Canadian Tire Stock Price (TSE:CTC.A) Should Continue to Roll Higher

Iconic Canadian retailer could be looking to make more acquisitions like that of Forzani Group

Juri Zguri | Ubika Research Analyst | May 9, 2016: Canadian Tire Corporation, Limited (TSE:CTC.A) is set to release Q1/2016 earnings on May 10. While we do not expect large volatility in the stock price as a result of the report, investors would be wise to assess the general trends in the retail environment, and some initiatives Canadian Tire continues to implement.

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Canada’s Economy Will Rebound in 2016 Bringing Canadian Tire Considerable Upside

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Statistics Canada reported a steady unemployment rate of 7.1% in April, while the economy lost 2,100 net jobs during the period, largely due to the 20,800 jobs lost in Alberta. Despite that, we believe this net job lost figure in April is considerably insignificant when taking into account the 41,000 spots created in March. In addition, we are seeing some relief in the price of oil, suggesting a stronger Canadian economy. With that in mind, we also saw retail sales in the month of February increase by 5.6% relative to a year ago, and an overall positive change Q/Q.

In all, we believe the following factors have, and will continue to affect the Canadian economy, and thus the vast retail space that Canadian Tire operates in:

• Significant relief in oil markets (April’s prices witnessed a nearly 20% increase) will boost the Canadian economy, as well as its currency. This is especially important for Canadian Tire as it has been recently forced to up prices due to the weak Canadian dollar pushing up purchasing costs.
• Increased fiscal spending is said to contribute 0.5 percentage points of GDP increase this year, and 0.6 points in 2017. This increase in national income will eventually increase consumer spending on retail items such as cars and, in turn, automotive-related accessories, including tires. Investors should also note that consumer confidence is also on the rise due to this sharp jump in government expenditures.
• Bank of Canada Governor, Stephen Poloz, is optimistic towards the Canadian economy, noting that a 2016 rebound is likely and that an interest rate cut is improbable. He is also fond of the huge fiscal stimulus the Liberals have pushed forward to balance the relatively ineffective expansionary monetary policy that is currently in play.

Figure 1. Amplified Liberal Spending Plans to Expand GDP & Spending

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Source: Government Presentation: “An Historic Investment Plan”
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Canadian Tire Stock Price is Poised for Growth Due to Three Reasons:

1) Improving Productivity & ROIC
2) Strong Focus on e-Commerce
3) Acquisition Opportunities

Improving Productivity and Return on Invested Capital (ROIC)

Despite headwinds during the second half of 2015 causing sales to decline, Canadian Tire showed improvements from a productivity standpoint. We believe the initiatives management is implementing will continue to create incremental gains in Canadian Tire’s margins and thereby offset the headwinds that may linger into the first half of 2016. The CEO has mentioned savings were generated through better rates from its suppliers by consolidating purchases. In addition, the Company has enacted a large buyback program in order to make use of its large cash mountain of nearly $1 billion. Consequently, these initiatives by management and the enterprise at large will help improve Canadian Tire’s retail segment ROIC from its current 8.1%, to the target of 10.0%.

Stronger Focus on e-Commerce

Historically, Canadian Tire has not held much of a digital presence. However, with the massive advancement into e-commerce throughout the past years, the Company has wisely focused its effort into it. As Canadian online retail sales are expected to hit an estimated ~$40 billion per year by 2019 (12.9% increase per year to 2019), Canadian Tire is spending a large portion of its capital expenditures on the digital world, stating e-commerce is a “mammoth opportunity in the next 5 years.” The Company expects close to 10% of its sales to come from its website over the five-year period.

One feat the Company has implemented to promote its online presence is through its loyalty program, which includes the idea of redeemable e-money in addition to the status-quo ‘Canadian Tire Money’. We believe this initiative is extremely critical to the continued success story of Canadian Tire, mainly because of the (at least partial) diminished threat from online retailer giant Amazon.

Figure 2. Online Retail Industry Revenue Growth
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Source: IBISWorld
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Potential Acquisitions from Excess Cash

Competition in the retail space is certainly on the rise. Specifically, US mega-retailers such as Walmart and Costco continue to advance their presence into the Canadian market, especially following Target’s regional exit. That being said, Canadian Tire derives 50% of its sales from its core brand business, the products of which do not directly compete with one single retailer. In any case, the Company has realized that organic growth, while healthy, cannot be the sole method of expansion. Canadian Tire acquired the Forzani Group (FGL sports) in 2011, a segment that has grown notably in the past years through its premier brand, Sport Chek.

Figure 3. Canadian Tire Revenue Segments
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Source: Company Filings
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Management has noted that inorganic growth through acquisitions will play a large role in its initiatives towards a greater digital presence. We advise investors to keep an eye out for any potential deals.

Canadian Tire Faces Two Main Risks

Greater competition than expected on different fronts (i.e. Costco on core brand, Under Armour on FGL Group)
Continued weakness in the Canadian economy throughout 2016 and into 2017, causing generally lower spending on retail goods

Analyst 12-month Price Targets on Canadian Tire

Analysts from: Price Target
BMO Capital Markets $151
RBC Capital Markets $158
Desjardins Capital Markets $145
TD Securities $165
National Bank Financial $140
Credit Suisse Securities $127
Canaccord Genuity $129

Average Price Target: $145
Implied Upside: 5.2%

In closing, while we believe Canadian Tire is well positioned for upside in the coming week, investors must be aware that, on average, roughly 10% of annual sales are derived in the first quarter. As a result, a huge swing in the stock’s price is not likely. In addition, Canadian Tire trades at only a 5.1x estimated EV/EBITDA, compared to the peer group average of 7.9x. This could represent a steady price increase in the upcoming months.

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