Loblaw Companies Limited

Sophia Bisoukis - Vice President, Investor Relations Galen Weston - Executive Chairman and President Richard Dufresne - Chief Financial Officer

Patricia Baker - Scotia Capital Equity Michael Van Aelst - TD Newcrest Peter Sklar - BMO Capital Markets Irene Nattel - RBC Capital Markets Mark Petrie - CIBC World Markets David Hartley - Credit Suisse Capital Markets Kenric Tyghe - Raymond James Jim Durran - Barclays Capital Vishal Shreedhar - National Bank Financial Keith Howlett - Desjardins Securities Research Chris Li - Bank of America Merrill Lynch

Thank you, Michelle, and good morning. Welcome to the Loblaw Companies Limited fourth quarter 2015 results conference call.

I’m joined by Galen Weston, President and Executive Chairman; and Richard Dufresne, Chief Financial Officer. Before we begin today’s call, I want to remind you that the discussion will include forward-looking statements, such as the company’s beliefs and expectations regarding certain aspects of the financial performance in 2015 and future years.

These statements are based on certain assumptions and reflect management’s current expectations and they are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from our expectations. These risks and uncertainties are discussed in the company’s materials filed with the Canadian regulators from time to time.

Any forward-looking statements speak only as of the date they are made. The company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, other than what is required by law.

Certain non-GAAP financial measures may be discussed or referred to today. Please refer to our annual report and other materials filed with the Canadian Securities regulators for a reconciliation of each of these measures to the most direct comparable GAAP financial measure.

I will now turn the call over to Richard.

Thank you, Sophia, and good morning, everyone. Earlier today, we announced our financial results for the fourth quarter.

As a reminder, the fourth quarter of 2014 had 13 weeks compared to 12 weeks in 2015. We have outlined the impact of this additional week in 2014 in our news release.

My discussion today will focus on the comparative 12-week period. Adjusted net earnings available to common shareholders grew by 5.5% to $363 million and adjusted net earnings per share increased 6% to $0.88 a share.

We maintained a stable trading environment in the quarter with strong same-store sales and stable gross margins. We delivered incremental synergies, continued to achieve efficiencies, and began to return capital to shareholders by way of share repurchase, buying back 2.9 million shares in the quarter.

Total revenue was $10.9 billion, an increase of 2.3%, led by positive same-store sales performance in both our food and drug retail businesses. Food retail same-store sales grew by 3.1% in the quarter, excluding gas and tobacco.

Both our market and discount divisions contributed positively to this performance. Internal food inflation continued to outpace the CPI rate of 4.1%, driven by inflation in produce, meat and seafood.

Same-store sales growth in drug retail remained strong at 5%. In the front of the store, same-store sales grew by 5.7%, reflecting strong performance in all categories.

Pharmacy same-store sales grew by 4.2%. Retail segment gross margin of 26.8% was flat compared to the prior year.

This excludes the impact of the previously announced changes to our franchise fee arrangements, which reduced both food retail sales and gross profit by $32 million in the fourth quarter, with the corresponding decrease in SG&A expenses. In addition to the changes in the franchise fee arrangements, our results also reflect the impact of consolidating certain franchisees.

At the end of 2015, we now consolidate 85 franchisees out of over 500. The impact of consolidation is an increase in revenue, gross profit and SG&A.

We will continue to consolidate additional franchisees in 2016. The net impact for 2016 on net earnings available to common shareholders is expected to be minimal.

Further details are provided in our press release. Adjusted retail gross margin was stable in the quarter.

As expected, the benefit of incremental synergies was more than offset by the pressures from healthcare reform. On an adjusted basis, SG&A, as a percentage of sales, was flat.

We did deliver some benefit to SG&A, but it was masked by the negative impact of foreign exchange and of some prior-year nonrecurring gains. I’m pleased to report that we delivered $69 million in net synergies during the fourth quarter, bringing net synergies achieved in 2015 to $242 million.

We remain on track to achieve our net synergy target of $300 million in 2016. In the fourth quarter, the company recorded a charge of $112 million related to the decision to dispose certain assets of the Shoppers Home Healthcare business.

We expect the annualized impact of the divestiture to be a decrease in sales of approximately $245 million and an increase in EBITDA of $14 million. At PC Financial, Q4 revenue increased by $9 million, or 3.9%, driven by higher interest and interchange income as a result of our growth in our credit card receivables portfolio.

EBITDA of $51 million was flat as revenue growth was offset by higher costs associated with the Financial Services loyalty program. In the fourth quarter, our capital expenditures were $433 million.

Free cash flow for the year was about $1.3 billion. In closing, we continue to remain confident in our strategy and business performance.

In 2016, we expect to continue to deliver positive same-store sales and stable gross margins in our retail segment. Earnings will continue to outpace top line growth.

