x

Free Cash Flow ex Capex ($ Millions) $66 $340 $19 $379 $353FCF Yield (%) 3.6% 6.3% 1.5% 7.5% 3.9%

ROE (%) 18.1% 28.7% 11.6% 25.0% 17.4%

ROIC (%) 11.2% 33.4% 15.5% 26.6% 9.5%Source: Company reports, Barclays Capital estimates


25 January 2012 149

DOLLARAMA

Dollarama Inc.(DOL.TO): Quarterly and Annual EPS (CAD)

2011 2012 2013 Change y/y






Year 1.64A N/A 2.12E 2.13E N/A 2.50E 2.47E 29% 18%

P/E 26.8 20.8 17.6




We are initiating coverage of Dollarama (DOL.TO) with a 1-Overweight/2-Neutral rating and $49 price target, offering a potential total return of 12% from recent levels. In the context of a weak economic backdrop, we view Dollarama as one of our top defensive picks with an ability to deliver the strongest EPS growth within our coverage. Although Dollarama is not counter-cyclical, it offers solid defensive characteristics. Dollarama has compelling, low cost/quick payback new store growth prospects (in an underdeveloped market), best-in-class store economics driven by its dominant market position, weaker direct competition, and industry-leading offshore direct sourcing capabilities, and is backed by an experienced management team. Dollarama’s ability to generate strong free cash flow has enabled it to significantly reduce debt, and more recently introduced a dividend. With a long runway of store growth potential, strong FCF and a clean balance sheet, we see potential for dividend increases and/or introduction of a share buyback program. Our $49 price target is based on a 19.5x multiple applied to our fiscal 2013 (January) EPS estimate of $2.50. While a 19.5x target P/E multiple appears lofty relative to most stocks under our coverage, we believe investors should be willing to award Dollarama with an above-average valuation for 16% EPS growth (excludes extra week), plus a dividend. Our target price implies an 18x P/E on our F2014 EPS forecast of $2.78 which is in line with DOL’s FY1 P/E multiple of 17.9x.

Figure 149: Dollarama Valuation P/E Multiple

Yr ending Jan f2013 f2014 CommentsBarCap est BarCap estextra week

EPS range $2.45 $2.50 $2.55 $2.70 $2.78 $2.85 DOL has an extra week in f2013 Y/Y % chg 15% 18% 20% 8% 11% 14% adjusted f2013 EPS growth is 16%

P/E Multiple13.0x $32 $32 $33 $35 $36 $3714.0x $34 $35 $36 $38 $39 $40 <= DOL trough multiple15.0x $37 $37 $38 $41 $42 $4316.0x $39 $40 $41 $43 $44 $4617.0x $42 $42 $43 $46 $47 $4818.0x $44 $45 $46 $49 $50 $51 <= DOL & DLTR current multiple19.0x $47 $47 $48 $51 $53 $5419.5x $48 $49 $50 $53 $54 $56 <= BarCap valuation multiple20.0x $49 $50 $51 $54 $56 $57


For DOL.TO, an above-average multiple is warranted, in our

view

DOL CN / DOL.TO




Price (20-Jan-2012) CAD 44.00



25 January 2012 150

Since the Dollarama IPO in October 2009, the shares have traded at around a 9% premium to Dollar Tree (Dollarama’s closest comparable). At recent levels, Dollarama is trading in line with Dollar Tree. Given Dollarama’s greater dominance in its relative market and its superior store economics versus Dollar Tree, we believe a premium is justified. Thus, the relative comparison should provide additional support to our view of further valuation upside for Dollarama. If, as we expect, Canadian consumers continue to meaningfully reduce their spending through at least the first half of 2012 we expect this trend to become a catalyst to a valuation lift. Given the slightly more positive retail spending trends in the United States we could see a disconnect between Dollarama’s valuation multiple and Dollar Tree’s in 2012, resulting in a renewed premium for Dollarama.

Figure 150: Dollarama is trading at a discount to Dollar Tree

12x

13x

14x

15x

16x

17x

18x

19x

20x

Nov

-09

Jan-

10

Mar

-10

May

-10

Jul-1

0

Sep-

10

Nov

-10

Jan-

11

Mar

-11

May

-11

Jul-1

1

Sep-

11

Nov

-11

-20%

-10%

0%

10%

20%

30%

40%

50%

Premium/Discount (right axis) DOL Dollar Tree

Source: FactSet.

Figure 151: Dollarama Comparable Valuation


Dollar Stores / Discount / Off-Price RetailersDollarama DOL $44.00 $3,244 $ 1.64 $ 2.13 $ 2.47 26.8x 20.6x 17.8x 30.0% 15.7% 50.4%

Dollar Tree DLTR $84.46 $10,053 $ 3.10 $ 3.99 $ 4.73 27.2x 21.2x 17.8x 28.6% 18.6% 52.5%Family Dollar Store FDO $54.78 $6,451 $ 3.12 $ 3.62 $ 4.17 17.6x 15.1x 13.1x 16.1% 15.0% 33.6%Dollar General DG $40.96 $13,818 $ 1.82 $ 2.32 $ 2.70 22.5x 17.7x 15.2x 27.3% 16.3% 48.1%Fred's Discount Store FRED $14.76 $547 $ 0.75 $ 0.86 $ 0.98 19.6x 17.3x 15.0x 13.3% 14.9% 30.1%Big Lots BIG $40.21 $2,638 $ 2.83 $ 2.87 $ 3.37 14.2x 14.0x 11.9x 1.4% 17.1% 18.8%Average 22.1x 18.1x 15.6x 20.8% 16.0% 40.2%

General Merchandise RetailersCanadian Tire CTC/A $63.70 $4,970 $ 5.55 $ 5.47 $ 6.15 11.5x 11.6x 10.4x -1.5% 12.5% 10.8%Wal-Mart WMT $61.01 $208,941 $ 4.18 $ 4.49 $ 4.91 14.6x 13.6x 12.4x 7.3% 9.3% 17.3%Costco COST $81.41 $35,408 $ 3.30 $ 3.85 $ 4.37 24.7x 21.1x 18.6x 16.6% 13.6% 32.4%Target TGT $50.17 $33,694 $ 4.00 $ 4.24 $ 4.30 12.5x 11.8x 11.7x 5.8% 1.4% 7.3%Average 15.8x 14.6x 13.3x 7.1% 9.2% 17.0%

High Growth Canadian RetailersLululemon LULU $60.12 $6,575 $ 0.85 $ 1.24 $ 1.58 na 48.6x 38.1x 45.9% 27.7% 86.4%Tim Hortons THI $48.80 $7,728 $ 2.04 $ 2.35 $ 2.72 23.9x 20.8x 18.0x 15.1% 15.7% 33.2%Average 23.9x 34.7x 28.0x 30.5% 21.7% 59.8%

Other Canadian RetailersRONA RON $9.55 $1,215 $ 1.09 $ 0.74 $ 0.93 8.8x 12.9x 10.3x -32.1% 24.9% -15.2%Reitmans RET/A $14.27 $736 $ 1.29 $ 0.84 $ 1.12 11.0x 17.0x 12.8x -35.1% 32.9% -13.7%Average 9.9x 14.9x 11.5x -33.6% 28.9% -14.4%

Source: FactSet, Barclays Capital estimates. EPS estimates are consensus from FactSet.


25 January 2012 151

Company Profile Dollarama was founded in 1992 by current CEO, Larry Rossy. With more than 650 stores across Canada, Dollarama is by far the dominant dollar store chain in the country (more than 5x the next largest competitor). Dollarama stores average more than 9,800 gross square feet (80-85% selling square footage) and offer a wide assortment of private label and national brand products. The company carries more than 4,000 SKUs with a mix of general merchandise (50%), consumables (37%) and seasonal products (13%). The products are sold at fixed priced points of up to $2.00.

Following Dollarama’s IPO, Bain Capital owned 44.3mn shares (61% of outstanding) and the Rossy family owned 8.9mn shares (12% of outstanding). Through a series of secondary offerings, Bain Capital has sold its entire position while the Rossy family maintains 6% ownership.

Figure 152: Dollarama Insider Holdings History

IPO Secondary Secondary Secondary Secondary CurrentOct-09 Nov-09 Jan-10 Apr-10 Dec-10 Nov-11

Shares Offered (M) 17.1 2.6 11.7 10.2 11.2

% Outstanding 24% 4% 16% 14% 15%

Insider OwnershipBain Capital (M) 44.3 42.2 32.9 22.0 9.2 0.0 % Ownership 61% 58% 45% 30% 13% 0%Rossy Family (M) 8.9 8.4 6.0 4.4 4.4 4.4 % Ownership 12% 12% 8% 6% 6% 6%Combined (M) 53.1 50.6 39.0 26.4 13.6 4.4 % Ownership 73% 70% 54% 36% 19% 6%

Source: FactSet, Company Reports

Growth strategy & Outlook Although we do not believe Dollarama’s business is counter cyclical, we agree that it offers investors attractive defensive characteristics in the current environment that make it a compelling investment:

Compelling, low-cost/quick payback, new store growth opportunity in an underdeveloped retail segment. New store capital costs are minimal ($600k, including $400k for capex and $200k for inventory, per store). A typical Dollarama store reaches average annual sales of $2mn within the first two years and can achieve an average payback period of two years. We estimate that new store growth can be comfortably funded by internally generated funds with significant excess cash flows allowing the company to pay down debt while still aggressively growing the store network.

High return on capital achieved through a very strong competitive position. Dollarama has the best store economics in the North American dollar store space achieved through several strong competitive advantages including dominant market share and scale, market-leading offshore sourcing and merchandising competencies and an experienced management team. The Canadian dollar store space lacks well-capitalized competitors and convergent retailers which have entered the space haven’t been able to make it work in their operating environment (e.g., Loblaw).


25 January 2012 152

Move to multiple price points has been a success, driving above-average sales growth and de-risking margins through greater pricing flexibility. Prior to introducing price points above a dollar, Dollarama was limited in its ability to pass along COGS inflation, forcing it to either absorb the COGS inflation through lower gross margins or to discontinue the sale of those items. The introduction of price points above $1 has been a notable success with those items now representing 49% of total sales. The mix of items above $1 includes items that have been increased in price as COGS inflation required, and new items/categories that Dollarama could not include in its mix at the $1 price with an acceptable margin.

Enhancing shareholder returns through the introduction of a dividend. Dollarama announced its first quarterly dividend in F1Q12 at $0.09/share, offering investors a 1% annualized yield. Dollarama’s low-cost/quick payback new store openings allow it to generate strong free cash flows which far outstrip its capex needs for new store growth and technology deployment. As a result, it has ample excess free cash flow to reduce debt, increase its dividend and/or possibly buy back stock when that is deemed to be an appropriate use of funds.

Figure 153: Dollarama Free Cash Flow ($M)

Fiscal Year (Jan) 2009 2010 2011 2012E 2013E 2014E

Operating Cash Flow $129 $84 $119 $181 $204 $253Change in W/C -$12 $38 -$10 -$37 $6 -$5

Cash from Operations $117 $122 $109 $144 $209 $248Capex -$41 -$34 -$43 -$42 -$45 -$45

Free Cash Flow $76 $89 $66 $102 $164 $203

Dividends $0 $0 $0 -$13 -$29 -$33

Net Change in Share Capital $0 $272 $2 $0 $0 $0Acquisitions $0 $0 $0 $0 $0 $0

Net Change in Debt -$27 -$328 -$46 -$91 -$94 -$161

Remaining cash flow $49 $33 $22 -$2 $41 $9

Free Cash Flow per share $1.05 $1.22 $0.91 $1.35 $2.18 $2.69

Free Cash Flow Yield na 5.9% 3.5% 4.0% 4.9% 6.1%

ROE 63.6% 28.7% 18.1% 19.9% 19.5% 17.1%

Source: Barclays Capital estimates, Company Reports and FactSet.

Dollar Tree’s entry into the underdeveloped Canadian dollar store sector is not a near-term threat to Dollarama.

Dollarama’s accelerated new store growth strategy is sustainable for at least 5-7 more years even if Dollar Tree matches its new store opening pace, in our view. In light of the acquisition of Dollar Giant by Dollar Tree and its announced intention to grow the Dollar Giant network to 900-1,000 stores, Dollarama has stepped up its annual new store growth target to 50 stores per year, up from 30-40 stores per year in its pursuit of attaining its goal of 900 stores in Canada. Given that Dollarama has opened 60+ stores per year in the past, we do not expect the 50-store target to cause any significant logistical issues. Further, we believe Dollarama’s accelerated store-development strategy is sustainable in the context of the underdeveloped dollar store segment in Canada despite Dollar Tree’s new store growth plan.


25 January 2012 153

Canada can support at least 500 more dollar stores before risking significant new store growth productivity drain. Our store saturation analysis shows that the Canadian dollar store industry can support another 500 stores before reaching a saturation level that could potentially constrain sales productivity and gross margin in a material way. The U.S. dollar store industry is more concentrated than Canada’s, with the top two players (DLTR and FDO) having cumulative pop/store of 28k versus the top two Canadian players with any meaningful store growth (DOL and Dollar Giant) at 44k/share. One would have to include all of the smaller Canadian players to get to a similar saturation level as the top two U.S. players.

Figure 154: Small Format Retailing Saturation Analysis – Canada vs. US

US small format value retailing US discount retailing - Conv & SCStore Cumulative Cumulative Store Cumulative Cumulativecount stores Pop/store count stores Pop/store

Dollar Tree 4,152 75 Wal-Mart 3,837 81Family Dollar 6,943 11,095 28 Target 1,762 5,599 5699 cents only 285 11,380 27 Kmart 1,307 6,906 45

Meijer 197 7,103 44

Dollar General 9,641 21,021 15 Kohls 1,127 8,230 38Freds 674 21,695 14 Fred Meyer SC 131 8,361 37Big Lots 1,415 23,110 14 Shopko 147 8,508 37

Canadian small format value retailing CDN discount retailing - Conv & SCStore Cumulative Cumulative Store Cumulative Cumulativecount stores Pop/store count stores Pop/store

Dollarama 680 51 WalMart* 372 93Dollar Giant 95 775 44 Target* 135 507 68Everything for a $1 67 842 41 Canadian Tire 487 994 35Buck or Two 56 898 38 Real Cdn SS 163 1,157 30Your Dollar Store 124 1,022 34Great Cdn $1 store 115 1,137 30 Zellers* 85 1,242 28

Giant Tiger 205 1,342 26The Bargain Shop 238 1,580 22Fields (HBC) 196 1,776 19 *Pro-forma after Zellers store acquisitions/divestitures


Figure 155: Canadian Dollar Store Saturation Forecast

Estimated calendar year 2011 2012E 2013E 2014E 2015E 2016E 2017E 2018E Saturation levelDollarama store count 680 730 780 830 880 930 980 1,030new store openings 28 50 50 50 50 50 50 50

Dollar Giant / Dollar Tree 95 145 195 245 295 345 395 445new store openings 7 50 50 50 50 50 50 50

Top 2 Dollar Store players 775 875 975 1,075 1,175 1,275 1,375 1,475new store openings 35 100 100 100 100 100 100 100cumulative new stores 135 235 335 435 535 635 735

Top 2 Players Pop / store (ooo's) 44 39 36 33 30 28 26 25

Other Dollar store competitors 362 367 372 377 382 387 392 397new store openings 5 5 5 5 5 5 5

Total Dollar Store format competition 1,137 1,242 1,347 1,452 1,557 1,662 1,767 1,872 2,394

Total Dollar store Pop / store (ooo's) 30 28 26 24 23 21 20 19 15

Other small format value retailers 639 639 639 639 639 639 639 639(Giant Tiger, The Bargain Shop, Fields) 0 0 0 0 0 0 0

Total small format value retail stores 1,776 1,881 1,986 2,091 2,196 2,301 2,406 2,511 2,394

19 18 18 17 16 15 15 14 15

Canadian population 34.5 34.5 34.8 35.1 35.4 35.6 35.9 36.2 35.9

Source: StatsCan, FactSet, Barclays Capital estimates.


25 January 2012 154

Management believes that Dollarama can profitably open stores across Canada, even in areas where it has the highest store density (Quebec). However, we expect a disproportionately higher number of new stores to be opened in the West given its much lower store density development.

Figure 156: Dollarama Population per Store by Province

West Ontario Quebec Atlantic Canada

Stores 106 261 221 64 652Population (M) 10.6 13.3 7.9 2.4 34.3Population per Store 99,878 50,955 35,929 36,814 52,597

Source: StatsCan, Company Reports, Barclays Capital estimates

Multiple price-point strategy is helping to drive higher average transaction size. In February 2009, Dollarama began offering products at fixed price points above a dollar ($1.25, $1.50 and $2.00). In addition to broadening its product offering, the multiple price point strategy has resulted in a higher average ticket. The sales penetration of products over $1 has increased in every quarter since its introduction. As of 3Q12, products sold above $1.00 represented 49% of sales.

The company is willing to experiment with products at higher price points (potentially up to $4.00) provided that they are new items or in new categories. We believe customers will be receptive to higher price points at Dollarama so long as the company continues to provide more compelling value relative to other discount stores or general merchandisers (i.e., Wal-Mart and Canadian Tire).

The roll-out of debit card payment systems has also contributed to a higher average ticket (debit card sales are 2x greater than the average transaction size for cash sales). Debit card transactions represent approximately 37% of Dollarama’s sales.

Declining traffic is of some concern but is consistent with what many other retailers have experienced in 2011. Dollarama’s transaction volume shifted from solid positive trends into negative territory starting in 4Q11 with snowstorm disruption presented as the initial catalyst. Based on the breadth of retailers that have experienced traffic/transaction count weakness in 2011 (Food retailers, Wal-Mart Canada, Tim Hortons) we do not see Dollarama’s trend as being specific to them, or the dollar store space. We do expect Dollarama to experience a deceleration in CSS growth in F2012 as the y/y lift of penetration gains of items above $1 eases (F2013 and F2014 CSS forecast at 3%). Fortunately, Dollarama continues to have significant square footage growth opportunities (+7% to 8%) and a number of productivity and efficiency initiatives that can support continued sector leading earnings growth.

