Analysis: With $5.7B Acquisition Of Safeway's Canadian Assets, Sobeys Is Telling Loblaw (L) To Move Aside

The deal could be summed up as a two-word message to Canada’s largest grocer, Loblaw Companies Ltd. (TSE:L): Move over.

Sobeys Inc. is buying Safeway Inc.’s (NYSE:SWY) Canadian division for $5.7 billion, solidifying its place as the country’s second-largest food retailer and nipping at the heels of a stagnant Loblaw, which has struggled to grow in recent years.

So, what made Safeway Canada such an irresistible meal? The food retail sector is hot in the Great White North.

Wal-Mart Canada Corp. (NYSE:WMT) is adding more grocery aisles to its stores. Target Canada Company (NYSE:TGT), another big-box retailer from the U.S., is opening its first Canadian stores this year.

And companies have long been salivating over Safeway Canada, which gives its new owner a huge presence in Western Canada. Of the company’s 223 stores, 75 are in British Columbia.

Loblaw and Metro Inc., a Quebec-based competitor, have eyed the company. And Paul Sobey, the chief executive of Sobeys parent company Empire Company Ltd. (TSE:EMP.A), said he has been considering the purchase since 2001.

“We’ve been looking at Canada Safeway, as with other opportunities, [for] a long, long period of time, he said, according to the Globe and Mail. “We’re very familiar with the assets.”

The purchase is also a win for the U.S.-based Safeway, which has been squeezed by a declining market share at home.

But Sobeys' purchase is not without its risks.

Researchers at UBS said in a note that discounters like Wal-Mart, Target and Costco will be able to offer lower prices as Safeway Canada tries to justify a purchase price that they said was already overvalued.

"The pressure will be to reduce prices as Wal-Mart, Target and Costco continue to push for market share at lower prices than Safeway Canada," the note said.

"We think the current bid valuation is already a stretch."

Shares in Empire were up 11 percent to $75.05 by 10:30 a.m. EDT on Thursday.