A couple of other considerations reflected in our outlook. For the full year 2016, we expect approximately $1.1 billion in adjusted depreciation and amortization; adjusted interest expense of approximately $500 million, of which $130 million will be in Q1; and adjusted tax rate of between 26.5% and 27.5%, in line with 2015; $1.2 billion of capital expenditures on a consolidated basis, of which $1 billion will be in our retail segment; and finally, we expect to generate over $1 billion in free cash flow in our retail business and use a significant portion of these funds to buy back shares.

I will now turn over the call to Galen.

Thank you, Richard, and good morning everyone. As you just heard, Loblaw continued to execute well against its financial plan in the fourth quarter.

Same-store sales in our food business were up 3.1%, as traffic increased in the quarter. We’re satisfied with our tonnage performance as we grew both tonnage volume and tonnage share.

At Shoppers Drug Mart, we had another strong quarter of sales performance. Pharmacy same-store sales grew 4.2%, benefiting from strong growth in prescription counts and average prescription value.

Front store sales grew by 5.7% led by double-digit growth in food and strength across all other major categories. As expected, regulatory changes in Ontario and Quebec negatively impacted our profitability in the quarter.

Overall, I’m pleased with the performance against our financial plan, both in the quarter and for the year. This provides a strong financial foundation from which we will continue to improve and grow our business.

We completed the roll out of SAP into all of our food stores in the quarter. This is enabling us to implement more efficient processes that will support improved decision making, reduce complexity and offer opportunities to realize further operational savings.

In 2015, we also advanced our omnichannel strategy, launching beautyboutique.ca and expanding Click & Collect. We are pleased with our progress and this year we will accelerate the roll-out of Click & Collect beyond today’s 39 stores.

We will also continue to invest in loyalty and our one-to-one relationship with customers, building upon recent improvements to PC Plus and the launch of personalized digital offers through My Optimum Rewards. As we approach the two-year anniversary of Shoppers Drug Mart joining our organization, I want to take a minute to reflect on our progress so far.

In 2014, we announced a program to deliver $300 million in annualized synergies within three years. Our colleagues across the company have done an excellent job planning, executing, and delivering against this target.

Approaching the end of the second year, we have already delivered $242 million and remain confident in achieving our goal. Our customers are also seeing the benefits of cooperation between our two organizations, whether through the launch of My Optimum digital loyalty platform, the roll-out of beautyboutique.ca, or the availability of President’s Choice and No Name brands.

In fact, we sold more than $0.25 billion of President’s Choice and No Name products in our Shoppers Drug Mart stores last year and we continue to see that number grow. Our food businesses are also benefiting from this cross-pollination of ideas as we’ve leveraged the expertise from Shoppers Drug Mart to enhance the beauty and HABA offerings in our supermarkets.

I’m equally pleased with what has been accomplished behind the scenes. From day one, our teams have built a relationship of mutual trust and respect.

And through steady progress, we have shared best practices to improve our systems, our processes and our talent. Now under common leadership, our supply chain, IT and finance functions are effectively working together, learning, sharing ideas and positioning us well for the work that we still have to do.

We reached another significant milestone in the fourth quarter. On our last call, I talked about the reduction of $1.9 billion in debt since the closing of the Shoppers acquisition and the completion of our deleveraging target.

With a strong balance sheet and free cash flow, we are able to invest in growth, while also returning value to shareholders through share repurchases. In the fourth quarter, we began to do so and used $185 million for the repurchase and cancellation of over 2.9 million shares.

Looking to the year ahead, we remain focused on our strategic framework, delivering the best in food, best in health and beauty, operational excellence and growth in what promises to remain a highly competitive grocery market with continued negative pressure in our drug retail business from healthcare reform. We expect to maintain positive same-store sales momentum and stable gross margin.

As we remain focused on driving efficiencies across the business, we will continue to invest in positioning the company for future growth and although moderated by these strategic investments and healthcare reform, we will drive bottom line growth in earnings in 2016. Thank you.

At this point, I’ll pass the call back to Sophia to take any questions.

Michelle, can you open up the lines?

I have two questions. Richard, first just on the SG&A, can you talk about what the specifics were to the higher spend in Q4 for SG&A to in-store investments to relate to the advancement of the digital strategy?

And then just taking it a step further, when we look forward 2016 and 2017, do you see some interesting opportunities to drive a lower SG&A rate or all for the combined company? And are those opportunities both at Shoppers and at Loblaw?

For the first part of your question, the investment in Q4 in our key initiatives, which are notably e-comm and loyalty, are actually relatively small. It’s going to accelerate more in 2016, so you’ll see more of those in 2016.