Figure 157: Growing penetration of product sales over $1.00

Fiscal Quarter Q1-10A Q2-10A Q3-10A Q4-10A Q1-11A Q2-11A Q3-11A Q4-11A Q1-12A Q2-12A Q3-12A

Average Ticket 3.5% 5.6% 6.2% 5.8% 6.6% 6.2% 6.3% 6.1% 6.3% 5.3% 5.2%

Transaction Volume 4.0% 1.4% 1.1% 3.3% 1.9% 1.4% 1.6% -0.7% -2.8% -0.5% -0.1%

CSS 7.5% 7.0% 7.3% 9.3% 8.6% 7.8% 8.0% 5.4% 3.3% 4.8% 5.1%

$1.00+ Penetration 12.0% 23.7% 27.0% 30.0% 34.0% 39.2% 40.0% 42.0% 44.0% 48.0% 49.0%

- Y/Y bps change 1,200bps 2,370bps 2,700bps 3,000bps 2,200bps 1,550bps 1,300bps 1,200bps 1,000bps 880bps 900bps


Productivity and efficiency enhancements are expected to result in further cost savings. Dollarama’s gross margin has improved by over 400bps since 2005. However, management


25 January 2012 155

has suggested that they do not expect any material upside to the current run-rate of approximately 37%. Over the long run, management strives to maintain a gross margin rate of around 36% where they believe they can achieve a healthy balance between maximizing value for shareholders and offering a compelling value proposition to customers. While management’s target suggests that gross margins may come under pressure in the future, we see opportunities for offsets through SG&A cost containment. We expect Dollarama to benefit from a number of infrastructure initiatives that should allow the company to lower its operating expense rate. These include the following:

Scanning technology: Dollarama completed the roll-out of point-of-sale scanners in F2011. As of F3Q12, scanning penetration reached 96% of products sold. While scanning technology increases pricing accuracy, which reduces shrink, the greater benefit will come from labour cost savings associated with physical inventory counting. The company is undergoing the validation phase which involves comparing the physical inventory count data to the scanner data. Management expects the scanner data to be used as the primary source of information for store replenishment by July 2012 which should lead to better in-stock position and reduced labour in stores. The labour cost of physical inventory counting is estimated at $15-$17mn per year. With about half of that cost expected to be eliminated, we estimate an EPS uplift of $0.06-$0.08.

Labour scheduling software: the company is testing Kronos biometric terminals in stores and expects to launch the first phase shortly. The system is expected to help better manage scheduling and in-store attendance. Management expects phase one to have a positive impact on store productivity starting in F2013. Phase two will be rolled out by the end of F2013, which will provide field management with a state-of-the-art labour screening tool that is expected to further enhance in-store productivity and improve customer service training. The company should realize benefits from the phase two roll-out in F2014.

DC and warehouse systems upgrade: The first phase of Dollarama’s DC automation initiative was completed in F1Q12 which has already resulted in labour efficiencies. The company plans to launch phase-two of its DC automation initiative, which is expected to generate further efficiencies in F2013. During F2Q12, the company began implementation of a new shipping and warehouse management system. The system will allow the company to optimize its warehousing capacity and result in various productivity gains beginning in F2013.

Dollarama’s purchasing scale and long-standing relationship with suppliers contributes to its competitive cost advantage. Dollarama initiated its overseas direct sourcing program in 1993. The company now sources 54% of its purchases directly from a low-cost supplier network. While the majority of overseas products are sourced from China, over the past two years the company has diversified its supplier network to include manufacturers from India, Indonesia, Thailand, Turkey and Italy. Dollarama’s supplier base is well diversified with no single supplier representing more than 6% of its total purchases. Dollarama also has its own development team that works closely with its suppliers to design its products, packaging, and labelling for its private-label brand.

Risks Import sourcing and/or transportation costs may rise, leading to lower margins.

Increased competition, resulting in more aggressive pricing; lower availability of prime real estate locations.

Over the past two years the company has diversified its

supplier network


25 January 2012 156

Sales and earnings growth slows below aggressive market expectations.

Counter-cyclical risk – more of a multiple constraint than an earnings risk.

Figure 158: Dollarama Financial Performance Summary

2009A 2010A 2011A 2012E 2013E 2014E

Revenue ($ Millions) $1,089 $1,254 $1,420 $1,594 $1,800 $1,945 Total Revenue Growth (%) 12.0% 15.1% 13.3% 12.3% 12.9% 8.0% Square Footage Growth (%) 10.2% 7.3% 8.9% 8.7% 9.1% 8.3% Total Same Store Sales (%) 4.4% 7.9% 7.6% 5.0% 3.5% 4.0% Average Ticket Growth (%) 3.9% 5.4% 6.3% 5.5% 3.0% 3.0% Volume Growth (%) 0.5% 2.3% 1.2% -0.5% 0.5% 1.0%

Gross Margin 33.5% 35.3% 36.1% 37.0% 36.8% 36.7%SG&A as a % of Revenue 19.4% 20.0% 19.6% 19.5% 19.2% 18.8%EBITDA Margin 14.1% 15.3% 16.5% 17.5% 17.6% 17.8%

Gross Margin Variance -31 bps 184 bps 78 bps 83 bps -15 bps -15 bpsSG&A Variance 64 bps 61 bps -39 bps -19 bps -21 bps -42 bpsEBITDA Variance -95 bps 123 bps 117 bps 102 bps 6 bps 27 bps

Net Debt/EBITDA (LTM) 6.60x 1.97x 1.32x 0.79x 0.27x -0.24xCapex as a % of Sales (LTM) 3.7% 2.7% 3.0% 2.6% 2.5% 2.3%Free Cash Flow ($ Millions, After Capex/WC) $76 $89 $66 $102 $164 $203Return on Invested Capital 2.6% 7.3% 11.2% 14.3% 16.1% 17.7%



25 January 2012 157

COMPANY SNAPSHOT

Dollarama Canadian Consumer & Retail

Income statement ($mn) 2011A 2012E 2013E 2014E CAGRRevenue 1,420 1,594 1,800 1,945 11.1% Stock Rating 1-OVERWEIGHTEBITDA 234 279 316 347 14.0% Sector View 2-NEUTRALEBIT 205 246 277 303 13.8% Price (20-Jan-2012) $44.00Pre-tax income 179 229 266 296 18.4% Price Target $49.00Net income 124 160 188 209 19.1% Ticker DOLEPS (reported) ($) 1.64 2.12 2.50 2.78 19.2%Diluted shares (m) 75 76 75 75 -0.1% Investment case

Dividend per share ($) - 0.18 0.40 0.45 NA


Balance sheet and cash flow ($mn) CAGRTangible fixed assets 152 162 168 169 3.6%Goodwill 728 728 728 728 0.0%Cash and equivalents 53 51 92 101 24.0%Total assets 1,311 1,366 1,429 1,447 3.4%Short and long-term debt 348 258 164 3 -78.8% Downside case $38.00Total liabilities 573 514 441 284 -20.9%Net debt/(funds) 309 221 86 (84) NAShareholders' equity 738 853 988 1,163 16.4%Change in working capital (10) (37) 6 (5) NAOperating cash flow 119 181 204 253 28.6%Capital expenditure 43 42 45 45 1.5%Net cash flow 66 102 164 203 45.2%


Valuation and leverage metrics AverageP/E (x) 26.8 20.7 17.6 15.8 20.2 EV/EBITDA (x) 15.5 12.7 10.7 9.3 12.1 NCF yield (%) 2.0 3.1 5.0 6.1 4.0Price/sales (x) 2.3 2.1 1.8 1.7 2.0 Price/BV (x) 4.5 3.9 3.3 2.8 3.6 Dividend yield (%) 0.0 0.4 0.9 1.0 0.6Total debt/capital (%) 32.0 23.2 14.2 0.3 17.4Total debt/EBITDA (x) 1.5 0.9 0.5 0.0 0.7

Source: FactSet

Selected operating metrics Same Store Sales vs. Sq. Ft. GrowthSame store sales growth (%) 7.6 5.0 3.5 4.0 5.0Square footage growth (%) 8.9 8.7 9.1 8.3 8.8Capex/sales (%) 3.0 2.6 2.5 2.3 2.6

Source: Company data, Barclays Capital Note: FY end jan.

Dollarama is the dominant dollar-store chain inCanada with significant growth prospects,compelling store economics and increased pricingflexibility with the successful introduction of itemsabove $1. Our price target is based on a forward P/Emultiple of 19.5x our F2013 EPS estimate of $2.50.

Our Upside scenario reflects more robust EBITDAmargin expansion driven by improved product mix,lower shrink and greater savings from storeproductivity initiatives. In this scenario, our 2013EEPS increases to $2.63. Applying a 19.5x P/Emultiple generates an Upside case of $52.

Our Downside case reflects further weakening instore traffic, constraining CSS. In this scenario, weestimate a Downside 2013 EPS of $2.36. Applying a16x P/E (representing a contraction from the current17.5x forward P/E) generates a Downside case of$38.

0%

2%

4%

6%

8%

10%

2011A 2012E 2013E 2014E


DownsideCase

$38(-13.6%)

PriceTarget

$47(6.8%)

UpsideCase

$50(13.6%)

13

23

33

43

53

1/28/2011 1/20/2012

DownsideCase

$38(-13.6%)

PriceTarget

$49(11.3%)

UpsideCase

$52(18.1%)

13

23

33

43

53

63

1/28/2011 1/20/2012


25 January 2012 158

Figure 159: SNAPSHOT North American Food Service Industry

Revenues ($M) Avg Sales $ MarketRank Company Units 2010 2009 % chg /Unit (000's) Share

1 Tim Hortons 3,750 $5,621 $5,311 5.8% $1,499.0 27.0%2 McDonald's 1,436 $3,335 $3,100 7.6% $2,322.4 16.0%3 Subway 2,557 $1,392 $1,260 10.5% $544.4 6.7%4 Cara (Swiss Cahlet, Harvey's, Kelseys, Montana's, Milestones) 680 $1,261 $1,267 -0.5% $1,854.3 6.1%5 Boston Pizza 392 $955 $985 -3.0% $2,436.2 4.6%6 Yum! Restaurants (KFC, Pizza Hut, Taco Bell) 1,091 $900 - na $824.9 4.3%7 A&W Food Services of Canada Inc. 730 $794 $757 4.9% $1,087.7 3.8%8 Wendy's Restaurants of Canada Inc. 367 $645 $658 -2.0% $1,757.5 3.1%9 Starbucks Coffee Canada 1,063 $633 $595 6.4% $595.5 3.0%

10 Dairy Queen 638 $507 $490 3.3% $794.2 2.4%11 Keg Restaurants Ltd. 103 $476 $463 2.9% $4,624.3 2.3%12 MTY Tiki Ming Enterprises Inc. 1,727 $461 $393 17.3% $266.9 2.2%13 Northland (Denny's, Moxie's) 145 $445 $399 11.5% $3,069.0 2.1%14 Priszm (KFC, Pizza Hut, Taco Bell) 429 $416 $442 -5.9% $969.2 2.0%15 Pizza Pizza 444 $414 $418 -1.0% $932.4 2.0%16 Imvescor (Pizza Delight, Mikes, Scores, Baton Rouge) 254 $413 $418 -1.2% $1,626.8 2.0%17 Burger King 296 $365 $364 0.3% $1,233.1 1.8%18 Prime Restaurants (East Side Mario's, Casey's, Bier Markt) 154 $337 $340 -0.9% $2,186.4 1.6%19 Yogen Fruz Canada Inc. 888 $289 $268 7.7% $325.0 1.4%20 Quiznos 458 $225 $225 0.0% $491.3 1.1%21 Domino's Pizza 340 $223 $199 12.2% $655.9 1.1%22 SIR Corp. (Jack Astor's, Alice Fazooli's, Canyon Creek) 46 $201 $197 2.1% $4,367.4 1.0%23 The Second Cup 349 $190 $190 -0.1% $545.0 0.9%24 Chairman's Brands (Coffee Time, Eggsmart, 241 Pizza) 493 $181 $190 -4.7% $367.3 0.9%25 Cora's 120 $150 $125 20.0% $1,250.0 0.7%

Source: Foodservice & Hospitality Magazine 18,950 $20,829 $1,099.1 100.0%

C$ millions 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 CAGRFull Service $15,845 $16,332 $16,908 $17,084 $18,059 $18,788 $19,350 $20,006 $20,865 $20,675 $20,931 2.8%Limited-Service $13,671 $14,607 $15,041 $15,386 $16,026 $16,415 $17,917 $18,385 $19,517 $20,134 $21,220 4.5%Other $5,345 $5,400 $5,516 $5,534 $5,733 $5,986 $6,089 $6,246 $6,414 $6,288 $6,465 1.9%Total $34,862 $36,340 $37,465 $38,003 $39,818 $41,190 $43,356 $44,637 $46,795 $47,096 $48,616 3.4%

# Locations 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 CAGRFull Service 29,248 28,923 29,534 30,420 31,683 31,386 30,387 30,079 31,156 30,485 29,796 0.2%Limited-Service 30,545 28,110 28,441 28,359 31,602 30,858 31,811 31,420 32,249 32,391 33,541 0.9%Other 14,219 14,148 13,906 13,519 13,119 13,388 13,366 13,161 13,249 13,068 12,688 -1.1%Total 74,012 71,181 71,881 72,298 76,404 75,632 75,564 74,660 76,654 75,944 76,025 0.3%Source: CFRA; Statistics Canada

QSR Segment Breakdown in Canada (2010)

Top 5 QSR chains Revenues ($M) Top 5 Casual-dining chains Revenues ($M)Tim Hortons $5,621.1 Boston Pizza $955.0McDonald's $3,335.0 Keg $476.3Subway $1,392.4 Moxie's $270.0A&W $794.0 East Side Mario's $217.9Wendy's $645.0 Kelsey's $192.9

Top 5 Burger Chains Revenues ($M) Top 5 Pizza chains Revenues ($M)McDonald's $3,335.0 Pizza Pizza $414.0A&W $794.0 Pizza Hut $300.0Wendy's $645.0 Domino's $223.0Burger King $365.0 Panago $132.4Harvey's $213.2 Pizza Nova $89.5

Top 3 Coffee/Donut chains Revenues ($M) Top 5 Ethnic chains Revenues ($M)Tim Hortons $5,621.1 MTY Tiki Ming $461.0Starbucks $633.0 Manchu Wok $119.3Second Cup $190.2 Mandarin $107.6

Edo Japan $65.0Teriyaki Experience $42.0

Source: Foodservice & Hospitality Magazine


25 January 2012 159

TIM HORTONS

Tim Hortons Inc.(THI.TO): Quarterly and Annual EPS (CAD)

2010 2011 2012 Change y/y






Year 2.04A N/A 2.35E 2.35E N/A 2.75E 2.72E 15% 17%

P/E 23.9 20.8 17.8




We are initiating coverage of Tim Hortons (THI.TO) with a 1-Overweight/2-Neutral rating and $54 price target, offering a potential total return of 12% from recent levels. Our $54 price target is based on a 19.5x multiple applied to our 2012 EPS estimate of $2.75. Tim Hortons’ stock price appreciated 18% in 2011 (S&P/TSX -11%) reflecting its relative safe haven status. While Tim’s is a member of the S&P/TSX Consumer Discretionary Index, the company has relatively strong defensive characteristics with approximately 55% of EBIT generated by rent and royalty fees, providing a stable stream of income. The company has also delivered industry-leading CSS growth through a combination of innovative new products, a strong marketing program, continuous store network refresh, and, when necessary, price increases. Finally, Tim’s has continuously supplemented EPS growth through share buybacks and has boosted the dividend four times since becoming a public company in 2006. While its U.S. growth strategy is taking longer than expected to materialize, we believe Canada has sufficient new store growth potential to give the U.S. operations time to ramp up Average Unit Volumes (AUV). Tim’s currently trades at 17.8x forward P/E, which is modestly below its historical average of 18.8x. In light of our cautious economic outlook, we believe investors’ flight to high quality defensive stocks could push Tim’s valuation to above-average levels.

Figure 160: Tim Hortons P/E Valuation Range

F2012 F2013 CommentsBarCap est BarCap est

EPS Range: $2.70 $2.75 $2.80 $2.98 $3.03 $3.08y/y % chg 15.2% 17.3% 19.5% 8.4% 10.2% 12.0%

P/E Multiples15.0x $41 $41 $42 $45 $46 $46 <= Trough multiple16.0x $43 $44 $45 $48 $49 $4917.0x $46 $47 $48 $51 $52 $5218.0x $49 $50 $50 $54 $55 $5619.0x $51 $52 $53 $57 $58 $59 <= Long Term Avg = 18.8x19.5x $53 $54 $55 $58 $59 $60 <= BarCap target valuation20.0x $54 $55 $56 $60 $61 $6221.0x $57 $58 $59 $63 $64 $6522.0x $59 $61 $62 $66 $67 $6823.0x $62 $63 $64 $69 $70 $71 <= QSR select Grp. Avg.24.0x $65 $66 $67 $72 $73 $7425.0x $68 $69 $70 $75 $76 $77 <= Peak valuation


While Tim’s is classified as a discretionary name, the

company has relatively strong defensive characteristics

THI CN / THI.TO




Price (20-Jan-2012) CAD 48.80



25 January 2012 160

While Tim’s valuation appears rich versus the other companies in our coverage universe, we believe it is justified by its strong earnings growth (second-highest in our group of stocks), high liquidity, and large (free-float) market cap ($8bn market cap; second largest behind Shoppers Drug Mart). As such, for investors familiar with the lack of liquidity in many of the Retail / Consumer names we believe Tim Hortons warrants a premium valuation.

Tim Hortons appears attractively valued on a relative basis versus its Quick Service Restaurant (QSR) peers. Historically, Tim Hortons has traded at an average discount of 22% compared to a select group of U.S. QSRs. Given the strong performance of a number of companies in the QSR space, this discount has widened to 27%. Relative to McDonald’s, Tim’s is trading at a 7% discount versus its historical 10% premium as McDonalds’ shares have experienced significant appreciation reflecting its market share gains versus the broader restaurant category and a flight to quality names. Reverting back to its historical mean versus McDonald’s would imply a valuation multiple of 21x for Tim Hortons. We also note that our 19.5x target multiple is below Tim’s long-term peak of 25x.

Figure 161: Quick Service Restaurants Historical Forward P/E Peak/Trough Cycle

Ticker Current Max Min Avg. Max Min Avg. Max Min Avg. Max Min Avg.

Tim Hortons THI 17.8x 19.3x 16.9x 18.1x 19.3x 15.2x 16.9x 24.7x 15.1x 18.3x 25.3x 15.1x 18.8x

Dunkin' Brands DNKN 20.6x

McDonalds MCD 17.7x 17.7x 14.2x 15.7x 17.7x 13.1x 15.0x 19.4x 13.1x 15.8x 32.7x 9.5x 17.1x

YUM! YUM 19.2x 19.2x 15.7x 17.5x 19.6x 11.5x 16.2x 21.6x 11.5x 17.0x 27.1x 7.3x 15.7x

Panera Bread PNRA 27.4x 27.5x 20.2x 24.5x 28.1x 16.4x 21.9x 28.1x 14.6x 21.4x 48.6x 14.6x 27.4x

Sonic SONC 12.2x 19.1x 10.5x 14.7x 19.6x 7.4x 14.1x 22.8x 6.3x 15.3x 26.7x 6.3x 17.6x

Chipotle CMG 40.6x 42.7x 32.4x 38.1x 42.7x 18.6x 30.0x 56.0x 15.7x 32.4x 75.0x 15.7x 35.1x

Starbucks SBUX 24.6x 24.6x 19.6x 22.0x 24.6x 10.9x 20.0x 35.8x 9.7x 20.5x 56.6x 9.7x 31.8x

Grp. Avg. ex THI 23.2x 25.1x 18.8x 22.1x 25.4x 13.0x 19.5x 30.6x 11.8x 20.4x 44.5x 10.5x 24.1x

THI vs Group avg -24% -23% -10% -18% -24% 17% -14% -19% 28% -11% -43% 43% -22%

THI vs MCD's 1% 9% 19% 15% 9% 16% 13% 28% 15% 16% -23% 59% 10%

1-Year 3-Year 5-Year All-Time

Source: FactSet.

