* Joe Fresh to roll out at about 700 J.C. Penney stores
* Q2 profit C$0.56/share vs C$0.69 year earlier
* Retail sales rise 1.1 pct
* Same-store sales up 0.2 pct
* Shares drop 1.3 pct on Toronto Stock Exchange
By Allison Martell
July 25 (Reuters) - Loblaw Cos Ltd, Canada's biggest grocer, reported lower quarterly profit on Wednesday on sluggish sales growth and higher expenses, sending its shares lower even as it announced a deal to expand its Joe Fresh clothing line in the United States.
The retailer said it would team up with U.S. department store chain J.C. Penney Co Inc to open nearly 700 of its Joe Fresh clothing shops inside renovated Penney stores from April 2013.
"I think it's actually a very good deal," said Edward Jones analyst Brian Yarbrough. "It helps them showcase their brand, it's a good way to grow sales and increase profits without having to put a lot of capital into the business."
Yarbrough said the plan is much less risky, and easier to roll back, than opening more standalone stores in the United States.
Loblaw's results were hurt by the C$20 million incremental cost of Loblaw's project to improve its supply chain and information technology systems. Higher labor and transportation costs, and input costs that it did not pass on to customers, also weighed on the results. Loblaw has said repeatedly that earnings will drop in 2012 as it spends to boost productivity.
"We remain confident that our ongoing investments in infrastructure, including the completion of our IT implementation, will enable efficiencies and expense leverage to drive future earnings growth," Executive Chairman Galen Weston said in a statement.
Loblaw and other Canadian grocers face rising competition as Wal-Mart Stores Inc boosts its food offerings in the country and ahead of the 2013 arrival of discount retailer Target Corp.
Loblaw's earnings fell to C$159 million ($156 million), or 56 Canadian cents a share, in the quarter, from C$197 million, or 69 Canadian cents a share, a year earlier. Analysts, on average, were expecting 61 Canadian cents, according to Thomson Reuters I/B/E/S.
Revenue at the company, majority-owned by George Weston Ltd , rose 1.3 percent to C$7.38 billion, compared with analyst expectations of C$7.37 billion.
Retail sales grew 1.1 percent, and sales at established stores, a key measure for retailers, rose 0.2 percent. Loblaw's operating profit margin fell to 3.8 percent from 4.7 percent.
Joe Fresh said its J.C. Penney stores, sized from 1,000 to 2,500 square feet, would start by selling women's apparel, and its products will also be sold on the U.S. retailer's website.
Penney is in the midst of a multi-year push to turn around its business, bringing in new brands and moving away from coupons and sales events in favor of lower regular prices. In May the company said same-store sales fell 18.9 percent in the first quarter, and scrapped its dividend.
"Obviously a lot of people are going to question, I mean, J.C. Penney is going through a major turnaround right now and there's a lot of questions," said Yarbrough, but he argued that while it may struggle for a couple years, Penney is shifting to a better pricing model.
While many U.S. retailers have found success in Canada, very few Canadian companies have cracked the tough U.S. market. One notable recent exception is Vancouver's Lululemon Athletica Inc , now expanding rapidly south of the border.
Loblaw sells Joe Fresh products, including clothing, footwear, outerwear and cosmetics, in more than 300 stores in Canada, typically inside grocery superstores. There are also 12 standalone Joe Fresh locations in Canada, and six in New York and New Jersey. The brand, with its distinctive bright orange color scheme, was launched in 2006.
Loblaw's stock fell 1.3 percent to C$31.51 on the Toronto Stock Exchange on Wednesday morning.