However, the noise that we saw in Q4, the one that is most bothering to us is out of our control, has to do with the re-evaluation of our US dollar payables and that affected G&A by some $20 million in Q4. That’s something that when the Canadian dollar goes down, it affects the – we just need to re-evaluate those numbers.

And so if it weren’t for that, actually, our EBITDA margin would have been flat year over year.

Is that $20 million, is that a good run rate to use for the coming next 12 months on a quarterly basis?

Yes, you should take that out in trying to estimate our G&A performance but we also had a few one-time gains in Q4 and we have some of those every quarter. I don’t want to dwell too much on those, but the FX one is something that you should take out.

For 2016 and 2017, definitely our financial model is predicated on operating leverage and the way to drive operating leverage is to have SG&A grow at a slower rate than our top line. And we are forecasting some improvement in the SG&A rate in both years, and so we’re going to work hard to deliver that to the market.

Just a broader question, when you look at the food retail industry, which has its own special dynamics and typically when you see a grocer finally get its model stabilized and where Loblaw is now with a more stable operating model. And typically, although nice free cash flow generators, when you look at the model, you expect that with a good platform, a good grocer should be able to grow earnings at a high single digit [indiscernible] low double digit, and when you, in your outlook, you preface that you expect that in 2016, you’ll grow earnings per share are greater than the top line.

That’s what we saw in 2015, I think 2.3% versus 6%. But if I’m looking at the business longer term, am I looking at it the right way, if I assume a high single digit, low double digit earnings growth rate of how we should try and see the business being positioned?

I need to be careful on my comment, Patricia, on this because I don’t want to give specific guidance, but clearly what we’re shooting for is for decent net earnings growth in our core business which, starting in 2016, will be supplemented by the benefit of share buybacks. We said that we’re going to allocate most of our free cash flow after dividends to share buybacks so together, these two elements should be driving a decent EPS growth going forward.

All of this, when you’re thinking of 2016, this is despite the fact that there will be continued pressure on the Rx piece of the Shoppers business?

Yes. And despite the fact that we’re going to be investing in our key initiatives also, all of this is factored into our thinking.

Can you give us a little bit more color on the profit trends drug versus food in Q4 and your expectations for 2016?

I don’t want to give specific trends of each business, Mike, except to say in Q3, we talked about the impact of healthcare reform that would be more significant in Q4 in Shoppers because of the timing of this unbudgeted impact that we had. But I think if you look at the sales performance of both businesses, I think it’s quite telling of the performance of each business.

Especially in Shoppers, the front store performance has been very strong and obviously that has helped cover some of the additional healthcare reform that we experienced in Q4.

So you are making some progress in mitigating the impact as you said you were going to try to do?

On a consolidated basis, yes.

When you look at your inflation at Loblaw at the food side, why is it above CPI? Is it a mix issue or is it mix impact or something else?

It’s essentially mix to the way the customer is trading. It is a tricky thing to track the real impact of inflation.

We’re trying to give you as much transparency as we can. The interesting thing about this particular quarter is we had the biggest gap between our sales and CPI and what you guys would consider Street math on inflation and yet our underlying performance in terms of actual tonnage and tonnage share growth was one of the best we had in a number of quarters.

So it just continues to illustrate that that simple math is not the most effective way to determine what the real growth is.

And then on your synergies, your target is $300 million. You’re already at $242 million, but that has some costs associated with getting to that $300 million.

So clearly, you’re on pace to get to that $300 million. Is there a time when you think you’re going to be comfortable talking about maybe a revised guidance for those synergies?

We will be thinking about that as we get into 2016, Michael, but we wanted to finish 2015 using the same principle that we had. So this is something we’re talking about and we’ll update you in the upcoming quarters.

And just finally on your loyalty programs, can you update us on the expected timing of when you’re going to be able to integrate that or give us some color on how you’re going to integrate it?

Let’s say later in the year. I’d like to be more specific than that, Michael, but I think probably not till later in the year.

That’s on the implementation or when you’re going to disclose it?

Not sure. But let’s say we’ll probably disclose it before we implement.

Can you describe where you are in terms of the SAP implementation? It seems to be fully implemented through your distribution, back office and retail network.

Does that mean that you still have the old system up and running as a redundancy or has the old system gone away?

So we would say that we are fully deployed and we have now officially, in sort of absolute terms, moved from implementation to optimization and I think I mentioned on the last call that we are starting to build benefits into the budgets for the operating divisions. There are a number of systems which takes some time to fully decommission and that will take place over the next 12 to 18 months.

And can you just review, on your CapEx spend, the $1 billion in the retail business, can you just review where that money was going? I thought that the CapEx might have eased somewhat given that the new SAP implementation is completed and there was a significant amount of CapEx associated with that program.