Figure 162: Tim Hortons Comparable Valuation

Price MarketTicker 20/01/2012 Cap ($M) FY0 FY1 FY2 FY0 FY1 FY2 FY0-FY1 FY1-FY2 FY0-FY2

THI - Consensus THI $48.80 $7,728 $2.04 $2.35 $2.72 23.9x 20.8x 18.0x 15% 16% 33%THI - BarCap est. THI $48.80 $7,728 $2.04 $2.35 $2.75 23.9x 20.8x 17.7x 15% 17% 35%

McDonald's MCD $101.74 $104,102 $4.58 $5.22 $5.73 22.2x 19.5x 17.8x 14% 10% 25%

Yum! YUM $62.48 $28,772 $2.38 $2.86 $3.22 26.3x 21.8x 19.4x 20% 13% 35%

Chipotle CMG $356.39 $11,154 $5.64 $6.83 $8.66 63.2x 52.2x 41.2x 21% 27% 54%

Panera PNRA $151.83 $4,291 $3.62 $4.64 $5.48 41.9x 32.7x 27.7x 28% 18% 51%

Sonic SONC $6.84 $414 $0.31 $0.53 $0.61 22.1x 12.9x 11.1x 70% 16% 98%

Dunkin' Brands DNKN $26.53 $3,187 $0.22 $0.92 $1.21 NA 29.0x 22.0x na 32% na

Starbucks SBUX $48.15 $35,891 $1.62 $1.83 $2.22 29.7x 26.4x 21.7x 13% 22% 37%

Average (ex THI) 34.2x 27.8x 23.0x 28% 20% 50%Wendy's WEN $5.25 $2,043 -$0.01 $0.14 $0.22 NA 36.4x 24.1x NA 51% NA

AFC Enterprises AFCE $14.41 $351 $0.90 $0.96 $1.12 16.0x 15.0x 12.9x 6% 17% 24%

Group Average $19,793 30.7x 26.7x 21.6x 24% 22% 45%

P/E EPS GrowthFiscal EPS

Source: FactSet, Barclays Capital estimates. EPS estimates are consensus from FactSet except where noted.


25 January 2012 161

Company profile Tim Hortons is Canada’s leading QSR franchisor, with more than 3,800 system-wide restaurants. Tim Hortons is the dominant player in Canada with 3,189 locations and a commanding 42% share of all QSR traffic. The company serves eight out of every 10 cups of coffee sold in Canada which, in part, speaks to its leadership in the morning daypart (64% share of traffic in breakfast daypart).

Figure 163: THI commands a 42% share of all QSR traffic in Canada

1.3%

1.8%

1.8%

2.1%

2.2%

2.3%

2.9%

4.4%

15.1%

41.8%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

Pizza Pizza

KFC

Burger King

DQ

Starbucks

Wendy's

A&W

Subway

McDonald's

Tim Hortons


The company also has an emerging presence in the United States. Over the past five years, Tim Hortons’ U.S. restaurant count has grown at a 16% CAGR to over 600 locations. In 2010, the company launched a new international strategy to roll-out up to 120 multi-format restaurants in the Gulf Cooperation Council (GCC) over five years. Through a Master Lease Agreement (MLA) the locations will be developed and operated by Apparel Group with a commitment to open five stores by the end of 2011. While the size and nature of the agreement is expected to be immaterial to Tim Hortons profits for some time, we believe the real value of this venture will be the learning Tim’s accrues from the initiative regarding brand development and operating outside of North America.

Tim’s is currently operating under the leadership of Paul House, chairman and former CEO, as the company looks to replace recently departed CEO Don Schroeder. While this is a more than acceptable short-term solution, the longer it takes to find a new CEO, the more uncertainty it creates for the stock. Tim’s has a number of significant challenges to deal with, including: 1) a potential slowing growth profile in Canada as the store network inches towards saturation, and 2) the longer-than-expected maturation cycle of the U.S. stores – although they are progressing, AUVs in the United States (aside from Buffalo) remain well below Canada averages. However, we believe Tim Hortons can sustain enough new store growth and menu innovation in Canada for at least five more years to support +10% earnings growth and allow the U.S. stores to find ways to reduce the maturation cycle enough to take over as the earnings growth driver when the time comes.

Tim’s has a number of significant challenges to deal with


25 January 2012 162

Figure 164: Canada remains the most significant driver of earnings

Store System % % Avg EBITC$mln Count AUV Sales Sales EBIT* EBIT per StoreCanada 3,148 $2.070 $5,181.8 92% $332.3 97% $0.106U.S. 602 $1.012 $452.3 8% $9.9 3% $0.017*excluding Distribution Income, Equity Income, VIEs and Corporate charges


Tim Hortons’ compelling franchise model delivers low-risk earnings growth. Like many franchise operations Tim Hortons generates the majority of its earnings (50%-60% of EBIT) from rent and royalty fees (as a percentage of system sales), providing investors with limited earnings volatility/risk assuming system sales remain in growth. Further, the company’s vertically integrated business model provides a high degree of quality control as well as an additional layer of revenue and income through the supply of goods and equipment to its restaurants.

Figure 165: Canada: Restaurant and AUV growth

Figure 166: U.S.: Restaurant and AUV growth

2,711 2,823 2,917 3,015 3,148

$1,793 $1,888 $1,955 $2,025 $2,070

2006 2007 2008 2009 2010

# Restaurants AUV (C$ 000's)

336398

520563

602

$944 $956 $930 $957 $978

2006 2007 2008 2009 2010

# Restaurants AUV (US$ 000's)

Source: Company reports Source: Company reports


25 January 2012 163

Figure 167: Tim Hortons vs. Dunkin’ Donuts

Tim Hortons Dunkin' Donuts

Canada U.S. U.S.% Franchised 99.5% 99.3% 99.8%Initial franchise fee Upfront fee plus cost of equipment sold to franchisees $40,000 - $80,000Agreement Term 20yrsRoyalty payment 3.5% - 4.5% 5.4%

Real estate 79% corporate owned or leasedMajority leased by franchisees from 3rd-

party landlordsRent (paid to corp.) 8.5% - 10% n/aAdvertising fund 3.5% 4.0% 5.0%

Disitribution/Supply chainVertically-integrated distribution platform; 5 DC's in Canada; 3rd-

party distributors in U.S.

Franchisee-owned purchasing and distribution cooperative (National Distributor

Commitment Program, NDCP)

Food ManufacturingCorporately controlled; supply agreement with Maidstone

Bakeries & other 3rd-party suppliers; 2 coffee roasting facilities (in ON & NY); fondant and fills plant (ON)

Franchisee-owned/operated; 100+ Centralized Mfg. Locations (CMLs); on-site baking in certain stores or sourced from

store with on-site productionAUV ('000s) $2,070 $978 $855Avg. Standard store size 1,400 to 3,090 sq ft 1,200 to 2,500 sq ft

10yrs, plus aggregrate renewal period of 10yrs


Growth Strategy & Outlook The quick serve restaurant sector is the most defensive segment within the restaurant industry due to its lower average transaction values and typical franchise structure. Not surprisingly, as the recession took hold, consumers’ restaurant expenditures declined as they shifted some of their food/entertainment dollars from “eating out” to “eating in”. Tim’s did experience a brief period of slowed CSS but responded immediately with an increased emphasis on value meals, which got it back on course. More recently, as part of its 3Q11 release, Tim’s noted a decline in traffic in Canada for the first time since 2008 with management expressing a sense that consumers are once again “hunkering down”.

Increasing returns to shareholders

Beyond these economic aberrations Tim’s results have been strong (industry leading in some periods) and generally very consistent. As with many franchise operations Tim’s growth capex needs are typically very limited. Combine that with the Canadian operations’ critical mass advantages and strong sales growth and you get a consistent stream of strong excess free cash flow that can be returned to shareholders to enhance its returns.

Historically, Tim’s has generated a consistent stream of strong

excess free cash flow


25 January 2012 164

Figure 168: Tim Hortons Free Cash Flow ($ mn)


Operating Cash Flow $329 $347 $355 $436 $767 $432 $528 $571

Change in W/C -$70 $38 $15 -$32 -$241 -$43 -$15 -$12

Cash from Operations $259 $385 $370 $404 $526 $389 $513 $559

Capex -$180 -$176 -$174 -$158 -$133 -$190 -$180 -$191

Free Cash Flow $79 $210 $195 $246 $393 $199 $333 $368

Dividends -$27 -$53 -$66 -$73 -$90 -$175 -$245 -$267

Net Change in Share Capital $697 -$178 -$169 -$131 -$247 -$597 -$200 -$250

Acquisitions/Dispositions $0 $0 $0 $0 $445 $38 $0 $0

Net Change in Debt -$793 -$1 -$4 -$3 -$29 -$4 $0 $0Remaining Free cash flow -$44 -$22 -$44 $40 $472 -$538 -$111 -$149

Free Cash Flow per share $0.41 $1.11 $1.06 $1.36 $2.25 $1.27 $2.18 $2.49

Free Cash Flow Yield 1.3% 3.2% 3.3% 4.5% 6.3% 2.8% 4.5% 5.1%

ROE 24.5% 26.7% 28.2% 27.9% 27.3% 28.3% 32.7% 32.5%Source: Company reports, Barclays Capital estimates.

Tim Hortons has had an impressive track record of returning this excess cash to shareholders through share repurchases and dividend increases. Since the IPO in 2006, Tim Hortons has raised its dividend four times (average 25% increase per year). The company has also aggressively repurchased stock which has enhanced EPS growth by approximately 3% per annum in each of the past four years.

An extraordinary appeal for investors in 2011 has been the security of the “special” share repurchase program that Tim’s put in place following the sale of its joint venture stake in the Maidstone bakery which is expected to contribute to a 7.7% EPS lift in fiscal 2011. Tim’s is using $445mn from the proceeds of that sale to buy back up to 10% of the company’s public float to offset the EPS drain of the lost equity income. As of 3Q11, the company had approximately $64mn available for repurchase before the program terminates in March 2012. We expect Tim Hortons will establish a new $200mn buyback program when the current one expires, or possibly sooner, which in combination with the current year’s program should lift EPS by 5% y/y in 2012.

Figure 169: Tim Hortons: Company-Generated Growth/Returns for Shareholders

2007 2008 2009 2010 CAGR 2011E 2012E

Net earnings growth 3.8% 12.0% 6.9% 10.2% 9.7% 7.3% 12.1%

Share count EPS impact 2.4% 3.0% 1.9% 4.0% 3.0% 7.7% 5.2%

Total EPS growth 6.2% 15.0% 8.8% 14.2% 12.6% 15.0% 17.3%

Dividend yield 0.8% 1.1% 1.3% 1.5% 1.2% 1.5% 1.6%

Company generated return 7.0% 16.1% 10.1% 15.7% 13.8% 16.5% 18.9%

TSX return (incl. dividends) 9.8% -32.4% 34.4% 17.3% 5.4%

ROE 26.7% 28.2% 27.9% 27.3% 28.3% 32.7%

Net debt to EBITDA 0.3x 0.4x 0.4x -0.3x 0.3x 0.2x Source: Company reports, Bloomberg, Barclays Capital estimates.

Tim Hortons’ growth strategies have remained fairly constant over the past several years with the exception of some significant changes in the United States and the introduction of an international strategy in 2011. Management’s broadly stated growth strategies for the 2011-2013 period includes the following four key elements:


25 January 2012 165

1. Attack daypart opportunities with new product and marketing opportunities to drive CSS;

2. Invest in building scale and the Tim Hortons brand in new and existing markets. The new markets strategy is predominantly focused on its U.S. growth platform and more recently on its second international venture (started with a JV in Ireland in 2006; recently opened its first store in Dubai) which is viewed as a go-slow test of a master franchise approach.

3. Identifying new avenues of growth – this includes new products, new formats, new markets;

4. Leverage the core business strengths and franchise system.

Tim Hortons has a solid track record of delivering industry leading CSS in both Canada and the United States.

Figure 170: Tim Hortons CSS – consistently ahead of QSR peers

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1Q-9

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3Q-1

1

QSR US Comp Average THI Canada CSS THI US CSS

Source: Company reports, Barclays Capital U.S. Restaurants team.

Canadian growth runway still compelling which buys the US time Canada has sufficient new store growth and menu potential to give the U.S. operations time to ramp up AUVs. We believe that Tim’s can be successful in the United States if it is patient and tactical. The real question is whether Tim’s can sustain enough growth in Canada to support +10% earnings growth and allow the established U.S. stores to reach necessary maturation and critical mass. We believe the answer is yes: Canada can buy the US time.

Significant underdeveloped daypart penetration being pursued through new product introductions. Tim’s strong CSS performance has, in part, been driven by the launch of innovative products to more effectively compete and grow in the morning, “snacking” and lunch dayparts. Since 2007, the company has introduced 20-25 products each year. In Canada, Tim Hortons is by far the dominant QSR in the morning daypart with more than a 63% share. In order to capture a greater share of the late morning business, Tim Hortons recently extended its breakfast hours from 11am to noon. Despite not competing in 50% of the lunch daypart categories (i.e., burgers and pizza), Tim Hortons is a close second at less than 3 percentage points behind McDonald’s. Tim Hortons’ more recent menu


25 January 2012 166

developments include the introduction of espresso-based lattes at very competitive price points (starting at $2). While specialty coffee represents a relatively small portion of the overall coffee market, it is one of the faster growing segments and allows Tim Hortons to build upon its leadership in the coffee category in Canada.

McDonald’s premium coffee push poses a longer-term risk. McDonald’s recently announced plans to invest $1 billion to undertake its largest store rebranding initiative in its history in Canada. This initiative includes further roll-out of its McCafé concept and new coffee and beverage products such as lattes, cappuccinos, and deluxe hot chocolate. Over half of McDonald’s Canada’s roughly 1,400 restaurant locations currently carry espresso-based beverages. By the end of 2012, the majority of the remaining locations will include a McCafé.

In support of its coffee push, McDonald’s has given away 60 million cups of coffee through six trial events in the past three years. According to management, McDonald’s marketing efforts drove coffee sales up 45% in 2010 with similar growth projected for 2011. As a result, McDonald’s breakfast daypart has experienced double-digit growth over the last three years making it the fastest growing daypart for the company. We do not expect McDonald’s to pose any material risk to Tim Hortons over our forecast horizon. However, given Tim Hortons’ dominant share in the morning daypart, it is the most exposed to McDonald’s coffee and café build-out. As such, we view McDonald’s as a longer-term competitive threat.

Despite Tim’s already extensive presence across Canada the company continues to see significant location growth opportunities in its home market. Historically, the company has built roughly 140 restaurants, replaced 20 and renovated on average about 100 restaurants per year. In the past five years, the company has opened, replaced and renovated more than 1,300 locations in Canada. Management believes that there is potential for 4,000+ Tim Hortons restaurants in Canada. Assuming an annual development of 140 net new stores, Tim Hortons would have at least five more years of store growth before reaching management’s targeted saturation level.

Figure 171: THI is the leader in the morning daypart

Figure 172: Respectable share of lunch even without burgers

1.0%

1.3%

1.4%

2.9%

17.6%

63.7%

0% 10% 20% 30% 40% 50% 60% 70%

Country Style

Subway

Starbuck's

A&W

McDonald's

Tim Hortons

3.7%

4.5%

5.2%

9.9%

18.5%

21.1%

0% 5% 10% 15% 20% 25%

Burger King

Wendy's

A&W

Subway

Tim Hortons

McDonald's

Source: Company reports. Source: Company reports

McDonald’s is a longer-term competitive threat

Still lots of room to grow in Canada before passing the

earnings growth baton to the US


25 January 2012 167

Figure 173: Still room for growth in Canada

2010A 2011E 2012E 2013E 2014E 2015E 2016E 2017EStore CountAtlantic 354 364 374 384 394 404 414 424 Quebec 439 489 539 589 639 689 739 789 Ontario 1,588 1,608 1,628 1,648 1,668 1,688 1,708 1,728 West 655 715 775 835 895 955 1,015 1,075 Total 3,036 3,176 3,316 3,456 3,596 3,736 3,876 4,016 Net New Stores 140 140 140 140 140 140 140 THI Target 4,000

Pop/store (000's)Atlantic 6.6 6.5 6.3 6.2 6.1 5.9 5.8 5.7Quebec 18.0 16.3 14.9 13.7 12.8 11.9 11.2 10.6Ontario 8.3 8.3 8.4 8.4 8.4 8.4 8.4 8.4West 16.1 14.9 14.0 13.1 12.4 11.8 11.2 10.7Total 11.2 10.9 10.5 10.2 9.9 9.7 9.4 9.2

Source: Company reports, Statistics Canada, Barclays Capital estimates

US Ops: making progress, but still a long way from a growth driver The U.S. store maturation cycle is still too long and the AUV is still too far below Canada’s for the U.S. roll-out to become a meaningful earnings growth driver in the foreseeable future. The concern remains that beyond Buffalo none of the other aggregated markets have come close to the Canadian AUV levels – although they are progressing. The Syracuse stores have reached a similar absolute AUV level (not inflation adjusted) that Buffalo reached in 1998 ($738/standard store; disclosed in IPO presentations). This directionally suggests that it could take Syracuse 10+ more years to reach Buffalo’s current AUV level, which is generally in line with the Canadian average. We remain hopeful, but cautious, that the addition of Cold Stone, other new products, and the potential success of the repositioned new store design may eventually contribute to a shrinking of the Tim’s new store productivity maturation cycle.

Figure 174: Tim Hortons

Standard Restaurants Years in Mkt ~ AUV'sBuffalo DMA 15+ Years $1.6 mlnColumbus / Detroit 12 - 15 yrs $900 to 950kRochester DMA 5 - 7 yrs $930kSyracuse DMA 3 - 5 yrs $700kCanada ~$2 mln


The recent U.S. repositioning and menu development needs to work if the US is ever going to be a meaningful earnings growth driver. As part of its efforts at boosting profitability in the United States, Tim Hortons has undergone two rounds of store closures in the New England region (11 stores in 2008; 34 restaurants and 18 self-serve kiosks in 2010). The shuttering of these restaurants has in part contributed to an improvement in the U.S. segment operating income as it has resulted in higher rents and royalties due to lower relief that was provided to the underperforming restaurants.

Given its lower awareness in the United States versus in Canada, the company has adopted a differentiated marketing approach to better establish itself as a true contender in the


25 January 2012 168

hyper-competitive U.S. QSR segment. Tim’s has also developed a new store concept that more clearly defines it as a “Café and Bake Shop”. In addition to new signage, the concept has a more inviting environment that encourages customers to dine in and try new products.

Tim Hortons has embarked on a number of strategic initiatives to make it “look bigger” through partnerships and strategic alliances with Cold Stone Creamery, The New York State Thruway, Tops Friendly Markets and the U.S. military. With over 1,400 locations, Cold Stone’s brand awareness in the United States is much higher than Tim Hortons. Thus, Tim’s is able to leverage Cold Stone’s brand power to draw in more customers. The Cold Stone partnership also allows Tim’s to leverage its fixed asset by doing more business between the hours of 3pm to 10pm, a segment where a traditional Tim Hortons-only store is not overly busy. There are currently 215 co-branded locations.

