Empire Co Ltd's Sobeys grocery chain is expanding its high-margin retail gasoline business in Eastern Canada, announcing plans on Thursday to buy 250 gas stations from Shell Canada.

But Empire's shares dropped as Sobeys' gross profit margin fell to 23.91 percent in its latest quarter from 24.73 percent a year earlier. The company said about half the decrease was due to an accounting change.

We believe the decline in gross margin reflects the highly competitive grocery environment, wrote BMO Capital Markets analyst Peter Sklar in a research note.

Empire's net income also fell sharply in the quarter. Earnings a year earlier were flattered by a gain from the sale of one of its businesses.

Sobeys, Canada's No. 2 grocer, will take over all of Shell's retail outlets in Atlantic Canada and the province of Quebec. The price was undisclosed but Sobeys said it would finance the deal with existing cash balances.

The gas station deal will expand Empire's current stable of 43 gas outlets operating under various banners in Atlantic Canada. Shell will continue to supply the fuel.

The company will continue to operate the outlets under the Shell banner. It aims to leverage Shell's strength as a brand against Sobeys' name recognition in the convenience store business, Sobeys Chief Executive Bill McEwan said in a statement.

STRONG RETURNS ON GAS

Other Canadian retailers have enjoyed strong returns at gas bars thanks to rising fuel prices. In the last quarter, Canadian Tire Corp's results were helped by a 27.4 percent increase in gasoline sales.

The Sobeys-Shell deal is expected to close by the end of March 2012.

Canadian grocers are facing tough competition from Wal-Mart, which has been rolling out more supercenters, which sell a wider array of grocery items than its regular stores.

The market will heat up further when Target Corp enters the Canadian market in 2013, but the impact on Sobeys may be less than on its rivals as it has signed a long-term wholesale agreement to supply the U.S. discount retailer with groceries.

Sales at Sobeys rose 3.4 percent in the quarter ended November 5 to C$3.98 billion. Sales at established stores, a key measure for retailers, rose 1.9 percent.

Empire's net earnings for the quarter ended November 5 fell to C$78.1 million ($75.0 million), or C$1.15 a share, from C$142.9 million, or C$2.09, a year earlier. Its net earnings were higher in the year-before quarter due to proceeds from the sale of industrial equipment company Wajax.

Excluding special items, the company earned C$1.10 a share, up from C$1.02 in the same quarter last year.

Empire sales were up 3.2 percent at C$4.04 billion.

SHELL DIVESTS IN ATLANTIC PROVINCES

Shell said in May it would sell its retail operations in Quebec and the Maritimes as part of its continuing divestment in Eastern Canada.

We will continue to have direct operations and investments ... in the rest of the country, in certain markets, David Saint-Laurent, Shell Canada's general manager for retail said in an interview. It was just really strategically a good thing for us in Quebec and Atlantic.

Shares of Empire were down 2.7 percent at C$60.35 on Thursday afternoon on the Toronto Stock Exchange.

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