So Peter, our retail CapEx which is the one that you need to focus on because that’s the one that drives free cash flow, the CapEx for choice is financed and generated in choice so you need to focus on the retail number. The retail number is actually going to be down $200 million versus 2015.

And the bulk of it is going to our stores, so more than half. And so the money spent on IT and supply chain has gone much lower going forward, so that’s where you should see the money.

So our focus is to make sure that we drive return on capital on these investments and we’re well on our way on doing that.

With this new accounting where you’re consolidating the franchisees, as the franchisees spend capital, do you consolidate their capital or is their capital still excluded from your financial statements?

Good point. Yes, it gets consolidated.

So when I say a $1 billion, it includes the impact of consolidation of franchisees. So if you were to compare apples to apples, it would actually go down a little bit more.

And finally, with the new SAP up and running, can you talk a little bit about what your expectations are in 2016 versus 2015 on shrink? Do you anticipate that shrink will improve or shrink will deteriorate as the merchants climb the learning curve on these new systems?

So our expectation is that we will see moderate improvements in shrink. So if the ramp-up of SAP created kind of a new run rate for shrink, some of it, we certainly would consider real shrink, some of it just transfer from shrink to margin, but we’ve zeroed in on a meaningful number that the teams are going to look at to improve the operating processes.

And it’s the visibility to information, inventory, what’s trading, what’s being scrapped that has been so significantly improved by SAP and this is what the teams are wrapping their heads around right now and using to target their efforts to reduce the number.

Just wondering if you could talk a little bit about consumer behavior and sensitivity around promotional activity, whether you’re seeing any changes in mix, as inflation keeps up and really whether what you’re seeing in terms of trends between discount and conventional?

Probably the trends that you would expect, so if you remember, when you’ve asked this question over the last couple of quarters, we’ve generally seen the customer mixing up, so mixing to higher value product, innovative product, fresh product, natural foods product. That’s been contributing to what we call the positive inflation effect, the positive mix effect.

As the economy has started to come under some pressure and inflation has continued to push up in some of those key fresh categories, we’re starting to see not a huge amount, but certainly notable amounts of the opposite effect. So the example that will probably resonate most with a lot of folks is cauliflower.

Cauliflower was written up in the paper a few times a couple months ago of being very, I think at $8.99, maybe over $9 a bushel. So what happened there was all of the sudden people stopped buying cauliflower and we saw spike in volume around a lower-priced product, which was potatoes.

And so essentially, you see tonnage and you see the average item price drop and that’s really about customers trading inside their basket for better value. And then, yes, certainly where the economy is under the most pressure, we are seeing disproportionate momentum in the discount side of our business.

The most illustrative example of that is in Alberta and the good news for us in that province is that we’re really well positioned in terms of discount and so I don’t want to say that’s entirely helpful, but certainly I think we’re more insulated from the impact than others.

Just on the Shoppers side, can you just a little bit, clearly, Optimum is a hugely successful program, the degree to which that you’re really using Optimum to drive traffic, both on a category basis and absolute basis?

So we’re using it a lot and using it very effectively, not to the exclusion of the traditional methods of promotion and merchandising, but as a complement. What makes Optimum so powerful is the historical record that the analytics teams have about how the customer responds to every variation of an Optimum promotional event gives that group really high level of precision in terms of predicting the cost of a promotional event and the sales that come out of that particular promotional event.

And actually what we’re doing at the moment is take some of those best practices, that capability and that learning and start to deploy it more effectively against what is now a pretty substantial PC Plus customer transaction database and see if we can’t start getting smarter about how we drive promotion and the way that we predict the response. So it is definitely a capability benefit that we are working hard to deploy effectively across the Loblaw business.

Presumably it’s even towards greater integration later this year that will only accelerate?

That’s certainly our view. Shoppers has the benefit of having some very, very high margin categories which allow them to materially shift mix as a part of their promotional efforts, which is not quite as obvious to us because so much of the business is done in the grocery and fresh departments, which essentially trade at the same margin level.

And then just one final question, if I may, is there any update that you can give us on early learnings from Click & Collect?

So more than what we’ve said. So what we said was we’re happy with the first 39 stores.

We’re really comfortable with the way that we can execute on the customer proposition and we are focused on us seeing how many transactions we can run through each unit and what it will take to actually scale that model up to the right level inside each individual unit. But we’re sufficiently comfortable with how it’s performing today that we are accelerating to the next threshold through 2016 and there’s a capital investment that comes with building those units inside stores.

And then there’s the P&L cost, because these things essentially lose money as they start to ramp up to a certain level of scale. And so there is a lag between the time you ramp up the top line and the time that the bottom line follows.

At this point in time, do you have any visibility on when the P&L lag diminishes or when it actually moves into breakeven or what’s required to get it there?