Tim’s partnership strategy also allows the company to seed the brand and enter into new geographies with minimal capital investment. However, store development in the United States will primarily focus on existing markets, with roughly 30% of capex devoted to growing in contiguous markets. When entering a new market, Tim’s more recent strategy has been to launch with more stores at once, as it had done in Syracuse. In 2008, Tim’s opened 17 restaurants within 120 days, providing more immediate scale versus building out stores one by one.

We are encouraged by Tim’s U.S. growth strategies as the company has returned to generating positive operating income over the past two years. However, as we’ve noted previously, the U.S. store maturation cycle is still too slow and AUVs still too low for the U.S. operations to become a more meaningful earnings driver in the near term. As we’ve highlighted above, the Canada segment standard-store AUV is double that in the United States while estimated average EBIT per store in Canada is six times greater than the US.

Figure 175: Tim’s US operations financial performance trend

C$mln 2006 2007 2008 2009* 2010Store Count 336 398 520 563 602 System Sales $279.3 $321.9 $369.0 $461.6 $452.3EBIT $1.7 -$4.8 -$5.2 $4.8 $9.9*53 weeks


Coffee price outlook Volatility in coffee commodity prices can impact margins as Tim Hortons sells coffee to franchisees on a “penny-profit” basis. While this is beneficial to margins in a declining price environment, it can also place pressure on margins if the competitive environment does not allow Tim Hortons to implement price increases. In order to achieve reasonable cost certainty, Tim’s typically hedges its future coffee purchase 6-12 months forward. This practice has been particularly effective in light of the highly unpredictable coffee prices in the spot market over the past two years. The company has bought forward partly through 2012 (not the entire year yet). Based on management’s current outlook, Tim Hortons does not plan to take any price increases in 2012 unless cost pressures force it to.

We are encouraged by Tim’s U.S. growth strategies


25 January 2012 169

Risks Commodity risks – volatile coffee pricing exposes Tim Hortons to margin risk.

FX risk – U.S. dollar denominated coffee prices and growing presence in the United States result in FX-related earnings risk.

Potential inroads in Canada by McDonald’s in the coffee and breakfast daypart segments which are Tim’s core business.

Tim’s greatest long-term earnings risk is if it fails to get the U.S. operations’ profitability up to a sufficient level to sustain consolidated company earnings growth (including share buybacks) at 10% per year. We estimate that Tim Hortons has at least five more years of substantial new store growth in Canada before it reaches maturation and menu development continues to drive at least 1%-2% CSS growth every year.

Figure 176: Brazilian Natural Arabica Spot Price

Figure 177: Coffee “C” Futures Curve

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Source: ICO. Source: Bloomberg.


25 January 2012 170

Figure 178: Tim Hortons Financial Performance Summary

2009A 2010A 2011E 2012E 2013E

Sales ($M) $1,704 $1,785 $1,927 $2,059 $2,178

Sales Growth (%) 26.4% 4.8% 7.9% 6.9% 5.8%

Canada Same Store Sales (%) 2.9% 4.9% 3.5% 3.0% 3.0%

US Same Store Sales (%) 3.2% 3.9% 5.5% 5.0% 4.0%

Weighted Same Store Sales (%) 2.9% 4.8% 3.7% 3.2% 3.1%

Total Revenue ($M) $2,439 $2,566 $2,761 $2,938 $3,129

Total Revenue Growth (%) 19.3% 5.2% 7.6% 6.4% 6.5%

Canada Sq. Ft. Growth (%) 3.6% 4.0% 4.0% 4.1% 3.6%

US Sq. Ft. Growth (%) 7.8% -1.8% 12.9% 11.4% 6.9%

Total Sq. Ft. Growth (%) 4.2% 3.1% 5.3% 5.2% 4.1%

Gross Margin on Sales (%) 14.0% 14.4% 11.6% 13.4% 13.7%

Gross Margin Variance (bps) 165 bps 33 bps -280 bps 180 bps 30 bps

EBITDA Margin on Revenue (%) 25.9% 26.9% 24.7% 25.8% 25.8%

EBITDA Margin Variance (bps) -154bps 99bps -222bps 113 bp 4 bp

Net Debt/EBITDA (LTM) 0.4x -0.3x 0.3x 0.2x 0.1x

Capex as a % of Total Revenue (LTM) 6.5% 5.2% 6.9% 6.1% 6.1%

Free Cash Flow ($M, After Capex/WC) $258 $393 $285 $362 $393

Return on Equity 27.9% 27.3% 28.3% 32.7% 32.5%

Return on Invested Capital 24.6% 32.8% 27.5% 29.4% 29.9%

*Sales refers to warehouse sales and to Corporate stores and store consolidated under FIN 46 Rules.

**Depreciation not reported in quarterly release - BarCap estimateSource: Company reports, Barclays Capital estimates.


25 January 2012 171

COMPANY SNAPSHOT

Tim Hortons Canadian Consumer & Retail

Income statement ($mn) 2010A 2011E 2012E 2013E CAGRRevenue 2,566 2,761 2,938 3,129 6.8% Stock Rating 1-OVERWEIGHTEBITDA 690 681 758 809 5.4% Sector View 2-NEUTRALEBIT 571 566 633 674 5.7% Price (20-Jan-2012) $48.80Pre-tax income 548 544 608 650 5.8% Price Target $54.00Net income 356 381 428 457 8.7% Ticker THIEPS (reported) ($) 2.04 2.35 2.75 3.03 14.1%Diluted shares (m) 174 163 155 151 -4.7% Investment case



Balance sheet and cash flow ($mn) CAGRTangible fixed assets 1,374 1,476 1,531 1,587 4.9%Intangible assets 5 5 5 5 -3.9%Cash and equivalents 574 182 227 244 -24.8%Total assets 2,482 2,177 2,305 2,403 -1.1%Short and long-term debt 355 360 360 360 0.5% Downside case $45.00Other long-term liabilities 112 117 117 117 1.4%Total liabilities 919 792 807 820 -3.7%Net debt/(funds) (220) 177 133 116 NAShareholders' equity 1,437 1,262 1,376 1,461 0.6%Change in working capital 94 (43) (15) (12) NAOperating cash flow 526 475 542 584 3.6%Capital expenditure 133 190 180 191 12.8%Free cash flow 393 285 362 393 0.0% Upside/downside scenarios

Valuation and leverage metrics AverageP/E (x) 23.9 20.8 17.7 16.1 19.6 EV/EBITDA (x) 12.0 11.9 10.2 9.2 10.8 FCF yield (%) 4.6 3.6 4.8 5.3 4.6Price/sales (x) 3.3 2.9 2.6 2.3 2.8 Price/BV (x) 5.9 6.3 5.5 5.0 5.7 Dividend yield (%) 1.1 1.4 1.6 1.7 1.4Total debt/capital (%) 19.8 22.2 20.7 19.8 20.6Total debt/EBITDA (x) 0.5 0.5 0.5 0.4 0.5 Source: FactSet

Same Store SalesSelected operating metricsSame store sales growth (%) 4.8 3.7 3.2 3.1 3.7Can same store sales (%) 4.9 3.5 3.0 3.0 3.6US same store sales (%) 3.9 5.5 5.0 4.0 4.6Square footage growth (%) 3.1 5.3 5.2 4.1 4.4


THI is a leading QSR with a dominant position inCanada. Its franchise model and industry-leadingCSS has helped deliver a stable stream of incomedespite a slowing economy, making THI a strongdefensive investment. Our 19.5x target multiplereflects its relative safe haven status, strong EPSgrowth, and Canadian scarcity premium.

Our Upside case reflects new restaurant growth atthe high end of guidance range in Canada and U.S.and more robust CSS driven by new productinnovations. In this scenario, our 2012 EPS forecastwould increase to $2.89 driving an Upside case of$58 using our 20x target multiple.

Our Downside scenario reflects continued weaknessin traffic volume in Canada, constraining CSS. Webelieve a lower target multiple is warranted under aslower growth scenario. Applying a 17x P/E on areduced 2012 EPS forecast of $2.67 generates ourDownside case of $45.

0%1%2%3%4%5%6%

2010A 2011E 2012E 2013E

Canada US

DownsideCase

$45(-7.67%)

PriceTarget

$54(10.7%)

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$58(18.9%)

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40

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70

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70

1/27/2011 1/20/2012


25 January 2012 172

Figure 179: SNAPSHOT: North American Home Hardware Industry – Canada vs. US

Canadian Hardware Industry United States Hardware IndustrySystem Market System Market

Stores Sales ($B) Share Stores Sales ($B) Share1 Rona 917 $7.2 17.7% 1 Home Depot 2,248 $68.0 26.2%

2 Canadian Tire 488 $5.8 14.3% 2 Lowe's 1,749 $48.8 18.8%

3 Home Depot 179 $5.6 13.7% 3 Menard 255 $8.3 3.2%

4 Home Hardware 1,080 $5.0 12.3% 4 ProBuild 454 $3.5 1.3%

5 Tim-Br-Marts 745 $3.3 8.1% 5 Fastenal 2,490 $2.3 0.9%

6 ILDC 135 $1.7 4.2% 6 84 Lumber 274 $1.5 0.6%

7 Sexton Group 285 $1.3 3.3% 7 Sutherland Lumber 56 $1.0 0.4%

8 BMR Group 183 $1.3 3.2% 8 Northern Tool & Equip. 65 $0.9 0.3%

9 Castle building Centres 284 $1.0 2.5% 9 Stock Building Supply 57 $0.9 0.3%

10 Allroc Building Products 56 $0.7 1.8% 10 Sears Hardware 111 $0.7 0.3%

Top Ten 4,352 $33.0 81.2% Top Ten 7,759 $135.8 52.3%

11 Delroc Industries 117 $0.6 1.5% 11 Builders FirstSource 89 $0.7 0.3%

12 Alpa Lumber 650 $0.6 1.4% 12 Carter Lumber 189 $0.7 0.3%

13 Federated Co-ops 19 $0.5 1.3% 13 Orchard Supply Hardware 88 $0.6 0.2%

14 Kent Building Supplies 210 $0.4 1.0% 14 BMC 77 $0.6 0.2%

15 TORBSA 33 $0.4 1.0% 15 McCoy's Building Supply 83 $0.5 0.2%

Top Fifteen 5,381 $35.5 87.5% Top Fifteen 8,285 $138.9 53.5%

Remaining $5.1 12.5% Remaining $120.8 46.5%

Total Industry $40.6 100.0% Total $259.7 100.0%

Sources: Barclays Capital estimate, Hardware Merchandising Magazine, Home Channel News, Home Improvement Research Institute

RONA Home Depot Lowe's

12 Months Ending Dec-10 Jan-11 Jan-11Total Store Count 956 2,248 1,749

Franchise / Affiliate dealers 665 - -

Retail Square Footage (mlns) 21 235 199Sales per Corporate Store ($M) $12.5 $30.2 $27.9

Average store size (sq. ft.) 30,827 104,537 113,493

Revenue ($ Millions) $4,800 $67,997 $48,815Revenue growth (3Yr CAGR) 0.1% -4.2% 0.4%

Same Store Sales Growth (%) 0.0% 2.9% 1.3%

Gross Margin (%) 27.8% 34.3% 35.1%EBITDA Margin (%) 7.1% 10.9% 10.5%

Operating Margin (%) 4.8% 8.6% 7.3%

Net Margin (%) 3.0% 5.0% 4.1%

Inventory Turns 4.3x 4.3x 3.8x

Capex as a % of Revenue 1.5% 1.6% 1.6%

Net Debt to EBITDA 1.1x 1.2x 1.1xFree Cash Flow ex Capex ($M) $192 $3,489 $3,069

FCF Yield (%) 9.9% 6.5% 9.3%

ROE (%) 8.0% 8.2% 10.8%ROIC (%) 7.6% 6.7% 8.4%



25 January 2012 173

RONA INC.

RONA Inc.(RON.TO): Quarterly and Annual EPS (CAD)

2010 2011 2012 Change y/y


Q1 0.02A N/A -0.13A N/A N/A N/A N/A -750% N/A




Year 1.03A N/A 0.68E 0.76E N/A 0.91E 0.97E -34% 34%

P/E 9.3 14.0 10.5




We are initiating coverage of RONA Inc. (RON.TO) with a 2-Equal Weight/2-Neutral rating and a $10 price target, offering investors a total potential return of 6% from recent levels. RON is recently trading at a 35% discount to the average forward valuation of Home Depot and Lowe’s, which is in line with the long-term historical average discount. Our price target is based on an 11x P/E on our F2012 EPS forecast of $0.91. Our P/E multiple of 11x is below RON’s long-term average of 12x, reflecting a less robust housing and renovation spending outlook as these drivers are expected to ease toward normalized growth rates over the next 2-5 years. We see the potential for a short-term trading opportunity in RONA’s shares over the next 12 months driven by: 1) a broad market valuation lift as E.U. and U.S. uncertainty eases, 2) a potential relative valuation lift if U.S. housing trends improve, increasing HD or LOW multiples, and 3) a possible 1H12 renovation spending bounce in Canada that could lift RONA’s CSS back into positive territory for the first time since 2Q10. However, most of the underlying fundamentals over the next 12 months, or more, point to a range-bound valuation.

Figure 180: Rona P/E Valuation Range

f2012 f2013 Comments

BarCap est BarCap estEPS range $0.85 $0.91 $0.95 $0.85 $1.02 $0.95

y/y growth 24.1% 32.5% 38.7% 24.1% 48.9% 38.7%

P/E Multiple7.0x $6 $6 $7 $6 $7 $7 Rona's trough multiple

8.0x $7 $7 $8 $7 $8 $89.0x $8 $8 $9 $8 $9 $9

10.0x $9 $9 $10 $9 $10 $10

11.0x $9 $10 $10 $9 $11 $10 BarCap target valuation multiple12.0x $10 $11 $11 $10 $12 $11 Rona's long-term average P/E13.0x $11 $12 $12 $11 $13 $12

14.0x $12 $13 $13 $12 $14 $13 HD & LOW current average P/E

15.0x $13 $14 $14 $13 $15 $14 HD & LOW 5 Yr. avg. P/E Source: Barclays Capital estimates. EPS range is for illustrative purposes only.

Most of the underlying fundamentals over the next 12

months point to a range-bound valuation

RON CN / RON.TO




Price (20-Jan-2012) CAD 9.55



25 January 2012 174

Figure 181: RONA’s Forward P/E history vs. HD and LOW

1-Yr 2-Yr 3-Yr 4-Yr 5-YrFY1 FY2 NTM Avg. Avg. Avg. Avg. Avg. Max Min Avg.

Home Depot 18.2x 15.9x 16.0x 14.7x 15.1x 15.6x 15.3x 14.9x 35.2x 10.3x 16.3x

Lowe's 16.3x 14.8x 14.8x 13.6x 14.3x 14.9x 14.8x 14.7x 38.3x 11.1x 18.4x

Rona 10.3x 9.0x 10.2x 10.8x 10.9x 10.9x 10.3x 10.5x 17.5x 7.3x 11.7x

Avg. Ex Rona 17.3x 15.3x 15.4x 14.1x 14.7x 15.3x 15.1x 14.8x 36.8x 10.7x 17.3xAverage 15.0x 13.2x 13.7x 13.0x 13.5x 13.8x 13.5x 13.4x 30.4x 9.6x 15.4x

Rona's relative valuation vs.Home Depot -43% -43% -36% -27% -28% -30% -33% -29% -50% -29% -28%

Lowe's -37% -39% -31% -21% -24% -27% -31% -28% -54% -34% -36%

Average Discount -40% -41% -33% -24% -26% -29% -32% -29% -52% -32% -32%

Fwd. P/E All-Time

Source: FactSet / Reuters.

Figure 182: Home Improvement Retail forward PE trends

0x

5x

10x

15x

20x

25x

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

RON HD LOW

Source: FactSet / Reuters

RONA’s shares are currently trading at a 10.2x forward P/E multiple on consensus EPS, which is in line with its 5-year average. This compares to the stock’s long-term average of 12x and average P/E during the North American housing boom of 13x-14x. With expectations of materially slower renovation spending growth (2%-4%) once the renovation market stabilizes and Lowe’s build-out still a risk factor it seems doubtful that investors will be willing to pay the same normalized P/E multiple for RONA’s shares that they did during the most recent housing/renovation boom - especially if interest rates start to rise. Beyond recovery/rebound multiple expansion on a normalized basis we do not expect Rona’s forward P/E multiple to settle in above 10x-11x versus the loftier 13x-14x range they achieved during the housing boom.

As the analysis below shows, if we increase our F2012 CSS forecast from -0.2% to 2% (more in line with what we expect normalized renovation spending growth will be) and provide RONA with expense rate leverage through to EBITDA, our earnings estimate increases to $1.02 from $0.91, matching our current F2013 EPS forecast. While investors may be willing to pay a recovery multiple for those higher-than-expected F2012 earnings we believe they should not pay more than 10x-11x for F2013 EPS which would likely be 10% above F2012, or approximately $1.12. Putting a 10x-11x P/E on the F2013 EPS of $1.12 would support a valuation of $11-$12 two years from now, which is 15%-26% above


25 January 2012 175

the current share price, but limited upside versus any price appreciation the stock might achieve in response to a more robust 2012.

