Empire Company Limited: Fueling Value Through Margin Strength and Strategic Capital Allocation

Empire Company Limited (TSX: EML) has emerged as a standout player in Canada's grocery retail sector, leveraging disciplined capital allocation and operational efficiency to drive sustainable adjusted EPS growth. With a renewed $400 million Normal Course Issuer Bid (NCIB) and margin expansion amid macroeconomic headwinds, the company is positioning itself as a compelling valuation play. Let's dissect the key drivers and risks shaping its investment case.

1. Adjusted EPS Growth: A Foundation of Operational Discipline

Empire's Q2 2025 results highlight its ability to sustain adjusted EPS growth despite inflationary pressures. The $0.73 per-share result (up 8.7% year-over-year) reflects margin resilience in its core food retail business. Gross margins expanded by 48 basis points, driven by:
- Supply chain optimization: Better inventory management and shrink reduction in Full-Service banners.
- Product mix shifts: A 15-basis-point contribution from higher-margin items like Own Brands, which now account for ~14% of sales.
- Fuel sales exclusion: Gross margin calculations exclude fuel, which has been volatile due to price fluctuations.

The company's focus on store-level execution—such as upgrading 20-25% of its store network through renovations and sustainability initiatives—is critical. These investments, targeting energy-efficient refrigeration and fresh-food quality, aim to boost customer traffic and basket size. While SG&A costs rose 46 basis points, this reflected strategic reinvestment in e-commerce and digital tools rather than structural inefficiency.

2. Share Buybacks Amid Tax Headwinds: A Test of Conviction

Empire's decision to proceed with a $400 million NCIB (despite a new 2% Canadian tax on equity repurchases) signals confidence in its stock's undervaluation. The tax, effective since January 2024, reduces the net benefit of buybacks but hasn't deterred management. Key points:
- Cost of capital: EMLAF's trailing P/E of ~14x is below its 5-year average of ~16x, suggesting shares are cheap relative to growth prospects.
- Net debt position: With ~$1.8 billion in liquidity and manageable debt, the company can balance buybacks with growth capex.
- Shareholder returns: The dividend was raised by 10% to $0.22 per share annually, reinforcing its commitment to rewarding investors.

The tax's impact is material—adding ~$11 million to retained earnings dilution in fiscal 2025—but manageable given EML's robust cash flows. Investors should monitor whether the NCIB is utilized aggressively or held back due to valuation concerns.

3. Operational Efficiency: The E-Commerce and Store Synergy Play

While traditional grocery sales face weak basket-size trends, Empire is countering with two key growth engines:
1. E-Commerce Scaling:
- Voilà's 12% sales growth in Q2 (and 80%+ growth in Q4 2024) shows progress in leveraging Instacart and Uber Eats partnerships.
- The pause on its fourth Customer Fulfillment Center (CFC) in Vancouver reflects a pragmatic focus on optimizing existing infrastructure.
- Risks: E-commerce margins remain thin, with net earnings dilution cited in Q2. Sustaining growth without overextending is key.

1. Store Network Expansion:
2. FreshCo's Western Canada push: Plans to reach 65 stores by 2027 (up from 49 today) target price-sensitive consumers.
3. Premium banners: Farm Boy and Longo's expansions in Ontario are capital-light but high-margin opportunities.

4. Risks and Mitigation: Navigating Tariffs and Labor Costs

Empire isn't immune to macro challenges:
- U.S. tariffs: ~12% of sales come from U.S. suppliers, but the company is pivoting to Canadian suppliers to reduce exposure.
- Labor costs: Rising wage pressures, especially in Ontario, require continued focus on automation and productivity.
- GuruFocus warnings: Five red flags (unspecified) could relate to debt levels or inventory turnover—investors should dig into Q2's MD&A for details.

Valuation Upside Catalysts

Empire's blend of margin resilience, shareholder-friendly policies, and growth initiatives creates a compelling risk-reward profile. Key catalysts include:
- Margin expansion acceleration: If gross margins return to 10-20 basis-point growth (vs. recent 40+ bps), EBITDA could surprise to the upside.
- NCIB execution: Aggressive buybacks at current valuations could reduce shares outstanding by ~2% annually, boosting EPS accretion.
- FreshCo/Farm Boy performance: Hitting 65+ FreshCo stores and expanding Farm Boy's footprint could drive same-store sales recovery.

Investment Thesis

Empire Company Limited presents a balanced opportunity for investors seeking value in a defensive sector. Its margin discipline, strategic capital allocation, and diversified growth avenues (e-commerce, store upgrades) offset near-term risks like tariffs and weak consumer spending. With a P/E below historical averages and a renewed NCIB, the stock offers both growth and income appeal.

Recommendation: Consider accumulating EMLAF for a 12-18 month horizon, targeting a 15-20% upside. Monitor Q3 results for signs of margin stabilization and NCIB utilization. Avoid if macro conditions deteriorate sharply or the Scene+ loyalty program falters.

This analysis underscores Empire's ability to navigate challenges while prioritizing returns—making it a standout play in Canada's grocery retail landscape.