We think we do. We have a pretty good model and we adjust it based on how these particular units start to perform.

The more of these units we have then the more awareness we build, the more we are able to scale up the sales. It really is about getting the sales through each one of these units up to the right level.

But it would be inappropriate for me to comment on what we believe that is, because at this stage, the number is moving around as we ramp up the business. And I would just reiterate that in the context of these investments, our commitment, both internally and externally, is that we’re going to be able to fund those investments strategically to position the company appropriately for the long term and also drive satisfactory earnings growth on a day-to-day basis.

I just wanted to follow up on your CapEx spend. Could you give a bit more color in terms of the greater than half of the $1 billion in the retail segment, how much of that is renovations or are there some new stores built in to that?

I guess the bulk of it is renovation. We don’t give that level of detail, but the bulk of it are renovations and yes, there are new stores, both in our food and drug business that are going to be opened in 2016.

And do you have a view on total square footage growth for 2016, net square footage growth?

If you think about what we try and do is we try and deliver over time somewhere in the range of 1%. That’s kind of our baseline target.

Obviously, with the closures associated with projects in spring, we’re going to see a reduction in square footage. So this will be less in terms of real growth than we would have had in the past, but 1% is still the target run rate for adding square footage to the market for us.

Despite the store closure that we announced last year, we should finish 2016 ahead of 2015 in square footage.

And then in terms of the renovations, what’s your targeted payback period for those on average?

We look at return on capital using a number of metrics. Pay back is one, undiscounted pay back is another, IRR is one and NPV is another one.

So we try to balance all of these metrics to make sure all the projects that we are putting into place are driving value, but we don’t disclose what those metrics are. But by looking at many of them, you can make sure that they will drive return.

On Shoppers, if we exclude the impact of regulatory reform, how would the operating earnings in that division be tracking relative to when you acquired the business?

If you were to exclude drug reform and if you were to put the synergies attributed to Shoppers in their numbers, the business is probably doing the best it has ever done over a long time.

And given the investments you’ve made obviously to improve the business and grow the assortment there, what’s your outlook over the next year or two?

We’re very much encouraged by the traction that we’re getting with adding food in the mix. Obviously, as you can imagine, the PC brand resonates way more with consumers and the margin that we’re obtaining on that business is significantly higher than what Shoppers was obtaining on its own business.

And that is creating a halo effect throughout the store, which is benefiting all categories and you see that by the performance of the same-store sales on the front store.

And could you just comment on the union situation for 2016, any big contracts that may be coming up?

Yes, I’d say it’s a busy year and there is a couple of big contracts that are in front of us. The biggest ones being No Frills, which we feel reasonably comfortable with.

We had one of our big distribution centers here in Ontario, which we ratified an agreement just a couple of weeks ago. And then we have another important DC out West where we’re in the middle of negotiations, but I wouldn’t say that this is not an unusual year.

We’re just cycling through the normal course of having multiple collective bargaining agreements that come up for negotiation every year and a very good team who works hard to make sure it doesn’t disrupt our business.

Richard, just on the $20 million you referenced earlier for the payables, is that contained in your adjusted earnings for the quarter or your adjusted EBITDA?

It is. We wouldn’t adjust for that.

We don’t adjust for this, so it’s included in there.

And that would be in your SG&A line?

Definitely, yes.

I’m just wondering if the risk of you providing forward guidance, but what the heck, given there’s a lot of initiatives you have going on with synergies and labor agreements, savings perhaps this year or lapping the drug adherence and all the initiatives you have going on in your stores, I’m just wondering if it’s possible this year, if it’s a goal this year to have your SG&A dollars actually flat year over year?

Flat is a big ask in dollars, Dave, but I can tell you rates will be down.

How big an ask is it?

Don’t push your luck, David.

Why don’t I just take it to the store level? It’s something you’ve talked about, but I may have missed it earlier in the call, but net promoter scores.

You’ve invested a lot of time, effort, money in the store systems, merchandising. How are the net promoter scores looking nowadays?

They’re moving up steadily on average. So we feel good about the progress.

We always like it to be going a little faster and to be getting a little higher. But if you take, for example, the Superstores in Western Canada, we identified an opportunity inside our NPS customer surveys that they were uncomfortable with customers who were unhappy with the length of the lines in our front end.

So we implemented a policy of keeping our front ends fully staffed all through the weekend. And we have seen a significant improvement in overall NPS scores as a direct result of that change and a really encouraging response in customer sales.

So we continue to feel that it is a very powerful indicator of future performance and the operating teams work hard to continue to move the numbers up across every element of their business.

And just finally on SAP optimization, not integration now, could you maybe talk a little bit about the milestones, what we should see coming in terms of having that optimization, achieving certain levels of optimization over the next 12 to 18 months. Where would you see that first?