Figure 183: RONA Upside Scenario Analysis

Upside Scenario to 2012E Peak2011E 2012E 2013E A B C EBITDA

EPS $0.68 $0.91 $1.02 $0.97 $1.02 $1.08 $1.58CSS -7.5% -0.2% 2.0% 1.0% 2.0% 3.0% 3.0%

EBITDA margin 5.79% 6.35% 6.70% 6.50% 6.63% 6.75% 8.50%margin var. (vs. '11) 56bps 91bps 71bps 83bps 96bps 271bps

P/E multiple Target Share Price10x $6.85 $9.07 $10.20 $9.71 $10.24 $10.78 $15.82

11x $7.53 $9.98 $11.22 $10.68 $11.26 $11.86 $17.4012x $8.22 $10.89 $12.24 $11.65 $12.29 $12.94 $18.98

13x $8.90 $11.80 $13.26 $12.62 $13.31 $14.01 $20.5614x $9.59 $12.70 $14.28 $13.59 $14.33 $15.09 $22.14


Figure 184: Specialty Retail Comparable Valuations


Home Improvement RetailersRONA RON $9.55 $1,215 $ 1.03 $ 0.74 $ 0.93 9.3x 12.9x 10.3x -28.0% 24.9% -10.1%

Home Depot HD $44.51 $68,615 $ 2.01 $ 2.39 $ 2.74 22.1x 18.6x 16.2x 18.8% 14.7% 36.3%

Lowe's LOW $26.53 $33,230 $ 1.42 $ 1.61 $ 1.78 18.7x 16.4x 14.9x 13.6% 10.5% 25.5%

Home Improvement Retailer Average 14.8x 15.5x 13.0x -7.4% 21.0% 10.0%

General Merchandise

Canadian Tire CTC/A $63.70 $4,970 $ 5.56 $ 5.47 $ 6.15 11.5x 11.6x 10.4x -1.6% 12.5% 10.7%

Wal-Mart WMT $61.01 $208,941 $ 4.18 $ 4.49 $ 4.91 14.6x 13.6x 12.4x 7.4% 9.3% 17.4%

Target TGT $50.17 $33,694 $ 4.00 $ 4.24 $ 4.30 12.5x 11.8x 11.7x 5.9% 1.4% 7.4%

Sears Holdings SHLD $49.00 $5,237 $ 1.19 $ (5.10) $ (4.86) 41.2x na na -528.2% -4.6% -508.5%

Kohl's KSS $47.37 $12,005 $ 3.66 $ 4.24 $ 4.95 12.9x 11.2x 9.6x 15.9% 16.6% 35.2%Nordstroms JWN $50.02 $10,475 $ 2.75 $ 3.13 $ 3.58 18.2x 16.0x 14.0x 13.7% 14.5% 30.3%

Dillards DDS $46.21 $2,136 $ 2.67 $ 3.91 $ 4.65 17.3x 11.8x 9.9x 46.3% 19.1% 74.3%

Macy's M $35.38 $14,853 $ 1.98 $ 2.79 $ 3.23 17.9x 12.7x 11.0x 41.0% 15.7% 63.2%

JC Penney JCP $35.09 $7,493 $ 1.59 $ 1.25 $ 1.66 22.1x 28.1x 21.2x -21.5% 32.9% 4.3%Source: FactSet, Barclays Capital estimates. EPS estimates are consensus from FactSet.

Corporate Profile RONA is the largest retailer of hardware, home renovation and gardening products in Canada with an estimated 18% share of industry sales. The company operates more than 950 corporate, franchise and affiliate stores through various sizes and formats as highlighted below.


25 January 2012 176

Figure 185: RONA – Company Snapshot (f2010)

Type of store Canada Banners Sq. Ft/Store

Big-box 78RONA; RONA Home & Garden; RONA L'entrepot; RONA Le Regional; Reno-Depot 60,000 - 165, 000

Proximity 143RONA; RONA Le Renovateur; RONA Home Centre 5,000 - 60,000Totem 30,000Materiaux Coupal n/aDick's Lumber n/aSTUDIO by RONA 8,000

Commercial & Professional

48Noble; Plomberie Payette & Perreault; Les Boutique Eaudace; MPH Supply Ltd; Better Bathrooms; Don Park; La Boutique de Plomberie Decoration

n/a

Affiliated dealers 682

RONA Home Center, RONA Le Renovateur; RONA Le Quencaillier, RONA Hardware, RONA L'express, RONA L'express Materiaux; RONA Building Centre

5,000 - 60,000

BOTANIX n/aTruServ; True Value; Contry Depot; V&S 1,000 - 10,000

Total 951 Source: Company reports.

Growth Strategy & Outlook Canada’s housing market has avoided the boom/bust scenario of the United States, experiencing a slowdown as the recession unfolded followed by a strong recovery. Renovation spending trends have tended to mirror the resale housing trends. The housing/renovation spending recovery was fuelled by the spending stimulus of: 1) low interest rates, 2) the 2009/10 home renovation tax credit (HRTC) which expired in February 2010, and 3) the introduction of the HST (Harmonized sales tax) in Ontario in July 2010, which motivated consumers to move purchases forward to avoid increased tax exposure. Subsequent to the recovery, the housing (resales and starts) and renovation markets have experienced choppy but generally positive results, on a rolling 12-month basis, supported by continuous growth in housing prices.

Figure 186: Resale activity and renovation spending

-40%

-20%

0%

20%

40%

60%

80%

1Q03 4Q03 3Q04 2Q05 1Q06 4Q06 3Q07 2Q08 1Q09 4Q09 3Q10 2Q110%2%

4%6%

8%

10%12%

14%

16%18%

20%

Resale Activity (left) Reno. Spend (right)

Source: CREA, Statistics Canada.


25 January 2012 177

Renovation spending slowed as the recession hit – as a result, RONA has been struggling with flat to negative CSS growth for 9 out of the past 11 quarters. RONA’s weak CSS have generally been in line with an industry-wide slowdown of residential renovation spending that started in 1Q10. As the chart below demonstrates, RONA’s same store sales performance has typically followed, at a discounted absolute level, the growth trends in the broader renovation market. Unfortunately for Rona this has meant that its same-store sales have been stuck in largely negative territory since 1Q06, with the exception of the stimulus induced lifts in 4Q09 and 1Q10, while the reported residential renovation trends have remained in modest positive growth.

Figure 187: Canadian Renovation Spending Growth vs. Rona CSS

-15%

-10%

-5%

0%

5%

10%

15%

20%1Q

06

3Q 0

6

1Q 0

7

3Q 0

7

1Q 0

8

3Q 0

8

1Q 0

9

3Q 0

9

1Q 1

0

3Q 1

0

1Q 1

1

3Q 1

1

1Q 1

2

3Q 1

2

Renovation Spending (Y/Y) RONA CSS

Forecast

Source: Company reports, Statistics Canada

Rona’s negative CSS trends have been directionally similar to those of Home Depot and Lowe’s in Canada. Home Depot Canada experienced a 12-month period of outperformance as sales rebounded from the constraints of a disruptive SAP enterprise system installation but its CSS results since 3Q10 have been weak. Lowe’s Canada, despite having newer stores that should be comping strongly as they ramp toward maturity, have been suffering negative CSS for the past five quarters with weaker comps than RONA in four of those quarters. We suspect, but cannot confirm, that the reason for this disconnect is that current renovation spending growth is skewed to smaller markets where the Big Box format is not as prevalent.

Figure 188: Home Improvement Retailers’ CSS Comparison

1Q 09 2Q 09 3Q 09 4Q 09 1Q 10 2Q 10 3Q 10 4Q 10 1Q 11 2Q 11 3Q 11

Rona -8.5% -6.2% -5.3% 0.7% 10.8% 0.9% -2.3% -6.4% -12.6% -9.6% -5.1%

Home Depot negative negative flat DD positive positive flat -5.6% negative negative flat N/A

Lowes LSD

negative - positive 16.0% 14.0% 2.4% -8.0% -15.5% -16.6% -6.7% -6.4%


Debt-laden Canadian consumers are retrenching

Canadian consumers have taken full advantage of low interest rates to purchase homes, cars and other big ticket/interest sensitive items, steadily driving their debt leverage-to- personal income ratio above the levels U.S. consumers achieved at the peak of the housing boom in the United States. Unfortunately, a lack of meaningful employment growth, wage

Same-store sales have been stuck in largely negative territory

since 1Q06


25 January 2012 178

growth lagging cost inflation and the overhang of ongoing financial stresses in the E.U. and United States has made consumers increasingly uneasy about their increased personal debt exposure. The result appears to be a renewed round of “wallet tightening” with consumers’ spending habits returning to patterns seen as the recession unfolded.

Figure 189: Personal Debt to Disposable Income: Canada vs. US

80%

90%

100%

110%

120%

130%

140%

150%

160%

1Q-9

0

2Q-9

1

3Q-9

2

4Q-9

3

1Q-9

5

2Q-9

6

3Q-9

7

4Q-9

8

1Q-0

0

2Q-0

1

3Q-0

2

4Q-0

3

1Q-0

5

2Q-0

6

3Q-0

7

4Q-0

8

1Q-1

0

2Q-1

1

Canada US

Source: Statistics Canada; Federal Research Board.

We don’t expect the renovation market to settle into a new rhythm of modest growth until 2013 with 2012 looking to be a bit of a roller coaster ride. Choppy year-over-year resale housing trends have typically driven similar volatility in renovation spending over the past two years. Increases in resale housing activity y/y over the past eight months support the possibility of a modest 1H12 recovery in renovation spending. However, we are concerned that a generally more cautious consumer may cut back or delay renovation plans versus what we have seen in the recent past, resulting in flat to negative trends throughout all of 2012. We also note that deleveraging by a heavily debt-laden consumer could add further pressure on big-ticket discretionary spending.

Renovation spending typically lags resale housing activity by six months on an upswing, with a much shorter lag on a downturn. As the following table shows, this historical relationship, while not highly consistent, does have some patterned correlation with the renovation spending trends we have seen over the past two years – strong resale activity in 3Q09 to 1Q10 fuelled strong renovation spending growth in 4Q09 to 3Q10. Resale housing activity has been quite volatile by quarter over the past three years partly due to the timing of stimulus (HRTC and the HST). If the general pattern holds true (6-month lag) renovation spending should be poised for a meaningful increase in 1H12 as a result of strong resale activity growth over the past eight consecutive months and potentially into 1H12 against weaker prior year trends.

Deleveraging by a heavily debt-laden consumer could add

further pressure on big-ticket discretionary spending


25 January 2012 179

Figure 190: Canadian Resale housing activity vs. Renovation spending – y/y % chg

Resale Housing Activity (actuals) - Y/Y % chg

Q1 Q2 Q3 Q4 H1 H2 Total Yr.2009 -27.0% 1.4% 17.7% 58.4% -10.5% 32.7% 7.7%

2010 45.3% -2.9% -23.6% -15.7% 13.6% -20.1% -3.9%

2011 -6.5% -1.2% 13.0% 6.1% e -3.5% 9.8% e 2.2% e

2012 easy PY easy PY tougher PY weak PY tough PY

Residential Renovation Spending (NSA) - Y/Y % chgQ1 Q2 Q3 Q4 H1 H2 Total Yr.

2009 0.2% 2.0% 3.7% 11.8% 1.2% 7.5% 4.5%2010 17.7% 14.6% 8.3% 3.5% 15.9% 6.0% 10.6%2011 2.3% 1.2% 5.5% 1.2% e 1.7% 3.4% 2.5% e2012 easy PY easier PY tougher PY weak PY tougher PY

Source: StatsCan, CREA and Barclays Capital estimates

While this could provide some long-awaited upside support to RONA’s share price through improved CSS in Q1 and/or Q2 we do not see this as the beginning of a sustainable recovery. The majority of factors point to a continuation of low to no growth until 2013 when, hopefully, more meaningful employment and/or wage growth combined with more modest, but stable/consistent resale housing activity establishes steady renovation spending growth.

Consumer debt leverage is expected to remain a spending constraint until employment and/or wage growth improves and/or consumers work its debt leverage down to a more comfortable level.

Employment growth outlook appears to be deteriorating. Despite having a lower unemployment rate than the US, employment growth in Canada since the initial recovery has been tepid. The largest segments of employment recovery coming out of the recession were jobs in construction and government. Slowed growth expectations for the E.U., emerging markets and potentially the United States combined with: 1) slowed domestic housing demand, 2) the government’s push to cut jobs to manage ballooning deficits, and 3) a pullback in commodity costs, support a cautious expectation.

Cost inflation is outpacing wage inflation lead by food and gasoline prices constraining consumers’ discretionary spending.

The majority of factors point to a continuation of low to no growth

until 2013


25 January 2012 180

Figure 191: Cost inflation trending above wage growth

-2%

-1%

0%1%

2%

3%4%

5%

6%

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Wage Growth Total CPI

Source: Statistics Canada.

House price risk – while we do not expect a widespread decline in house prices, some of the more heated markets in Western Canada are experiencing a pullback/slower growth.

Figure 192: House prices cooling in certain markets

-10.0%-5.0%0.0%5.0%

10.0%15.0%20.0%25.0%30.0%35.0%

Jan-

10

Mar

-10

May

-10

Jul-1

0

Sep-

10

Nov

-10

Jan-

11

Mar

-11

May

-11

Jul-1

1

Sep-

11

Nov

-11

Calgary Edmonton Vancouver Victoria

Source: CREA.

Lowe’s remains committed to Canada Lowe’s continues to build out its Canadian platform albeit at a slowed pace – what matters is they don’t appear to be leaving. Lowe’s currently has 29 big box home improvement stores in Canada. For 2011, Lowe’s is targeting 25 new stores in North America, with up to one-third (~8 stores) in Canada. For the 2012-2015 period, Lowe’s has reduced its store growth plans in North America to approximately 10-15 stores per year, of which 70% will be outside the United States (i.e. Canada and Mexico). We see Lowe’s adding 3-5 new stores per year in Canada. While this is a slower rate of growth compared to its 2011 objectives, Lowe’s remains firmly committed to the Canadian market.

We believe the Canadian Big Box market is already well developed. Unfortunately in a slowed growth, or declining, renovation market Lowe’s adding any square footage in major

Lowe’s has reduced its store growth plans in North America to approximately 10-15 stores per year, of which 70% will be

outside the US


25 January 2012 181

markets can hurt the incumbents. We believe that Canada cannot profitably accommodate a third Big Box retailer.

Figure 193: Big Box Market Saturation – Canada vs. US

United States CanadaHome Depot 1,976 179Lowe's 1,723 29Rona 80

Bix Box Stores 3,699 288Metro Population (M) 258.3 23.6Population per Store 69,834 81,854

Source: Company reports, US Census Bureau, Statistics Canada, Barclays Capital estimates.

We estimate that Lowe’s build-out could be eroding Rona’s EPS growth by 2%-3% each year. In our analysis, we estimate that the total big-box store sales will grow 2%-3% each year. However, we do not expect any new big box store additions from the incumbents (i.e. Rona and HD). With Lowe’s expected to add 3-5 big-box stores per year, we estimate that the market share loss will translate to 2%-3% EPS drain each year for RONA.

Figure 194: RONA’s Big-Box risk to Lowe’s Build-out

f2007 f2008 f2009 f2010 f2011E f2012E f2013E f2014E f2015ENational Big Box Store CountHome Depot 165 176 179 179 179 179 179 179 179Lowe's 0 11 16 24 29 34 39 43 47Rona 77 77 77 78 80 80 80 80 80Total 242 264 272 281 288 293 298 302 306

Estimated Big Box Sales ($M) $8,586 $8,159 $8,073 $8,073 $8,234 $8,399 $8,651 $8,911 $9,178 Y/Y Growth (%) -5.0% -1.1% 0.0% 2.0% 2.0% 3.0% 3.0% 3.0%

Baseline Big Box Sales per Store $35.5 $30.9 $29.7 $28.7 $28.6 $28.7 $29.0 $29.5 $30.0

National Big Box Sales ($M)Home Depot $5,854 $5,439 $5,313 $5,143 $5,118 $5,131 $5,196 $5,281 $5,369Lowe's $0 $340 $475 $690 $829 $975 $1,132 $1,269 $1,410

Rona - without Lowe's $2,732 $2,483 $2,428 $2,450 $2,543 $2,594 $2,672 $2,752 $2,835Rona - with Lowe's $2,732 $2,380 $2,285 $2,241 $2,287 $2,293 $2,322 $2,360 $2,399Total Difference $0 -$103 -$143 -$209 -$256 -$301 -$350 -$392 -$435Incremental Drain -$103 -$39 -$66 -$47 -$45 -$49 -$42 -$44

Incremental Annual Impact Gross Profit ($M) -$33 -$13 -$21 -$15 -$14 -$16 -$13 -$14EBITDA ($M) -$12 -$5 -$8 -$6 -$5 -$6 -$5 -$5Net Income ($M) -$9 -$3 -$6 -$4 -$4 -$4 -$4 -$4EPS ($M) -$0.08 -$0.03 -$0.04 -$0.03 -$0.03 -$0.03 -$0.03 -$0.03% Drain 4.3% 3.2% 3.0% 2.4% 2.2%


RONA is dealing with the New Reality RONA has cranked up cost containment efforts to offset weakened sales trend. In our view, RONA has done an admirable job dealing with very challenging market conditions over the past two-and-a-half years. Through aggressive procurement savings, increased distribution efficiency, some SG&A cost containment and increased private label penetration the company has been able to contain the margin compression risk of slowed to declining sales. This was most evident in the company’s recent 3Q11 results, which saw CSS fall 5% while the gross margin expanded 80 bps and the EBITDA margin remained


25 January 2012 182

essentially flat. Gross margin expansion was driven by procurement savings from suppliers and a more limited, but still positive contribution from growing private and controlled-brand product sales. As of September 2011, RONA’s private label penetration level was at 26% compared to 24% a year ago. We expect that RONA will continue to put pressure on its suppliers as will all retailers who continue to struggle with declining industry demand.

Figure 195: RONA has experienced gross margin gains in 7 of the last 11 quarters

1Q-09 2Q-09 3Q-09 4Q-09 1Q-10 2Q-10 3Q-10 4Q-10 1Q-11 2Q-11 3Q-11

Same Store Sales -9% -6% -5% 1% 11% 1% -2% -6% -13% -10% -5%Revenue Growth -7% -7% -4% 2% 13% 2% -1% 0% -4% -2% 2%

Gross Profit Growth -6% -6% -5% 2% 13% 3% 1% 3% -6% -4% 5%SG&A Growth -7% -2% -3% 1% 9% 5% 3% 8% 4% 8% 6%EBITDA Growth -10% -14% -8% 3% 48% 0% -5% -14% -95% -35% -4%

Gross Margin Variance 28bps 20bps -22bps 11bps 4bps 26bps 32bps 86bps -74bps -46bps 80bpsSG&A as % of Rev Variance 12bps 77bps 17bps -17bps -58bps 40bps 58bps 153bps 213bps 217bps 81bpsEBITDA Margin Variance 16bps -57bps -39bps 28bps 62bps -14bps -26bps -67bps -287bps -263bps -1bps

Sales ($M) $846 $1,370 $1,321 $1,141 $957 $1,404 $1,319 $1,139 $918 $1,370 $1,347EBITDA ($M) $24 $131 $112 $78 $34 $129 $103 $63 $2 $83 $99Note: All 2009 figures and 2010 growth/vairance are GAAP. All other figures are IFRS.Note: EBITDA excludes finance income


RONA continues to press for industry consolidation using every tool in the shed. Rona’s growth in Canada has always involved a significant contribution from acquisitions. Even before Lowe’s arrival in Canada, Rona was a leading consolidator, partly in recognition that Home Depot had a material head-start capturing big box opportunities outside of Quebec. From 1990 to 2005, Rona’s acquisition activity was primarily focussed on Retail/Corporate acquisitions and Affiliate/Wholesale recruitment. The acquisition of TOTEM in 2005 marked the end of any meaningfully sized retail/corporately owned acquisition targets in Canada with the exception of Kent in Atlantic Canada. The lack of retail acquisition growth prospects ultimately lead to Rona’s entry into the commercial/professional sector in 2007 through the acquisition of Noble Trade.

Retail acquisitions: Cashway (2000), REVY (2001), Lansing Buildall (2001), TOTEM (2005), Materiaux Coupal (2006), Dick’s Lumber (2007).

Commercial/Professional acquisitions: Noble Trade (2007), Best-MAR (2008), Plomberie Payette & Perreault (2010), MPH Supply (2010), Don Park (2010), La Boutique de Plomberie Decoration (2010).

Affiliated dealers : TruServ (2010).

