Investment Opinion

Investment Opinion

For Eleventh Consecutive Quarter, Gross Margin Gains Drive Earnings Growth

Despite a highly competitive and promotional environment, ongoing declines in

general merchandise sales as Loblaw refines its GM categories/strategies,

deflation in the drugstore segment, $20 MM decline in contribution from PC

Financial as Loblaw invests to grow this segment and incremental IT/supply

chain spend, Loblaw delivered strong Q2/11 underlying earnings and earnings

growth driven by gross margin gains in the retail segment. Q2/11 EPS (excluding

a $0.04/share charge related to prior period commodity tax matters) of $0.74 was

+13% and $0.01/ higher than our forecast and in the middle of the quarterly

forecast range.

Seeing the Light

Loblaw is now almost mid-way through the final stages of its investment program

to rebuild supply chain, IT and the organization to enable the Company to truly

leverage its industry-leading market position. As we move through 2012 and into

2013 and incremental expenses taper off, Loblaw should deliver accelerating free

cash flow, which could be deployed to raise the dividend and/or execute upon the

NCIB.

Inflation Creeping In… A Bit

Both in the release and on the call, Loblaw management noted that inflation was

"modest" and well below the StatsCan measure of +4%. Food retailers would

clearly welcome inflation as overall market growth is extremely modest, but

Loblaw management reiterated that consumers are pinched by rising gas prices

and are extremely price/value focused