How would it fall in succession? Is it in-store or is it kind of a margin-related thing, better inventory counts, et cetera?

Could you maybe give a little color on that?

I’m not sure this is going to give you quite the level of prioritization that you were hoping for, but what I’m about to say is true. It’s all of the above.

So we have a very specific list of initiatives around what we call SAP optimization. Each one of those initiatives has a dollar value associated with them and a business owner whose responsibility is to support the organization and going out and getting that benefit.

And they would run across shrink lines, inventory lines, labor lines and in stock promotional allocation lines and even in margin. So I would say that where we have the most optimism today based on where people are focusing their effort is really on in-store improvements around inventory allocation and the benefit to labor of not having to track through quite so much disorganized inventory.

And probably near the tail-end of this optimization cycle, we expect big things to come from margin. But we’re working on every line right now and seeing positive signs.

Finally, would it be fair to say then in 2016 most of the earnings growth that you achieved, the EPS growth, I should say, that you achieve will be driven by below the line rather than above the line. And if that’s true, when do you see that flipping over such that above the line is driving more EPS growth in the future?

You’re going to see growth coming from above the line and below the line. Gross margin dollars will increase in 2016.

And our plan is that SG&A should grow at a lower rate than those gross margin dollars grow, so that net where you have a compounding effect or an operating leverage effect associated with the efforts we’re putting on our cost management.

So both will contribute about equal measure?

I’m not going to go as far as that to give you the detail, but yes, we’re counting on both our food and drug business to drive growth in both gross margin and help on the G&A side.

Just with respect to your tonnage and share growth, could you give some color on Eastern versus Western Canada, how balanced that was, and moreover, was it balanced? Was it more specifically Western Canada driven?

So we typically don’t break down our market share and tonnage performance by region and I think there are always pockets of a little bit of over performance, pockets of underperformance and then net-net, I would say it’s balanced. A little bit of strength in the two west and east ends of the business, but nothing that would suggest a major imbalance in the way that we’re performing.

Just switching gears to Shoppers, front-store sales performance particularly strong and you highlighted growth in all categories, I’m just curious, was that growth heavily weighted towards or was it the strength perhaps in beauty that offset the weak flu season and gave you that performance in the front-store or is there something else that we’re missing?

Certainly, we feel that Target’s exit put some momentum back into the front of store at Shoppers Drug Mart, also put a little bit momentum back in the front store in some of the regions of the food business where Target had a strong presence. That’s probably the thing that we under anticipated in the year.

There’s also the strategic position of Shoppers Drug Mart and the way that the consumers are thinking about shopping, which is these are small stores in highly convenient locations and as you upgrade the everyday consumable offer, not just in food but certainly in food and in HABA, we are seeing the customer respond really positively to that. So it’s a little bit of both.

And then just switching gears in terms of banner refresh, you have a new Fortinos that’s gone up out in Oakville and I’m particularly impressed. I’m wondering if this is an indication of things to come or is that more just a little bit of a banner or signature store.

I’m just curious as to how we should think about refresh and banner positioning of that going forward?

So Fortinos is a great business. It’s been a part of our portfolio for many, many years.

It’s geographically focused in the Burlington, Hamilton and then the branch in Woodbridge area. We don’t expect to see that format or that banner moving outside of that geography and we don’t see rapid acceleration of the growth of those stores.

Maybe another one here or there over the next few years, but we definitely see some of the innovation coming out of that business in fresh food as best practices that we need to endeavor to leverage across other areas of the business. No different to the way that we’re doing precisely that with T&T and we’re doing that with our business.

These are great differentiated fresh propositions that serve a particular multicultural demographic and we want to deploy that capability as broadly as we can so that it drives the biggest bang for buck.

Just wanted to ask a few questions, so first of all, Western Canada. Do you feel that in Western Canada, given the economic situation in Alberta, that you’re gaining share and does that gaining share allowing you to actually grow revenue or is the consumer hunkering down so much that revenues are flat to down?

We really don’t give performance breakdowns by region or by province in terms of share or sales. We don’t expect to go backwards anywhere.

It’s the first premise, we feel our Superstore network in the West and increasingly in Ontario are strong business platforms, which would suggest that we expect to continue to see growth in that format for long into the future.

On the FX side of the equation, obviously, there’s been a lot of volatility in the Canadian dollar versus US dollar, but generally speaking, it looks to be continuing to contribute to inflation in 2016. How concerned are you about pass-through?

It’s now two years’ worth of fairly significant inflation and do you suspect that pass-through is going to be more difficult in 2016?

So again, it’s been almost three years where we’ve had abnormal inflation in major categories across the business and we were asked this question in the middle of this year. We were asked this question at the end of last year and I think the answer remains the same.