RONA continues to expand its arsenal of consolidation levers. With Lowe’s continuing to open new big box stores, albeit at a slowed pace, in the midst of declining industry sales, RONA is feeling an even greater need to get the consolidation ball rolling to offset any sales/profit drain Lowe’s build-out may be placing on RONA’s retail network. Over the past two years Rona has added some new tools to its M&A tool box:

For RONA, no acquisition pipeline means muted sales


25 January 2012 183

1. Providing financial support to Affiliate members to acquire local competitors. This financial support has several approaches. First, RONA has a program that offers Affiliates who acquire local competitors more favourable purchasing terms. A second approach involves RONA acquiring affiliate members’ businesses to facilitate succession planning. This allows RONA to place the stores in the hands of less risk averse operators who may be more willing to acquire local competitors.

2. TruServ acquisition provides independents with a less onerous affiliate structure choice. RONA’s acquisition of TruServ allows it to offer independents a less restrictive membership agreement option than what the RONA affiliate agreement requires and a wider merchandise offering that may be a better fit than RONA’s predominantly hardware program. RONA obviously hopes that the TruServ program will allow it to broaden its appeal to Canada’s smaller independents.

Figure 196: Independents operators represent over 50% of stores

Rona19%

Independents51%

Large public retailers (Home

Depot, Cdn. Tire, Lowe's)

30%


Risks Continued weakness in Canadian housing starts and renovation activity will affect

financial performance.

Competitive intensity is increasing as Lowe's continues to build out its Canadian stores, which is leading to lower sales and margins as promotions increase to drive traffic.

Upside risks to our Rona thesis include acceleration in the housing market or CSS trends.


25 January 2012 184

Figure 197: RONA Financial Performance Summary

GAAP IFRS IFRS IFRS IFRSf2009A f2010A f2011F f2012F f2013F

Net Revenue ($ Thousands)) $4,677,359 $4,819,589 $4,767,169 $4,903,316 $4,962,442 Net Revenue Growth (%) -4.4% 2.6% -1.1% 2.9% 1.2%

Corporate Square Footage Growth (%) -0.4% 9.3% 2.3% 1.6% 1.6%

Same Store Sales Growth (%) -4.8% 0.5% -7.5% -0.2% 2.0%

Gross Margin 27.4% 28.2% 28.3% 28.6% 28.7%


EBITDA Margin 7.4% 6.9% 5.8% 6.4% 6.7%

Gross Margin Variance 8 bps 39 bps 10 bps 22 bps 10 bps

SG&A Variance 40 bps 67 bps 120 bps -34 bps -25 bps

EBITDA Variance -33 bps -27 bps -110 bps 56 bps 35 bps


Capex as a % of Sales (LTM) 3.2% 1.5% 1.7% 2.0% 2.0%Free Cash Flow $157,342 -$95,611 $12,504 $36,378 $182,270

Return on Equity 9.4% 7.4% 5.1% 6.2% 6.5%

Return on Invested Capital 7.7% 6.1% 4.4% 5.4% 5.9%Source: Company reports, Barclays Capital estimates.

Figure 198: RONA Free Cash Flow ($M)


Operating Cash Flow $283 $286 $264 $258 $264 $245 $292 $313

Change in W/C $0 -$9 $83 $50 -$190 -$56 -$86 $45

Cash from Operations $283 $277 $347 $308 $74 $190 $206 $358

Capex $51 $43 $151 $158 $2 $80 $100 $100

Free Cash Flow $232 $234 $196 $150 $72 $110 $106 $258Dividends $0 $0 $0 -$2 $0 -$18 -$19 -$19

Net Change in Share Capital $5 $5 $6 $170 $0 $3 -$40 $0

Acquisitions -$169 -$229 -$5 -$1 -$98 -$41 $0 $0

Net Change in Debt $252 $57 -$167 $45 -$110 -$30 -$26 -$26

Remaining Free cash flow $320 $68 $30 $362 -$135 $24 $22 $213Free Cash Flow per share $1.99 $2.00 $1.68 $1.20 $0.55 $0.84 $0.83 $2.04


ROE 15.8% 13.3% 12.4% 9.4% 8.0% 5.1% 6.2% 6.5%Source: Company Reports, Barclays Capital Estimates


25 January 2012 185

COMPANY SNAPSHOT

RONA Canadian Consumer & Retail

Income statement ($mn) 2010A 2011E 2012E 2013E CAGRRevenue 4,820 4,767 4,903 4,962 1.0% Stock Rating 2-EQUAL WEIGHTEBITDA 332 276 312 333 0.0% Sector View 2-NEUTRALEBIT 220 165 198 215 -0.7% Price (20-Jan-2012) $9.55Pre-tax income 200 144 183 201 0.1% Price Target $10.00Net income 135 90 116 129 -1.6% Ticker RONEPS (reported) ($) 1.03 0.68 0.91 1.02 -0.3%Diluted shares (m) 131 131 128 126 -1.3% Investment case

Dividend per share ($) - 0.14 0.15 0.15 NA


Balance sheet and cash flow ($mn) CAGRTangible fixed assets 885 901 893 880 -0.2%Goodwill 529 546 546 546 1.0%Cash and equivalents 76 167 116 250 48.9%Total assets 2,922 3,125 3,196 3,252 3.6%Short and long-term debt 467 456 430 405 -4.7% Downside case $8.00Other long-term liabilities 29 31 31 31 1.4%Total liabilities 1,009 966 986 940 -2.3%Net debt/(funds) 392 288 315 155 -26.6%Shareholders' equity 1,877 2,120 2,171 2,274 6.6%Change in working capital (190) (56) (86) 45 NAOperating cash flow 74 151 155 302 59.5%Capital expenditure 72 80 100 100 11.4%Free cash flow 2 71 55 202 NA Upside/downside scenarios

Valuation and leverage metrics AverageP/E (x) 9.3 13.9 10.5 9.4 10.8 EV/EBITDA (x) 4.9 5.6 4.9 4.1 4.9 FCF yield (%) 0.2 5.7 4.5 16.7 6.8Price/sales (x) 0.3 0.3 0.2 0.2 0.3 Price/BV (x) 0.7 0.6 0.6 0.5 0.6 Dividend yield (%) 0.0 1.5 1.5 1.6 1.2Total debt/capital (%) 19.9 17.7 16.5 15.1 17.3Total Debt/EBITDA (x) 1.4 1.7 1.4 1.2 1.4 Source: FactSet

Same Store Same Store SalesSelected operating metricsSame store sales growth (%) 0.5 -7.5 -0.2 2.0 -1.3Square footage growth (%) 6.7 2.1 1.9 1.8 3.1Capex/sales (%) 0.02 0.02 0.02 0.02 1.8


We expect Rona's normalized valuation to beconstrained by an easing housing market andincreasing competitive pressures as Lowe'scontinues to expand its network in Canada. Ourtarget P/E multiple of 11x is below RON's long-termaverage of 12x reflecting a less robust housingenvironment outlook.

Our Upside case reflects a more robust housingoutlook and slower build-out by Lowes. In thisscenario we assume 10% upside to our Base case2012E EPS driven by stronger CSS. Applying ournormative P/E of 11x would generate an Upside caseof $11.

Our Downside scenario reflects increased competivepressures from Lowe's and a more severe housingdownturn causing increased CSS and marginpressure, reducing our 2012E EPS by 11%. Applyinga 9.5x P/E (recent trough multiple) generates aDownside case of $8.

-8.0%-6.0%-4.0%-2.0%0.0%2.0%4.0%

2010A 2011E 2012E 2013E

DownsideCase

$8(-17.5%)

PriceTarget

$10(3.0%)

UpsideCase

$11(13.4%)

4

9

14

19

1/27/2011 1/20/2012

DownsideCase

$8(-16.2%)

PriceTarget

$10(4.7%)

UpsideCase

$11(15.1%)

4

9

14

19

1/27/2011 1/20/2012


25 January 2012 186

Figure 199: SNAPSHOT: North American Convenience Store Industry

Rank Company Stores Mkt Share Company Stores Mkt Share1 7-Eleven Inc. 6,145 4.2% CoucheTard - Mac's 1,993 8.6%2 BP North American 4,727 3.2% Kwik-Way 1,365 5.9%3 Shell/Motiva Enterprises 4,636 3.2% Petro Canada/Superstop 1,354 5.8%4 ExxonMobil Corp. 4,060 2.8% Shell 651 2.8%5 ChevronTexaco Corp. 4,015 2.7% 7-Eleven 465 2.0%6 Couche Tard - Circle K 3,802 2.6% Esso / On The Run 410 1.8%7 Speedway SuperAmerica 2,759 1.9% Husky Oil 313 1.3%8 Citgo 1,820 1.2% Gem 268 1.2%9 Sunoco Inc. 1,811 1.2% Fas Gas/Race Trac Gas 428 1.8%

10 Valero Energy Corp. 1,671 1.1% Proprio 250 1.1%Top Ten 35,446 24% Top Ten 7,497 32%remaining 110,895 76% remaining 15,731 68%Total 146,341 100% Total 23,228 100%

Source: CS News Top 100 (2010); NACS SOI 2010; CCSA SOI 2010, Canadian Grocer Who's Who 2011, Company reports

Top Ten US Competitors Top Ten Canadian Competitors

2010 ATD Regional Store Count market shares

Total US Store Couche SevenC- stores Count Tard Eleven Caseys Pantry Susser

US West Coast (CA, HI, OR and WA) 15,648 475 3.0% 10.9%Arizona (AZ, NV and UT) 4,336 636 14.8% 9.2%

US Southwest (CO, KS, MO, NM, OK and TX) 21,028 421 1.8% 2.9% 2.5%Florida (FL) 9,348 416 4.4% 6.6% 4.4%

US Gulf (AL, AR, FL, LA, MS and TN) 11,947 337 2.5% 0.0% 1.9%US Southeast (AL, GA, NC, SC and VA) 24,461 333 1.5% 2.8% 3.9%

US Midwest (IL, IN, IA, KY, MI, MO, OH and WI) 24,864 497 4.0% 1.9% 5.3% 0.2%US Great Lakes 30,520 687 3.2% 5.3%Other (AK, DE, IH, NT, ND, SD, WY) 4,189 0.6% 3.9%Total US 146,341 3,802 2.6% 4.2% 1.1% 1.1% 0.4%

(CT, DC, IN, KT, ME, MD, MA, MI, NH,

Caseys Pantry Susser Delek12 Months Ending Apr-11 Apr-11 Sep-10 Dec-10 Dec-10

Total Canada USAStore Count 5,795 1,993 3,802 1,367 1,638 526 412Avg. Gross Square Footage (Millions) 20.3 7.0 13.3 4.1 4.6 1.8 1.0Average store size (sq. ft.) 2,500 - 4,500 2,500 - 4,500 2,500 - 4,500 2,500 - 3,500 2,800 3,400 2,465Sales per Store ($ Millions) $3.3 $2.1 $3.9 $4.1 $4.4 $5.4 $3.9

Total Revenue ($ Millions) $18,966 $4,198 $14,768 $5,635 $7,265 $2,824 $1,592Revenue growth (3Yr CAGR) 7.3% 11.8% 6.1% 5.3% 1.7% 4.8% -3.6%Total Gross Margin 14.7% 20.0% 13.2% 15.6% 12.0%* 9.8% 11.8%Total EBITDA Margin (%) 3.9% 4.9% 3.3%* 1.9% 3.3%Total Operating Margin (%) 2.8% 3.4% 1.6%* 0.9% -Total Net Margin (%) 2.0% 1.7% 1.4%* -0.2% -

Merchandise SSS growth 1.8% 4.2% 4.8% 5.6% 4.0% 4.3%Merchandise Revenue ($ Millions) $6,222 $2,050 $4,172 $1,611 $1,798 $806 $384Merchandise Gross Margin 34.3% 33.1% 39.9% 33.8% 33.6% 30.5%Gas Volume (mlns of gallons) 678 3,649 1,394 2,047 735 424Gas Revenue ($ Millions) $12,744 $2,148 $10,596 $3,999 $5,414 $1,987 $1,208Gas Volume Comps 3.9% 0.7% 1.6% -4.9%Gas Dollar Margin - cents per 5.38 / ltr 15.79 / gal 15.21 / gal 12.9 / gal 18.4 / gal 16.1 / gal

Capex as a % Total Revenue 1.2% 3.8% 1.4% 3.1%Net Debt to Total EBITDA 0.3x 2.3x 2.3x 3.8xFCF ex Capex ($ Millions) $394 $47 $54 -$18FCF Yield (%) 9.6% 2.8% 12.3% -9.6%ROE (%) 19.6% 15.7% 26.2%* -1.8%ROIC (%) 18.4% 7.8% 10.7%* -0.6%Source: Company reports, Barclays Capital estimates *Excludes impairment charges

Couche Tard


25 January 2012 187

ALIMENTATION COUCHE-TARD (ATD-B)

Alimentation Couche-Tard Inc.(ATD-B.TO): Quarterly and Annual EPS (USD)

2011 2012 2013 Change y/y

FY Apr Actual Old New Cons Old New Cons 2012 2013





Year 2.01A N/A 2.20E 2.21E N/A 2.39E 2.39E 9% 9%

P/E 14.9 13.6 12.5




We are initiating coverage of Alimentation Couche-Tard (ATD-B.TO) with a 2-Equal Weight/2-Neutral rating and $32 price target, offering a potential total return of 8% from recent levels. Our $32 target is based on a 13.5x P/E multiple on our fiscal 2013 (April) EPS estimate of US$2.39 (converted at CAD/USD of $1.00). Couche-Tard has a well established reputation for financial discipline, a long-term track record of delivering above-average ROE and using excess free cash flow to enhance shareholder returns through a combination of dividend increases and share buybacks. We believe that these factors along with investors’ appetite for higher quality stocks contributed to Couche-Tard’s share price outperformance in 2011 (+13% vs. S&P/TSX index at -11%). However, Couche-Tard now trades at 12.6x NTM consensus EPS, which is in line with its five-year average. While our 13.5x target P/E implies some valuation uplift from current levels, we are hard-pressed to see any material multiple expansion in the near term as still high retail gas prices continue to strain consumer spending power, adding incremental pressure to an already constrained consumer. As an industry consolidator, acquisitions are a potential upside to our earnings forecast for Couche-Tard. However, we are not forecasting any large-scale acquisitions given the unpredictable timing and size of such transactions.

Figure 200: Couche-Tard P/E Valuation Range

F2013E F2014E CommentsBarCap Est. BarCap Est.

EPS Range (US$) $2.30 $2.39 $2.45 $2.45 $2.64 $2.60Y/Y % chg 4.6% 8.6% 11.5% 2.6% 10.4% 8.9%Multiples

9.0x $21 $21 $22 $22 $24 $23 <= ATD's historical trough P/E10.0x $23 $24 $25 $25 $26 $26

11.0x $25 $26 $27 $27 $29 $2912.0x $28 $29 $29 $29 $32 $31 <= 3-yr average multiple

13.0x $30 $31 $32 $32 $34 $34

13.5x $31 $32 $33 $33 $36 $35 <= BarCap valuation multiple14.0x $32 $33 $34 $34 $37 $36

15.0x $35 $36 $37 $37 $40 $3916.0x $37 $38 $39 $39 $42 $42 <= LT Avg. P/E = 15.8x

17.0x $39 $41 $42 $42 $45 $44

18.0x $41 $43 $44 $44 $47 $47 Source: Barclays Capital estimates. EPS range is for illustrative purposes only

Near term multiple expansion appears unlikely

ATD/B CN / ATD-B.TO




Price (20-Jan-2012) CAD 29.85



25 January 2012 188

Figure 201: Alimentation Couche Tard Forward P/E

Min 8.8x

Max 21.3x

LT Avg 15.8x

5x

7x

9x

11x

13x

15x

17x

19x

21x

23x

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: FactSet.

Figure 202: North American Convenience Store Historical Forward P/E Peak/Trough Cycles

Price Market Fiscal EPS PE EPS GrowthTicker 20/01/2012 Cap ($M) FY0 FY1 FY2 FY0 FY1 FY2 FY0-FY1 FY1-FY2 CAGR

Couche-Tard Consensus ATD.B $29.85 $3,677 $ 1.97 $ 2.21 $ 2.38 15.2x 13.5x 12.5x 11.9% 8.1% 10.0%

Caseys General CASY $53.03 $2,018 $ 2.59 $ 3.10 $ 3.49 20.5x 17.1x 15.2x 19.6% 12.7% 16.1%The Pantry Inc. PTRY $12.13 $273 $ 0.78 $ 0.87 $ 1.23 15.6x 13.9x 9.9x 11.8% 40.5% 25.3%Susser Holdings SUSS $24.01 $493 $ 1.10 $ 2.55 $ 1.37 21.8x 9.4x 17.6x 132.1% -46.5% 11.4%

Average 19.3x 13.5x 14.2x 54.5% 2.2% 17.6% Source: FactSet. EPS is consensus from FactSet.

Figure 203: Convenience Stores Comparable Valuations

Price Enterprise Fiscal EBITDA EV/EBITDA EBITDA GrowthTicker 20/01/2012 Value ($M) FY0 FY1 FY2 FY0 FY1 FY2 FY0-FY1 FY1-FY2 CAGR

Couche-Tard Consensus ATD.B $29.85 $3,688 $744 $775 $816 5.0x 4.8x 4.5x 4.2% 5.3% 4.7%

Caseys General CASY $53.03 $2,559 $289 $320 $351 8.8x 8.0x 7.3x 10.5% 9.6% 10.1%The Pantry Inc. PTRY $12.13 $1,304 $227 $227 $238 5.8x 5.7x 5.5x 0.2% 4.7% 2.4%Susser Holdings SUSS $24.01 $877 $117 $159 $134 7.5x 5.5x 6.5x 35.9% -15.7% 7.0%

Average 7.4x 6.4x 6.4x 15.5% -0.4% 6.5%Source: FactSet. EBITDA is consensus from FactSet.

Convenience stores can be viewed as relatively defensive since merchandise margin volatility is typically marginal compared with many general merchandise and specialty apparel retailers. Although Convenience store merchandise can be viewed as highly discretionary, the low average price point and high turns nature of many of the merchandise offerings tends to limit margin volatility. As well, with most C-store locations having the benefit of weekly gas station traffic they are less likely to fall off consumers’ list of stores visited.

Low gas margins (5%-6% gross margin) mean that gasoline demand trends have a very limited affect on earnings growth compared to the volatility of gas margins which fluctuate dramatically week to week with WTI.

We believe that a significant portion of Couche-Tard’s share price appreciation over the past 12 months have been driven by this relatively defensive appeal and investors’ accurate anticipation of dividend increases and active share buybacks.

Gasoline demand trends have a very limited affect on earnings

growth


25 January 2012 189

So far, F2012 has been a good year for Couche-Tard with an above-average level of acquisition activity (~300 stores as of F3Q12), gas margins running well above their historical average ($0.185/gal vs. the $0.145 mean) and continued progress on cost containment (SG&A ex interchange fees, acquisition costs and FX up only 0.7% in F1H12). Strong cash flows (LTM FCF yield of 6%) and an under-levered balance sheet (0.1x net debt/EBITDA) have allowed the company to enhance shareholder returns with three dividend increases in the past 12 months (yield of 2%) and the repurchase of shares through its NCIB program. We expect share repurchases in F2012 to contribute 3% to EPS growth.

