Canadian Tire CTC-a
June 13, 2006 - 3:41pm EST by
issambres839
2006 2007
Price: 66.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 5,400 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

With accelerated sales and earnings growth and buoyed by significant real estate and credit card assets, Canadian Tire represents substantial value at current prices. With an extremely undervalued $2 billion in book value in real estate and a credit card business that could be worth $3 billion, investors are getting Canadian Tire’s retail business for free. Canadian Tire is also undergoing a massive capital expenditure overhaul program. Combined with the tailwinds of a strong economy and a robust consumer, Canadian Tire’s retail sales and earnings should be strong for the next couple of years.

What is Canadian Tire?

Canadian Tire is a retailer with a financial division. There are four conceptual parts to the Canadian Tire company: Canadian Tire Retail, Mark’s Work Warehouse, Canadian Tire Petroleum, and Canadian Financial Services.

Canadian Tire Retail is Canadian Tire stores and PartSource. Canadian Tire Stores are a weird mix of automotive, sporting goods and home products. Canadians love these stores. Canadian Tire stores are a seasonal business. Seasonal in terms of, when seasons change Canadian Tire is where most Canadians think of to go to stock up on the latest season’s stuff, like camping, barbecue, hockey, back to school, etc.

One third of the bicycles sold in Canada are bought at Canadian Tire. One quarter of all barbeque grills are bought at Canadian Tire. One fifth of all hockey sticks sold in the world are bought at a Canadian Tire. They have 120 categories of automotive, sporting goods and home products. Canadian Tire has a market leading position in terms of market share in 60% of those categories. For example, they are first in market position in camping gear.

Canadian Tire operates 462 stores through an independent dealer franchise network. This decentralized approach allows dealers to stock what they think the store needs, not what a centralized corporation believes they need. However, it is important to note that Canadian Tire owns almost all of the land underneath its stores, as well as the stores themselves.

PartSource operates 54 PartSource stores, offering automotive parts to commercial installers and automotive enthusiasts.

Canadian Tire acquired Mark's Work Wearhouse in February 2002 for C$100.8 million. “Mark's offers primarily men's and ladies' casual clothing, footwear and accessories for business casual and industrial work environments, as well as for recreational use or relaxation. Canadian Tire Corporation now operates 334 corporate and franchise stores across Canada under the Mark's Work Wearhouse, Work World and the L'Equipeur brand in Quebec.”

Mark’s was founded in 1977 in Alberta and is mainly in the booming Western region of Canada, especially in Alberta. Just three years after the acquisition, Mark’s is doing C$65 million plus in operating annual earnings before taxes. I would say this was a nice acquisition.

Canadian Tire Petroleum is the largest independent retailer of gasoline in Canada. Canadian Tire's 259 agent-operated sites also market products such as oil changes, propane and convenience items. CTP also operates a chain of 67 car washes (high margin), adjacent to its petroleum sites. They also own most of the land of the gas stations as well.

Canadian Tire Financial Services offers a variety of financial products, primarily branded credit cards, which give Canadian Tire customers a choice of payment options, as well as increased loyalty rewards. Canadian Tire has 1.7 million active accounts and the receivables exceed $3.1 billion. This represents 5% of the burgeoning Canadian credit card market of $60 billion. This is an excellent market to be in as it has grown 9.9% a year for the past three years.

Why you want to invest in a Canadian Retailer right now

There are substantial long life tailwinds to the Canadian economy right now. First and foremost the country is filled with commodities of every kind and there is a gold rush going on for looking for everything from oil to natural gas to diamonds to uranium to copper and nickel. This commodity boom is sending employees and investment all over Canada and especially the West.

What the boom is also doing is driving down unemployment and boosting wages everywhere. Canadian unemployment is at a 31 year low and wage growth is accelerating.

There is also a hidden benefit to the strong Canadian dollar. Even though the company hedges every six months, the continued upward move of the CAD has added a hidden long term gross margin benefit to retailers as most of their goods are sourced in US dollars or are sourced with countries whose currencies are tied to the USD.

Finally, the government is so flush with money, it is giving handouts, tax incentives and is starting to ramp up spending on infrastructure projects. For example, Alberta recently paid every citizen of Alberta $400, because it didn’t know what to do with its surplus. All of this benefits consumers, especially in Western Canada. And all of the tailwinds come as the company is undergoing a massive capex and expansion program, which is due to pay enormous benefits later this year and next year.

Accelerated growth plan

Canadian Tire is in the midst of a big expansion and renovation of many of their stores. In fact, they are planning to add 586,000 square feet of retail space this quarter alone. This year’s capital expenditure program is going to top $500 million. So, what exactly are they doing?

They are undergoing an expansive remodel of their Canadian Tire stores into what they call “Concept 20/20” stores. These stores are bigger, carry more merchandise and also are easy to navigate through. Sixty stores are going to be retrofitted this year, compared to eleven last year. Only twenty new stores are going to be opened as comparison.