Absolutely, we’re watching it. At this stage, we don’t see any major change in the way that the consumer is behaving.

And so, so far, the ability to pass-through this inflation has surprised us. In other words, we’ve been able to do it more than we expected.

Having said that, there is a limit, without doubt, that the consumer experiences and it happens differently at different price points and different categories across the store and the cauliflower example is a great example of that. Red meat is another place traditionally where price points get to a certain level and then the volume or the tonnage drops off significantly.

Customers trade in to cheaper forms of protein. All of these things are happening, but none of them are happening at a rate that is fundamentally changing the sales trajectory of the market.

But we are keeping a really close eye on it. We can’t actually predict at this stage what is going to happen in 2016.

Just one last question with respect to free cash flow and your buyback intentions. So Richard, you were mentioning that although that total CapEx is $1.3 billion versus previous set of $1 billion, that because it’s coming out of the REIT largely that you’re not concerned about the free cash flow being generated by the retail operations.

So I’m reading in to that and assuming that you would not have a different view on how active you could be on your buyback in 2016, is that correct?

Yes, I’m not sure I understand your question, but the answer to the question is yes. Let me just clarify.

From a free cash flow perspective, the contribution of Choice properties is the distribution that we get. Whether or not they increase their CapEx or not is going to be financed in their own entity, so actually no impact from the free cash flow of Loblaw, which is the one being used to buy back shares, because the bank account of Choice is in Choice and bank account of Loblaw is in Loblaw.

So therefore, as we bring down CapEx in retail, it frees up cash flow to buy back shares in Loblaw. So that’s the point and that’s why we will, going forward, outline the different CapEx levels because if Choice decides to grow more aggressively, you will see a higher total number, but that’s not necessarily relevant to our ability to generate free cash.

As far as the buyback is concerned, I realize there are dollar constraints, but can you give us some idea as to how active you’re going to be, like what percent of shares outstanding you might be hoping to buy back?

I don’t want to go to that level of detail because we’re just getting the program going so we’re getting – we did some in Q4. We have an ambitious program this year.

And as you see us execute on it, we’ll be able to provide you more details, but we just want to make sure that it’s all going well and that we deliver our internal plan before talking about it more confidently.

And then last question, just on drug reform. Any update on what’s going on in Quebec, the whole tendering process that got cabled, is there any additional color that you received that you could share with us?

Not that, would be particularly valuable. I would say there’s still uncertainty and nothing has been passed at this stage.

Lots of conversations are taking place between the various stakeholders and we have a pretty good idea, a very good idea of what the impact would be if the proposed legislation were in fact to pass. But there is still too much uncertainty to know whether it is and if it is then whether it remains intact as we see it today.

So I think what we feel is that at this stage, we’re going to have to work through it and we’re going to find ways to manage and do our best to make up for whatever the financial impact is.

The dollar impact that Galen mentioned that we have an estimate of is actually budgeted in 2016 for us.

With respect to what’s known at this point?

Yes, exactly.

Just looking longer term at Shoppers, the actual Shoppers format, does it still deliver adequate returns considering all the ongoing reforms or do you think you have to make adjustments to the model to make it more profitable for you guys?

No, we still think it works very well.

In terms of the profitability, and I think I might have asked this question before, but the profitability for a generic versus the branded equivalent on gross profit dollars, is it still greater for the generic across Canada?

Yes.

Sorry, the answer is yes?

The answer is yes.

In terms of your discussions with the government, how would you characterize that currently versus, let’s say, when you acquired Shoppers? Is it a more collaborative environment still today or call it more collaborative now than it was?

I would say there are two phases in the Shoppers Drug Mart history of how it engaged with government. The first phase, a number of years ago, was very oppositional but that was six, seven, eight years ago.

Before we acquired it, Shoppers had already changed its approach to a much more constructive and collaborative way of engaging with all the various governments. Remember, this is provincial, so there are 10 different bodies who we work with.

And Loblaw has had a collaborative approach to this type of policy for many, many years and so we’re working together in as constructive way as possible. I think if really the heart of the question is what’s the level of ongoing impact of healthcare reform, drug reform likely to be?

Our view is that it is definitely slowing. The slope of the curve is flattening.

But they are still pushing hard to find every penny of savings and we continue to work with them to get transparency, to get long-term certainty around what the impacts are and make sure that they understand what the impact of some of these policies is and that it is constructed as effectively and sensibly as possible for everyone. We have good dialogue, but they have a mandate which is to save money and they see drug and healthcare reform as a place where they would still like more.

And just two more quick ones here. In terms of professional services in pharmacy, what’s the outlook for that?

And what are your thoughts on Shoppers consolidating the pharmacy industry?