However, as many retailers have experienced over the past calendar year, consumers’ discretionary spending has been constrained as they wait for a stronger employment outlook and a stabilized housing market in the United States. This has resulted in weakened gas volume demand and some margin compression in the merchandise segment of their business in Canada and the US.

In addition, Phillip Morris USA implemented a new pricing structure starting in April 2011 which has eroded Tobacco category profitability. This program, with some modifications, has been extended through 2012. To counter this, Couche-Tard has launched its own private label cigarette line to recoup some of the lost margins; however, the program is in its infancy and with limited management disclosure on the program, its performance to-date is unknown.

Couche-Tard has launched its own private label cigarette line

Figure 204: Gasoline demand continues to trend lower

Figure 205: High gas prices causing consumers to drive less

$2.00

$2.50

$3.00

$3.50

$4.00

$4.50

Jan-

10

Mar

-10

Jun-

10

Sep-

10

Dec-

10

Feb-

11

May

-11

Aug-

11

Nov

-11

-5.0%-4.0%-3.0%-2.0%-1.0%0.0%1.0%2.0%3.0%

Retail Gas Price (left)

Gasoline Demand - 12-week rolling avg. (right)

2,920

2,940

2,960

2,980

3,000

3,020

3,040

3,060

2005

2006

2007

2008

2009

2010

2011

Veh

icle

Mile

s (m

illio

ns)

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

Vehicle Miles Driven (LTM) Y/Y % change

Source: EIA, OPIS. Source: US Department of Transportation.


25 January 2012 190

Figure 206: US Convenience Store Merchandise Performance Trends

Y/Y bps changeCalendar Year Q1/10 Q2/10 Q3/10 Q4/10 Q1/11 Q2/11 Q3/11 Q1/11 Q2/11 Q3/11

Merchandise CSSCaseys General Store 3.7% 2.1% 7.0% 7.1% 4.8% 6.2% 5.8% 113 410 (118)Delek Holdings 1.2% 4.6% 6.3% 4.4% 4.0% 0.6% 2.4% 280 (400) (390)The Pantry Inc. 3.6% 7.7% 5.7% 1.3% 2.0% -1.5% -0.8% (160) (920) (650)Susser Holdings 2.5% 3.1% 3.4% 7.3% 2.5% 5.8% 3.4% 0 270 0 Couche Tard (US) 3.2% 4.4% 4.9% 3.9% 3.6% 1.5% 2.5% 40 (290) (240)Average 2.8% 4.4% 5.5% 4.8% 3.4% 2.5% 2.7% 55bp (186bp) (280bp)

Merchandise Gross MarginCaseys General Store 41.1% 40.3% 40.6% 39.2% 44.4% 39.9% 32.5% 332 (45) (807)Delek Holdings 30.8% 31.3% 30.1% 29.8% 30.8% 30.2% 29.0% 0 (110) (110)The Pantry Inc. 33.8% 34.2% 34.4% 33.5% 34.3% 34.0% 33.8% 53 (21) (57)Susser Holdings 32.7% 33.3% 33.8% 33.9% 34.0% 33.7% 33.8% 135 44 4 Couche Tard (US) 33.0% 32.9% 33.0% 33.1% 33.5% 33.2% 32.7% 48 34 (27)Average 34.3% 34.4% 34.4% 33.9% 35.4% 34.2% 32.4% 114bp (19bp) (199bp)


Figure 207: Convenience Store Gasoline Performance Trends

Y/Y bps changeCalendar Year Q1/10 Q2/10 Q3/10 Q4/10 Q1/11 Q2/11 Q3/11 Q1/11 Q2/11 Q3/11

Gasoline CSVCaseys General Store 0.2% 1.5% 3.6% 3.5% -1.9% -2.7% -2.9% (210) (420) (650)Delek Holdings -0.3% 3.4% 5.2% -0.8% -2.3% -1.3% 3.2% (200) (470) (200)The Pantry Inc. -7.5% -5.6% -7.2% -5.2% -6.9% -9.3% -8.3% 60 (370) (110)Susser Holdings -0.2% 1.8% 3.9% 4.3% 4.5% 5.0% 5.6% 470 320 170 Couche Tard (US) -0.7% 1.1% 0.5% 0.7% 0.3% -1.6% 0.2% 100 (270) (30)Avg. CSS Gas Volume -1.7% 0.4% 1.2% 0.5% -1.3% -2.0% -0.4% 44bp (242bp) (164bp)

U.S. Gasoline Demand -1.3% 1.2% 1.4% 0.7% 0.3% -1.0% -2.8% 154bp (220bp) (416bp)

Gas Margin per GallonCaseys General Store $0.131 $0.164 $0.149 $0.139 $0.156 $0.172 $0.167 19.1% 4.9% 12.1%Delek Holdings $0.129 $0.186 $0.196 $0.131 $0.125 $0.186 $0.196 -3.1% 0.0% 0.0%The Pantry Inc. $0.140 $0.156 $0.112 $0.104 $0.137 $0.166 $0.135 -2.1% 6.4% 20.5%Susser Holdings $0.111 $0.248 $0.228 $0.149 $0.153 $0.312 $0.228 37.8% 25.8% 0.0%Couche Tard (US) $0.142 $0.191 $0.171 $0.134 $0.142 $0.200 $0.170 -0.1% 4.3% -0.5% - Difference ATD - Avg. ($0.014) ($0.003) $0.000 ($0.003) $0.001 $0.010 $0.011 - - -Avg. Gas $ Margin / Gallon $0.131 $0.189 $0.171 $0.131 $0.143 $0.207 $0.179 10.3% 8.3% 6.4%


Company profile Couche-Tard is the largest convenience store operator (by store count) in Canada, the second largest independent in the United States behind 7-Eleven and the sixth ranked overall in the United States behind the Integrated Oil companies. The company also has more than 4,000 international licensed locations under the Circle K banner in Asia, UAE, and Mexico.


25 January 2012 191

Figure 208: Company snapshot

Canada U.S. Total# Stores with Motor fuel 671 3,446 4,117# Stores without Motor fuel 1,292 332 1,624

Revenue ($M) $4,198 $14,353 $18,551% of Total Revenue 23% 77% 100%

Merchandise Sales ($M) $2,050 $4,074 $6,124% of Sales 49% 28% 33%

Motor Fuel Sales ($M) $2,148 $10,279 $12,427% of Sales 51% 72% 67%

Gross Profit ($M) $839 $1,894 $2,733% of Total Gross Profit 31% 69% 100%

Merchandise Gross Profit ($M) $703 $1,349 $2,052% of Gross Profit 84% 71% 75%

Motor Fuel Gross Profit ($M) $136 $545 $681% of Gross Profit 16% 29% 25%


Management retains voting control within a distinctive shareholder agreement. Couche-Tard has two share classes. The multiple voting A shares are entitled to 10 votes per share (83% of votes), while the subordinated B shares carry one vote per share (17% of votes). We note that management has a 23% economic interest in the class A multiple voting shares representing 58% of the company’s total voting interest. Under the shareholders agreement, when each of the majority holders (Alain Bouchard, CEO; Jacques D’Amours, VP Admin.; Richard Fortin, Chairman; and Real Plourde, EVP) reach the age of 65, or they collectively own less than 50% of voting rights, their holdings of subordinated shares will automatically convert to the multiple voting shares.

Growth Strategy & Outlook Couche-Tard’s earnings growth strategy is focused on the following key drivers:

Acquisitions – Alimentation Couche-Tard continues to actively pursue reasonably priced acquisition opportunities as outlined earlier.

Foodservice growth – Couche-Tard is in the midst of expanding its food service offering toward a targeted penetration of 25% of gross profit, up from the current 18%.

Cost reduction efforts – benchmarking and an ongoing commitment to cost reduction have allowed ACT to reduce its SG&A expense rate by almost 100bps in two years. A more concerted, centralized procurement effort was launched in 2008/09, which has made a meaningful contribution to ACT’s gross margin capacity; unfortunately it has acted more as a buffer to downward margin pressure over the past four years.

Return of excess free cash flow – although acquisitions and reinvestment in its business is the preferred use of funds, Alimentation Couche-Tard takes a balanced approach to the deployment of free cash flow as evidenced by its active use of the share buyback program.

As an industry consolidator, acquisition is part of the company’s ongoing growth strategy – F2012 has been an active acquisition year. The C-store industry is highly fragmented and largely dominated by single-store operators (accounting for 63% of C-stores in the United States). The top 10 C-store chains represent only 24% and 32% of the industry store count in the United States and Canada, respectively. Major integrated oil companies continue to have a significant presence in the c-store space; however, over the


25 January 2012 192

past decade the integrated oil companies have increasingly divested their gas station/C-store locations seeing that portion of their business as a low return use of capital. This trend has provided Couche-Tard and other well-capitalized competitors an opportunity to act as industry consolidators.

Since the 1,663-store Circle K acquisition in F2004, Couche-Tard has acquired an additional 1,000 stores through more than 25 separate transactions. While the timing and size of future acquisitions is difficult to predict, Couche-Tard continues to play an active role in consolidation, as evidenced by its recent acquisition of 322 stores (plus 65 reseller contracts) from Exxon Mobil and the failed unsolicited bid for Casey’s General Stores in F2011. As that failed bid demonstrated, Alimentation Couche-Tard is a financially disciplined company that is willing to walk away from potential acquisitions if the purchase price puts an acceptable return at risk.

F2012 has been Couche-Tard’s most active company-operated acquisition year since F2007. So far in F2012 ACT has announced the acquisition of 465 stores, many of which will be consolidated into its results starting in 3Q12.

Figure 209: Couche-Tard Acquisition Summary

F2004 F2005 F2006 F2007 F2008 F2009 F2010 F2011 F2012E

Company-operated 1,706 45 75 421 46 107 70 47 190

Affiliated Stores 627 - 27 75 - - 444 - 275


Couche-Tard has achieved a compelling ROE track record and has a strong financial position that can support continued acquisition activity. Couche-Tard’s financial and operational discipline has allowed it to deliver industry-leading ROE despite the challenges of volatile gas margins and acquisition integration risk. As of F2Q12A, Couche-Tard had net debt of $90mn, and a net debt/EBITDA ratio of 0.1x (versus the public peer group average of 2.9x) providing it with acquisition leverage capacity of at least $1.8bn (2.5x net debt/EBITDA), if the need arises. Couche-Tard already has access to over $895mn in liquidity through a combination of cash ($489mn) and unused authorized credit agreements ($407mn). In addition, the company’s cash flow generation capacity enables it to boost returns to shareholders through dividend increases and/or share buybacks.

Figure 210: Couche-Tard Company-Generated Returns

Fiscal Year (Apr) 2008 2009 2010 2011 CAGR 2012E 2013E

Net earnings growth -8.2% 33.7% 11.8% 33.6% 25.9% 6.7% 3.0%

EPS growth due to changes in WASO -5.9% 16.9% 5.4% 0.4% 7.3% 2.8% 5.7%

Total EPS growth -14.1% 50.6% 17.2% 34.0% 33.2% 9.5% 8.6%

Dividend yield 0.7% 1.0% 0.8% 0.9% 0.9% 0.9% 1.0%

Company generated return -13.4% 51.6% 18.0% 34.9% 34.1% 10.3% 9.7%

TSX return (incl. dividends) 6.5% -30.7% 34.7% 17.2% 5.2%

ROE 15.1% 19.1% 17.5% 19.6% 19.9% 19.6%

Net debt to EBITDA 1.3x 1.0x 0.8x 0.3x 0.3x 0.2xSource: FactSet Bloomberg, Company Reports, Barclays Capital estimates

In a slowed growth environment Couche-Tard has increasingly deployed FCF toward dividend increases and share buybacks – the dividend has been increased three times in the past year. In the absence of acquisitions and other Capex priorities, ACT has often

Since F2004, Couche-Tard has acquired an additional 1,000

stores


25 January 2012 193

deployed FCF toward share repurchases. ACT recently renewed its NCIB which allows it to repurchase up to 2.7mn Class A shares (5% of outstanding shares) and 11.1mn Class B shares (or 10% of the outstanding) up to October 24, 2012. Since the implementation of the program, Couche-Tard has repurchased 1.8mn Class B shares. Under its previous NCIB (expired Oct. 20, 2011), Couche-Tard repurchased 13,700 Class A and 7.1mn Class B shares, which represents 0.5% and 63%, respectively, of the amount permitted for repurchase.

Figure 211: Couche-Tard Free Cash Flow ($ mn)

Fiscal Year (Apr) 2007 2008 2009 2010 2011 2012E 2013E 2014E

Operating Cash Flow $372 $397 $473 $538 $628 $647 $647 $687Change in W/C $31 -$37 $30 -$47 -$9 $103 $6 $0

Cash from Operations $403 $360 $503 $491 $619 $750 $653 $686Capex -$373 -$280 -$238 -$275 -$225 -$225 -$250 -$300

Free Cash Flow $30 $80 $265 $216 $394 $525 $403 $386

Dividends -$20 -$26 -$24 -$25 -$33 -$48 -$53 -$57

Net Change in Share Capital $1 -$97 -$98 -$54 -$62 -$265 -$264 -$147

Acquisitions -$601 -$71 -$81 -$156 -$39 -$235 -$63 -$50

Net Change in Debt $346 -$14 -$117 -$47 -$196 $80 $0 $0

Remaining cash flow -$244 -$128 -$55 -$66 $65 $56 $24 $132

net debt / EBITDA 1.5x 1.3x 1.0x 0.8x 0.3x 0.3x 0.2x 0.1x

Free Cash Flow per share $0.14 $0.39 $1.34 $1.15 $2.09 $2.86 $2.32 $2.30


ROE 18.0% 15.1% 19.1% 17.5% 19.6% 19.9% 19.6% 18.8% Source: FactSet, Bloomberg, Company Reports, Barclays Capital estimates

Increased focus on food service development could increase EPS by as much as 15%. Couche-Tard has set a penetration target of 25% of gross profit versus the current rate of 18% for its expanded food service growth initiative. Over the past five years, Couche-Tard has grown its food service sales at a 6.4% CAGR, modestly outpacing the industry average growth rate of 6%. At the end of F2011, Couche-Tard’s food service sales represented approximately 10.5% of total merchandise sales and 18% of merchandise gross profits. Couche-Tard has significant room to grow in this category as its penetration remains below the U.S. C-store industry average for food service penetration of 13% and 22% of merchandise sales and gross profits, respectively. In fact, the company has already achieved higher food service penetration in Western Canada and in some regions in the United States.

Management is targeting food service penetration of 15% of sales and 25% of gross profit dollars over the next five-plus years. We estimate that each 100-bp increase in food service penetration as a percentage of gross profit could add $0.04/share, or a 2% uplift to earnings. Achieving management’s targeted penetration rate would add $0.30 to EPS, or an incremental EPS increase of 15%.

Couche-Tard has significant room to grow in the food service

category


25 January 2012 194

Figure 212: Achieving foodservice penetration target could generate 15% EPS uplift

Increase in Food Service PenetarionMgmt.

F2011 +50 bps +100 bps +200 bps TargetPenetration (as % of gross profit) 18.0% 18.5% 19.0% 20.0% 25.0%

Food Service sales $640.5 $659.5 $679.0 $718.2 $922.5% of in-store sales 10.5% 10.8% 11.1% 11.7% 15.1%

Incremental Gross profit/EPS impact vs. F2011Gross profit $369 $5 $10 $21 $76EPS $2.01 $0.02 $0.04 $0.08 $0.30

% increase 1.0% 2.1% 4.2% 15.1% Source: Company reports, Barclays Capital estimates

Ongoing cost-containment focus has delivered up to a 100bp improvement in ACT’s SG&A expense rate, increasing earnings power by up to $0.05 per share. Excluding FX and credit card fees, operating expenses as a percentage of merchandise sales have declined in 10 of the past 11 quarters. The results reflect management’s continued efforts to reduce costs and improve operating efficiency. This has been achieved through numerous store and corporate level initiatives, which was kick-started in mid-2008 as the recession hit by an initial hiring freeze and reduced executive compensation. Benchmarking identified several opportunities which resulted in several initiatives such as the installation of a labour scheduling program, sharing of best practices within the company’s divisions and the closure of underperforming stores.

Figure 213: Couche-Tard Operating Expense History

4Q 09 1Q 10 2Q 10 3Q 10 4Q 10 1Q 11 2Q 11 3Q 11 4Q 11 1Q 12 2Q 12

OPEX (% of merch. sales ex. FX and credit card fees)

31.4% 28.3% 28.7% 31.3% 30.5% 27.8% 28.2% 30.8% 30.5% 27.5% 27.9%

Y/Y change -120 bps -90 bps -240 bps -130 bps -90 bps -50 bps -50 bps -50 bps 0 bps -30 bps -30 bps

Source: Company Reports, Barclays Estimates

Fuel margins are a tailwind for F2012E, but an expected headwind in F2013E. Motor fuel represents more than two-thirds of Couche-Tard’s total sales; however, it carries a significantly lower profit margin compared to in-store merchandise (33% vs. 5–6%), which reduces the gross profit importance of gasoline sales to only 25%. Fuel margins have been very volatile over the past five years as the wholesale price of gasoline which is largely dependent on the price of crude oil has been highly volatile pre- and post-recession. In general, retail fuel margins tend to expand in an environment with rapidly declining energy prices; however, retail gas prices remain sticky when wholesale prices fall. While gas margins can fluctuate significantly on a quarter-to-quarter basis, over the long run they have typically reverted to a $0.14-$0.15 per gallon mean.

Based on recent fluctuations in WTI, we expect Couche-Tard to generate near-record gas margins in F2012E as the general downtrend in oil prices during the first half of the fiscal year has generated robust fuel margins. However, we are forecasting a moderation in fuel margins in F2013, reflecting our outlook for steady increases in crude oil and gasoline prices. We estimate that a $0.01/gallon change in U.S. gas margins impacts EPS by $0.17 or approximately 7%.

We expect Couche-Tard to generate near-record gas

margins in F2012E


25 January 2012 195

Figure 214: Couche-Tard – US Gas Margin forecast ($/gal)

$/gallon 2008 2009 2010 2011 2012E 2013EQ1 $0.1673 $0.1555 $0.1543 $0.1912 $0.1995 $0.1529Q2 $0.1304 $0.2488 $0.1578 $0.1712 $0.1704 $0.1553Q3 $0.1438 $0.1821 $0.1288 $0.1338 $0.1567 $0.1527Q4 $0.1002 $0.1138 $0.1421 $0.1424 $0.1467 $0.1531

FY $0.1358 $0.1755 $0.1451 $0.1579 $0.1668 $0.1541

$0

$20

$40

$60

$80

$100

$120

$140

$0.00

$0.50$1.00

$1.50$2.00$2.50

$3.00$3.50

$4.00$4.50

WTI (LHS) Retail Price (RHS)

$0.1358

$0.1755

$0.1451 $0.1579

$0.1663$0.1541

Source: OPIS, Company reports, Barclays Capital estimates.

