Pat McKeough responds to many requests from members of his Inner Circle for specific advice on Canadian stocks and other investments as well as questions on investment strategy and the economy. Every week, his comments and recommendations on the most intriguing questions of the past week go out to all Inner Circle members. And each week, we offer you one of the highlights from these Q&A sessions. While we reserve our buy-hold-sell advice for Inner Circle members, these excerpts provide a great deal of information and analysis on stocks we’ve covered for members of Pat’s Inner Circle.

This week we received a question from an Inner Circle member about Empire Company, which owns the Sobeys grocery chain. Empire has just made a major acquisition with the purchase of the Canadian stores of U.S. grocery chain Safeway. Pat looks at the advantages this confers—especially in geographical diversification across Canada—against the risks of integrating a large acquisition in the face of increasingly stiff competition in the grocery business.

Q: Pat: What do you think of Empire Company shares? Thank you.

A: Empire Company Ltd. (symbol EMP.A on Toronto; www.empireco.ca) is a diversified Canadian firm based in Stellarton, Nova Scotia.

Empire sells and distributes food through national grocery retailer Sobeys. It also invests in real estate and various publicly traded companies.

In June 2007, Empire paid $1.06 billion for the 29.9% of Sobeys that it did not already own. (Sobeys was a recommendation of our Successful Investor newsletter. We first recommended the stock in April 2003 at $36, so the buyout left our subscribers with a 61% gain.)

Sobeys owns or franchises about 1,500 stores across Canada. In addition to Sobeys, its banners include IGA, IGA Extra, Price Chopper and FreshCo.

The grocery-store operator accounts for over 99% of Empire’s revenue. However, food retailing is a high-volume, low-margin business, so Sobeys generates just 88% of Empire’s earnings.

The company’s real estate division includes commercial and residential property operations. It owns 42.8% of Crombie REIT (symbol CRR.UN on Toronto), which invests in retail, office and mixed-use properties. Empire handles its residential investments through a 40.7% interest in Genstar Development.

Empire also holds stocks that trade on Toronto and New York. Including its holdings in Crombie REIT and Genstar, Empire’s investment portfolio had a market value of $874.6 million, or $12.87 a share, on May 4, 2013.

Safeway acquisition gives Empire a major presence in grocery business in western Canada

In June 2013, Empire agreed to purchase the Canadian business of U.S. grocery store operator Safeway (symbol SWY on New York). The deal includes 213 grocery stores (199 of which have in-store pharmacies), 62 gas stations, 10 liquor stores and four distribution centres. Most of these stores are in western Canada, which complements Empire’s Sobeys stores in Eastern Canada.

Empire will pay $5.8 billion for the Safeway operations when the sale closes later this year. It will sell $1.6 billion worth of non-voting class A shares to help pay for this purchase. That will increase the total number of class A and B shares outstanding by roughly 31%. Empire also plans to sell 68 Safeway stores to Crombie REIT for $990 million.

In addition, the company will raise $216 million by selling most of its Empire Theatres business, which owns or has interests in 50 cinemas with 421 screens across the country.

To put these figures in context, Empire earned $384.8 million, or $5.65 a share, in its 2013 fiscal year, which ended May 4, 2013. That’s up 13.4% from $339.4 million, or $4.99 a share, in fiscal 2012. If you exclude costs related to the Safeway purchase and other unusual items, earnings per share would have risen 13.7%, to $5.39 from $4.74. Revenue gained 8.4%, to $17.6 billion from $16.2 billion.

In addition to selling assets and new shares, Empire will borrow $2.6 billion to finance the Safeway deal. As of May 4, 2013, its long-term debt was $915.9 million, or just 16% of its market cap, so it can comfortably afford to borrow more funds. It also held cash of $455.2 million, or $6.70 a share. Empire pays a quarterly dividend of $0.26 a share, for a 1.3% annualized yield.

In the Inner Circle Q&A, Pat examines the risk that comes with a big acquisition like Safeway. He looks at how long it will take Empire to integrate the distribution networks, administration and marketing activities of Sobeys and Safeway as the company competes with larger Canadian chains like Loblaw and non-traditional grocery sellers like Wal-Mart and Costco. Empire’s stock has gained 20% since the company announced the Safeway purchase and Pat looks at whether it can go higher. He concludes with his clear buy-hold-sell advice on the stock.

(Note: If you are a current member of the Inner Circle, please click here to view Pat’s recommendation. Be sure to log in first.)

COMMENTS PLEASE—Share your investment experience and opinions with fellow TSINetwork.ca members

Do you think U.S. big-box stores like Wal-Mart and Costco are a serious threat to the major Canadian grocery chains? Are you and people you know shopping less in Loblaw, Metro or Sobeys and more in the U.S.-based stores? Does this competition make the Canadian chains less attractive as investments? Let us know what you think.