The company is also aggressively expanding Mark’s Work store base, opening 21 new stores in 2006. The company opened 11 in 2005. The company is also experimenting with dual Canadian Tire/Mark’s Work stores in eight markets.

Canadian Tire has an aggressive plan through 2009 of what to do and it is highlighted quite well in their annual report and I recommend investors check it out. But consider that they plan to open almost 1.5 million square feet of new retail space this year.

Sales and Earnings growth are accelerating

Through this aggressive expansion and overhaul, Canadian Tire hopes to grow sales at 7-9% a year and earnings at 12-15% a year for the next four years. Estimates for this year at $4.25 to $4.35, next year I estimate that it will be at least $5 a share.

However, performance is tracking ahead of expectations. First quarter earnings grew 35% from last year. I believe the best performance will come in the second half when many of the new stores are retrofitted.

Hidden Real Estate Value

In their 2005 annual report, Canadian Tire reported its land value at $700 million and its building value at $1.3 billion. Both of these assets are at book value. These values are woefully short of the true value. Most of these assets were acquired in the 1950s through 1970s. The land in particular could be worth as much as four to five times the book value amount.

For example, Canadian Tire is sitting on a few buildings in mid town Toronto that is mixed use retail, commercial and residential that it has owned since the 1960s. The combined square footage is 4 million square feet. This asset is non-core and they are marketing it. Now, I’m not an expert on Canadian real estate, but it doesn’t take a rocket scientist to know that real estate prices just from inflation are substantially higher than the 60s, probably by a factor of four or five.

To highlight the opportunity of the land value, Canadian Tire completed a sale leaseback of just two distribution facilities in January for $229 million.

I estimate that the value of its property and buildings is at least $3 billion or 50% higher than the book value of $2 billion and it’s probably closer to $4 billion. Considering that the entire market cap of the company is $5.4 billion, this is quite a significant amount.

Credit Card portfolio has significant value

With a receivable account that exceeds $3 billion growing at almost 10% a year, Canadian Tire has an attractive portfolio that could easily fetch $3 to $3.5 billion in a sale. In fact, maybe they just sell off half and raise $1.5 billion. There are many options here. And the value accretes as they grow the credit card portfolio.

It is interesting to know that several North American retailers have done very well by selling their credit card divisions in the past five years.

Sum of the parts valuation

I estimate the value of the real estate to be at a minimum $3 billion. I also estimate that the credit card division is worth $3 billion. At this point, since the combination of those two values exceeds the value of the market cap, you just have to ask yourself what is the value of the retail company?

The value of the real estate and the credit card portion is over $73 a share. The retail division did EBITDA of $605.8 million last year. Giving it a 7 times EBITDA multiple, which is probably conservative due to its brand and growth opportunities, gets you $52 a share. That would value the entire company at $125 a share. This figure is remarkably close to the $129 a share that Bill Ackman of Pershing Square Capital thinks Canadian Tire is worth.

Bill Ackman of Pershing

Bill Ackman of Pershing Square Capital specifically touted the company at the Tomorrows Children Fund Conference (I was not there and this is not how I found out about the company). Mr. Ackman is an activist investor who has been successful in pressing for changes at fast-food giants Wendy's International Inc. and McDonald's Corp. He is now challenging Sears in its hostile takeover of its Canadian business.

He has called it his top “investment idea” and he already owns a “substantial” stake. Calling it a “Great company, great management, cheap stock,” he said Canadian Tire could be worth as much as $129.

While Mr. Ackman is an activist investor normally, due to the controlling stake by Martha Billes, I believe that he wishes to influence through persuasion not through proxy fight. Ms. Billes and her son Owen control 61 per cent of the voting shares while the rest are controlled by dealers who run the stores and trustees of the company's deferred profit sharing plan. The class A shares -- 96 per cent of all the stock -- are non-voting.

Multiple opportunities to unlock value

I believe that Canadian Tire can do several things to unlock value. First, it could sell half or all of its credit card division. It could also do more sale lease backs like the one it did early this year. Canadian Tire could also sell off its Petroleum division.

Also, interestingly when the big capex program is done in three years, Canadian Tire could very easily turn into an income trust.

The fact is, Canadian Tire is sitting on so many attractive assets and it has many opportunities of what to do with those assets. What is also great for investors is that these assets are accreting value not losing them as time goes on.

Summary

With tremendous economic tailwinds and in the midst of a rapid expansion to take advantage of the great Canadian retail environment, Canadian Tire is growth retailer. However, due to its tremendous asset value somewhat hidden inside the company, I believe you can buy this retailer for free once you exclude the retail and credit card values. I believe over the next year that Canadian Tire could easily trade up through $100 to my $125 price target.

Catalyst

-sales earnings beating estimates
-further sale/leasebacks of real estate assets
-sale of credit card portfolio
-any talk of management of restructuring assets
-potential acquisition
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