Favourable changes to debit card rules are unlikely to materially increase EPS growth. On June 29, 2011, the U.S. Federal Reserve announced the final rules under the Durbin amendment which set the maximum allowable interchange fee at 21 cents plus 5 bps of the transaction amount on every debit card transaction (effective October 1, 2011). Given that ACT does not disclose specific transaction details (i.e., the percent of purchases paid with debit; average transaction sizes), our ability to accurately forecast the potential savings from the new interchange fee legislation is significantly limited. Under a number of general assumptions, we estimate that ACT’s EPS could benefit by $0.15, assuming that the company does not pass through any savings to customers. Again, we emphasize that our analysis is, at best, a directional measure of the potential cost savings. Given that we expect most, if not all, of the savings to be passed on to consumers, the absolute magnitude of savings from the legislated changes is less relevant as the net EPS impact will be immaterial. We note that the legislation does not include restrictions on credit card interchange fees. Future regulations that reduce interchange fees on credit transactions could generate more meaningful savings for the company; however, there is currently no proposed legislation on this issue at the moment.


25 January 2012 196

Figure 215: New debit interchange rules not expected to generate significant savings

Couche Tard - Annualized Estimated Impact of Fee Reform

Current Debit & Credit card fee changes Merch Gas TotalDebit interchange fee reduction $0.4 $16.7 $17.0Alternate payment method: credit & debit $0.9 $3.4 $4.3Declining debit/credit PMT on small transactions $6.3 $9.8 $16.1EBT savings $7.5 $29.8 $37.4

Debit interchange fee reduction $0.00 $0.07 $0.07Alternate payment method: credit & debit $0.00 $0.01 $0.02Declining debit/credit PMT on small transactions $0.03 $0.04 $0.06

Estimated EPS savings of changes $0.03 $0.12 $0.15 Source: Company reports, Federal Reserve, Barclays Capital estimates.

Risks A Canadian and global economic slowdown could pressure multiples downward.

Higher gas prices can reduce store traffic; higher gas prices also increase the cost of credit card fees.

Risk of over-paying for acquisitions; acquisition strategies also present integration risk.

Figure 216: Alimentation Couche-Tard Financial Summary

(US$ M) 2009A 2010A 2011A 2012E 2013ECanadian Revenue $3,173 $3,634 $4,198 $4,853 $4,947 Y/Y Growth (%) 5.7% 14.5% 15.5% 15.6% 1.9% Merchandise SSS (%) 2.2% 4.8% 1.8% 1.7% 1.5% Same Store Fuel Volume (%) 3.7% 3.0% 3.9% -1.5% 0.8%

U.S. Revenue $12,608 $12,806 $14,768 $16,996 $17,164 Y/Y Growth (%) 1.9% 1.6% 15.3% 15.1% 1.0% Merchandise SSS (%) 0.6% 2.9% 4.2% 2.4% 1.8% Same Store Fuel Volume (%) -6.4% 1.0% 0.7% -0.2% 1.0%

Total Revenue $15,781 $16,440 $18,966 $21,850 $22,111 Y/Y Growth (%) 2.7% 4.2% 15.4% 15.2% 1.2%

Gross Margin (%) 15.4% 15.5% 14.7% 13.1% 13.5%SG&A as % Revenue (%) 11.7% 11.7% 10.8% 9.7% 10.0%EBITDA Margin (%) 3.7% 3.8% 3.9% 3.4% 3.5%

Gross Margin Variance 96 bp 10 bp -85 bp -155 bp 40 bpSG&A as % Revenue Variance 40 bp 0 bp -95 bp -101 bp 28 bpEBITDA Margin Variance 56 bp 11 bp 11 bp -54 bp 12 bp

Net Debt/EBITDA 1.0x 0.8x 0.3x 0.3x 0.2xCapex/Sales 1.5% 1.7% 1.2% 1.0% 1.1%Free Cash Flow (OCF-Capex/WC) $265 $216 $394 $525 $403ROE 19.1% 17.5% 19.6% 19.9% 19.6%ROIC 14.6% 14.3% 18.4% 17.8% 17.7%



25 January 2012 197

COMPANY SNAPSHOT

Alimentation Couche Tard Canadian Consumer & Retail

Income statement (US$mn) 2011A 2012E 2013E 2014E CAGRRevenue 18,550 22,275 22,111 22,585 6.8% Stock Rating 2-EQUAL WEIGHTEBITDA 726 758 776 823 4.3% Sector View 2-NEUTRALEBIT 512 529 544 579 4.2% Price (20-Jan-2012) $29.85Pre-tax income 503 536 552 588 5.4% Price Target $32.00Net income 368 403 415 442 6.3% Ticker ATD.BEPS (reported) (US$) 2.01 2.20 2.39 2.64 9.5%Diluted shares (m) 188 183 174 168 -3.7% Investment case



Balance sheet and cash flow (US$mn) CAGRTangible fixed assets 1,935 2,080 2,161 2,267 5.4%Intangible fixed assets 630 430 430 430 -11.9%Cash and equivalents 310 366 390 522 19.0%Total assets 3,926 4,228 4,352 4,607 5.5%Short and long-term debt 502 578 578 578 4.8% Downside case $29.00Total liabilities 1,945 2,205 2,231 2,248 4.9%Net debt/(funds) 206 212 188 56 -35.3%Shareholders' equity 1,981 2,022 2,121 2,359 6.0%Change in working capital (9) 103 6 (0) NAOperating cash flow 619 750 653 686 3.5%Capital expenditure 225 225 250 300 10.1%Net cash flow 100 57 24 132 10.0%


Valuation and leverage metrics AverageP/E (x) 19.6 17.9 16.5 15.0 17.3 EV/EBITDA (x) 10.5 9.8 9.1 8.1 9.4 FCF yield (%) 1.3 0.8 0.3 2.0 1.1Price/sales (x) 0.4 0.3 0.3 0.3 0.3 Price/BV (x) 3.7 3.6 3.2 2.8 3.3 Dividend yield (%) 0.5 0.7 0.8 0.9 0.7Total debt/capital (%) 20.2 22.2 21.4 19.7 20.9Total Debt/EBITDA (x) 0.7 0.8 0.7 0.7 0.7

Source: FactSet

Selected operating metrics Same Store SalesStore count 5,795 6,140 6,255 6,345 -Merch same store sales (%) 6.6 3.5 3.2 4.0 4.3Same store fuel volume (%) 6.9 2.4 -0.8 1.8 2.6Gross profit per gallon (US$) 0.16 0.17 0.15 0.15 15.7

Source: Company data, Barclays Capital Note: FY end Apr.

ATD is a strong C-store operator and financiallydisciplined company, as evidenced by its consistentearnings growth and effective FCF use. Our 13.5xtarget P/E reflects the earnings lift from its foodservice initiative and cost containment; however,near-term headwinds caused by high retail gasprices may limit valuation upside.

Our Upside case reflects expanded in-store marginsdriven by higher food service penetration and furthercost savings. In this scenario we derive an Upsidecase of $35 predicated on a 14x P/E multiple on2013E EPS of $2.53.

Rising gas prices could limit fuel demand and reducein-store traffic. Higher gas prices could also increasecredit card fees and squeeze fuel margins. Ourdownside scenario is based on a 13x P/E multiple on2013E EPS of $2.22.

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

2011A 2012E 2013E 2014E

Merchandise Fuel Volume

DownsideCase

$29(-2.84%)

PriceTarget

$33(10.5%)

UpsideCase

$35(17.2%)

12172227323742

1/27/2011 1/20/2012

DownsideCase

$29(-2.84%)

PriceTarget

$32(7.2%)

UpsideCase

$35(17.2%)

12172227323742

1/27/2011 1/20/2012


25 January 2012 198

Valuation Methodology and Risks

Canadian Retail & Consumer

Alimentation Couche-Tard Inc. (ATD/B CN / ATD-B.TO)

Valuation Methodology: Our price target of $32 is based on a forward P/E multiple of 13.5x our F2013 EPS estimate of $2.39

Risks which May Impede the Achievement of the Price Target: 1) Potential US and Canadian economic slowdowns would lower the sales and profitability at Couche Tard.

2) Increased gas prices usually lead to less miles travelled by consumers and would impact the financial performance at Couche Tard.

Canadian Tire Corp., Ltd. (CTC/A CN / CTC-A.TO)

Valuation Methodology: Our price target of $74 is based on a forward P/E multiple of 12x our F2012 EPS estimate of $6.14

Risks which May Impede the Achievement of the Price Target: 1) Canadian economic slowdown would lower sales and financial performance. 2) Wal-Mart's current buildout and the 2013 entry of Target will increase the competitive intensity of the market, potentially leading to lower sales and margins as promotions increase to drive traffic.

3) The recent acquisition of Forzani poses intergration risks.

Dollarama Inc. (DOL CN / DOL.TO)


Risks which May Impede the Achievement of the Price Target: 1) Dollarama sources many of their products overseas and any increased cost of acquiring products would impact the company's financial performance.

2) The consensus view for Dollarama's growth is aggressive and any significant slowdown in reported growth could lead to valuation multiple contraction.

Empire Co., Ltd. (EMP/A CN / EMP-A.TO)

Valuation Methodology: Our price target of $57 is based on an NAV using a 5x forward EV/EBITDA multiple on our F2013 Sobeys EBITDA estimate of $838mln

Risks which May Impede the Achievement of the Price Target: 1) All food retailers are facing margin deterioration based on a weakened Canadian consumer, an intensely promotional environment in response to Wal-Mart's national Supercenter buildout, and food cost increases from producers. 2) Sobeys is currently building an automated distribution center in Quebec, which can often lead to execution risks, though we note that their first automated distribution center in Vaughan, Ontario, was completed and activated seamlessly.

3) Empire, through its Genstar Partnership, is also exposed to the Canadian residential housing market that is potentially weakening.

George Weston Ltd. (WN CN / WN.TO)

Valuation Methodology: Our price target of $69 is based on an NAV using a 7x forward EV/EBITDA multiple on our F2012 estimated Weston Foods EBITDA of $329mln.

Risks which May Impede the Achievement of the Price Target: 1) George Weston is facing margin deterioration based on increased commodity costs (particularly wheat) and the inability to effectively pass on price increases to food retailers due to the economic condition of the Canadian consumer.

2) As a majority owner of Loblaw, George Weston's continued financial performance may be impacted by the ability of Loblaw to execute on its 5-year IT/supply chain infrastructure overhaul program without disruption to the customer.

Jean Coutu Group (PJC/A CN / PJC-A.TO)

Valuation Methodology: Our price target of $14 is based on a forward PE multiple of 14.5x our F2013 EPS estimate of $0.98

Risks which May Impede the Achievement of the Price Target: 1) Further government policy changes related to pharmacy profitability, particularly in Quebec, pose significant financial performance risks on Jean Coutu

2) In response to constrained Canadian consumers, drug retailers have increased promotional activity at the front-end of the store and this may negatively impact margins.

Loblaw Cos., Ltd. (L CN / L.TO)


Risks which May Impede the Achievement of the Price Target: 1) All food retailers are facing margin deterioration based on a weakened Canadian consumer, an intensely promotional environment in response to Wal-Mart's national Supercentre buildout, and food cost increases from producers. 2) Loblaw is in the final stages of a 5-year IT/supply chain infrastructure overhaul and will continue to be at high risk for execution and migration errors as the new systems roll out to stores in 2012 and 2013.

Metro Inc. (MRU/A CN / MRU-A.TO)


Risks which May Impede the Achievement of the Price Target: 1) All food retailers are facing margin deterioration based on a weakened Canadian consumer, an intensely promotional environment in response to Wal-Mart's national Supercenter buildout, and food cost increases from producers. 2) Metro is particularly at risk from Wal-Mart's SuperCenter buildout as the company has now turned its focus to Quebec,


25 January 2012 199

Valuation Methodology and Risks Metro's key market. The Quebec SuperCentre buildout is expected to last until the end of 2013.

North West Co., Inc. (NWC CN / NWC.TO)

Valuation Methodology: Our price target of $20 is based on a forward EV/EBITDA multiple of 8.5x our F2013 EBITDA estimate of $134mln

Risks which May Impede the Achievement of the Price Target: 1) All food retailers are facing margin deterioration based on a weakened Canadian consumer, an intensely promotional environment in response to Wal-Mart's national Supercenter buildout, and food cost increases from producers. 2) Government policy changes to programs like Nutrition North and the Alaska Permanent Fund can effect North West Company's sales and operational efficiency.

3) Deterioration in community relations would impact the company's financial performance.

RONA Inc. (RON CN / RON.TO)


Risks which May Impede the Achievement of the Price Target: 1) Continued weakness in Canadian housing starts and renovation activity will affect financial performance.

2) Lowe's continues to build out their Canadian stores which is increasing the competitive intensity of the market leading to lower sales and margins as promotions increase to drive traffic.

Shoppers Drug Mart Corp. (SC CN / SC.TO)


Risks which May Impede the Achievement of the Price Target: 1) Further government policy changes related to pharmacy profitability (for example British Columbia's reopening of the drug reform discussion) pose significant financial performance risks to Shoppers Drug Mart

2) In response to constrained Canadian consumers, drug retailers have increased promotional activity at the front-end of the store and this may negatively impact margins.

Tim Hortons Inc. (THI CN / THI.TO)


Risks which May Impede the Achievement of the Price Target: 1) Increased coffee prices may contract Tim Hortons' margins.

2) A weakened North American consumer could lead to lower sales at the franchise level and lower royalty revenue at the corporate level.

3) Disappointing international growth may impact Tim Hortons' valuation multiple.



25 January 2012 200

ANALYST(S) CERTIFICATION(S)

I, Jim Durran, hereby certify (1) that the views expressed in this research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of my compensation was, is or will be directly or indirectly related tothe specific recommendations or views expressed in this research report.

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Primary Stocks (Ticker, Date, Price)

Alimentation Couche-Tard Inc. (ATD-B.TO, 20-Jan-2012, CAD 29.85), 2-Equal Weight/2-Neutral

Canadian Tire Corp., Ltd. (CTC-A.TO, 20-Jan-2012, CAD 63.70), 1-Overweight/2-Neutral

Dollarama Inc. (DOL.TO, 20-Jan-2012, CAD 44.00), 1-Overweight/2-Neutral

Empire Co., Ltd. (EMP-A.TO, 20-Jan-2012, CAD 56.43), 2-Equal Weight/2-Neutral

George Weston Ltd. (WN.TO, 20-Jan-2012, CAD 66.12), 2-Equal Weight/2-Neutral

Jean Coutu Group (PJC-A.TO, 20-Jan-2012, CAD 13.27), 2-Equal Weight/2-Neutral

Loblaw Cos., Ltd. (L.TO, 20-Jan-2012, CAD 37.30), 2-Equal Weight/2-Neutral

Metro Inc. (MRU-A.TO, 20-Jan-2012, CAD 51.58), 2-Equal Weight/2-Neutral

North West Co., Inc. (NWC.TO, 20-Jan-2012, CAD 19.95), 2-Equal Weight/2-Neutral

RONA Inc. (RON.TO, 20-Jan-2012, CAD 9.55), 2-Equal Weight/2-Neutral

Shoppers Drug Mart Corp. (SC.TO, 20-Jan-2012, CAD 41.45), 2-Equal Weight/2-Neutral

Tim Hortons Inc. (THI.TO, 20-Jan-2012, CAD 48.80), 1-Overweight/2-Neutral

Other Material Conflicts

Barclays Capital is providing investment banking services to Ralcorp Holdings Inc in relation to the proposed spin-off of its Post Holdings Inc subsidiary.

Guide to the Barclays Capital Fundamental Equity Research Rating System:

Our coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2-Equal Weight or 3-Underweight (see definitions below) relative to other companies covered by the analyst or a team of analysts that are deemed to be in the same industry sector (the "sectorcoverage universe").

In addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or 3-Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investorsshould carefully read the entire research report including the definitions of all ratings and not infer its contents from ratings alone.

Stock Rating

1-Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.

2-Equal Weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.

3-Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.


25 January 2012 201


RS-Rating Suspended - The rating and target price have been suspended temporarily due to market events that made coverage impracticable orto comply with applicable regulations and/or firm policies in certain circumstances including when Barclays Capital is acting in an advisory capacity in a merger or strategic transaction involving the company.

Sector View

1-Positive - sector coverage universe fundamentals/valuations are improving.

2-Neutral - sector coverage universe fundamentals/valuations are steady, neither improving nor deteriorating.

3-Negative - sector coverage universe fundamentals/valuations are deteriorating.

Below is the list of companies that constitute the "sector coverage universe":

Canadian Retail & Consumer

Alimentation Couche-Tard Inc. (ATD-B.TO) Canadian Tire Corp., Ltd. (CTC-A.TO) Dollarama Inc. (DOL.TO)

Empire Co., Ltd. (EMP-A.TO) George Weston Ltd. (WN.TO) Jean Coutu Group (PJC-A.TO)

Loblaw Cos., Ltd. (L.TO) Metro Inc. (MRU-A.TO) North West Co., Inc. (NWC.TO)

RONA Inc. (RON.TO) Shoppers Drug Mart Corp. (SC.TO) Tim Hortons Inc. (THI.TO)

Distribution of Ratings:

Barclays Capital Inc. Equity Research has 2181 companies under coverage.

43% have been assigned a 1-Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Buy rating; 53% of companies with this rating are investment banking clients of the Firm.

42% have been assigned a 2-Equal Weight rating which, for purposes of mandatory regulatory disclosures, is classified as a Hold rating; 49% of companies with this rating are investment banking clients of the Firm.

13% have been assigned a 3-Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Sell rating; 39% ofcompanies with this rating are investment banking clients of the Firm.

Guide to the Barclays Capital Price Target:

Each analyst has a single price target on the stocks that they cover. The price target represents that analyst's expectation of where the stock willtrade in the next 12 months. Upside/downside scenarios, where provided, represent potential upside/potential downside to each analyst's pricetarget over the same 12-month period.

Barclays Capital offices involved in the production of equity research:

London

Barclays Capital, the investment banking division of Barclays Bank PLC (Barclays Capital, London)

New York

Barclays Capital Inc. (BCI, New York)

Tokyo

Barclays Capital Japan Limited (BCJL, Tokyo)

São Paulo

Banco Barclays S.A. (BBSA, São Paulo)

Hong Kong

Barclays Bank PLC, Hong Kong branch (Barclays Bank, Hong Kong)

Toronto

Barclays Capital Canada Inc. (BCC, Toronto)

Johannesburg

Absa Capital, a division of Absa Bank Limited (Absa Capital, Johannesburg)

Mexico City

Barclays Bank Mexico, S.A. (BBMX, Mexico City)

Taiwan

Barclays Capital Securities Taiwan Limited (BCSTW, Taiwan)

Seoul

Barclays Capital Securities Limited (BCSL, Seoul)

Mumbai


25 January 2012 202


Barclays Securities (India) Private Limited (BSIPL, Mumbai)

Singapore

Barclays Bank PLC, Singapore branch (Barclays Bank, Singapore)

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