So we’re not really very interested in consolidation. Yes, we’re generating free cash flow.

Yes, we’ve paid down our debt. But we still have lots of work to do with the big business we operate and lots of opportunity to create value with the assets that we have, in terms of things like expanded scope of practice.

So maybe back to your first question, do we see the Shoppers Drug Mart concept as a viable operation? Yes, but not without change, not without evolution, modification.

And as the profitability comes down in the pharmacy side of the business, we have stated on a number of occasions we see expanded scope of practice as one of the potential avenues to offset that and a source of incremental growth. We still feel the same way and we’re still working hard at looking for other ways to build on the customer platform that we have at Shoppers and some of the things that we know through Loblaw that we think will position us well for a future where the healthcare model is quite different and that is one of the areas that we are focusing on very intently.

I had a question on the food price inflation. I was just wondering if the gap in pricing between the discount channel and the conventional channel is widening as we go through the first part here of 2016?

You’re asking about the price gap?

Yes.

And do we see a widening between the two?

Right.

Not material. Certainly, my expectation is that the gap will need to narrow as the consumer gets more and more sensitive around price which you are seeing in our market division as an intensification of promotion.

I feel like I say that every year, but it seems to be true every year. People are looking for value and the high low retailers and the market division space deliver great value in the ads and they will do more of that.

Just on the disposition at Shoppers Drug Mart, is it just the Home Health retail stores? Is that what we’re talking about?

There are a few small businesses that we’re looking at that are non-core. So we’re in the process of disposing of these businesses and these businesses were not profitable, so therefore, it’s going to be a net benefit to the business going forward.

And just on the SAP savings, I think a few years ago, and I’m not holding you to this, but it was mentioned that once SAP was implemented there could be 60 basis points of savings relating just to no longer implementing it and lower depreciation. And I think 20 basis points of that was already realized so perhaps there’s 40 basis points left.

Is that still a number to think about or are we really in a new era and [indiscernible]?

That was the reduction in IT spend and the benefits that we anticipated from supply chain. We were at the run rate for IT spend today and so those benefits are largely already built in to the P&L.

Would they have built in 2015 or are they going to be built in 2016?

We got most of them in 2015. That’s when we hit our IT spend run rate.

Keith, the key driver of operating leverage going forward is certainly maintaining the growth of IT, supply chain and admin expense at the lower growth rate than top line so that we can drive operating leverage and those three buckets are significant dollar amounts, so we’re quite focused on managing them quite effectively.

Just finally on the labor agreements, I know that’s ongoing, but have you finished the bulk of the labor agreement buyouts or is there still more to come there?

Yes, we’re essentially complete.

Just wondering if you can maybe give us an update on how the food trials are going at some of the Shoppers store, in I believe, in Regina. How are they performing so far?

So well, and we’re excited particularly about the performance of the fresh food stores in the urban markets, so in GTA, Toronto market. I’m looking around, I think we’ve got 30 now of those stores.

We’re working our way up to 40. And really, very enthusiastic about the performance starting to see the financials shake out the way that we expected and when we developed the strategy.

The Regina pilot was intended to do something different which is to try and understand the extent to which this concept could travel in a less densely populated marketplace. That got off to a slower start to be sure, but in the last three or four months, we’re starting to see really strong signs of top line momentum.

And with top line, to get to top line, it’s only a matter of time before you get the bottom line working right. So very positive about the urban stores and feeling more optimistic about the suburban stores and not yet ready to determine whether there’s a suburban opportunity in the country for Shoppers and Fresh Food.

As the product offering at Shoppers continues to evolve over the longer term, is the current IT infrastructure, do you think is it sufficient to adapt to the changes that are happening or do you expect at some point, you would have to step up your investments in IT and then really revamp the current systems to meet the increasing demand?

We’ve started to integrate the Shoppers business on to SAP. We did it on the admin side just before Christmas so that’s completed.

Now the work is starting on what we refer to internally as master data. So that’s going to be the focus of 2016.

And in early 2017, we’re going to get to the warehouses because we want to be able to have the ability to ship all the goods to all our stores and wherever they are, i.e., so at one warehouse serves both Loblaw and Shoppers. So for that, we need a SAP solution and that will be implemented in 2017.

And last question, just maybe related to that is on project Delta, when do you expect that to be completed and what are some of the major benefit? Is it mostly revenue synergies because you’re freeing up pharmacists’ time to do more professional services or would that be actual cost benefits for Shoppers?

So Delta is going to deploy aggressively in 2016. And the business case is built on cost savings and that is basically reducing the amount of minutes that it takes to fill a script.

So it’s a labor savings. There’s a second element of the business case which you touched on, which is freeing up those highly trained and very capable pharmacists to do more, expand scope of practice and provide more services, which drives another source of revenue.