2 retail stocks; high vs. low-end positioning

The MoneyLetter recently surveyed analysts’ reports on Canadian consumer retail stocks and was intrigued by the juxtaposition of two that it found—a centuries old icon focused on high-end fashion apparel and accessories, and a late 20th century dollar store chain very much entrenched in its decidedly more egalitarian approach to product selection and pricing.

Retail_StocksHudson’s Bay Co. (TSX—HBC), the Toronto-headquartered consumer goods stock that operates a number of banners in North America and in Europe, continues to execute its transformation plan, says Toronto-based CIBC World Markets analyst Mark Petrie. The analyst, who keeps his ‘Neutral’ recommendation but reduces his 12-month target share price to $10 from $12, says that CIBC is confident that there is substantial value in HBC’s properties.

Acknowledging that the company’s management has a history of monetization strategies, the analyst notes that, minus considerable retail operations improvements, real estate monetization moves will be a necessity. He adds that the company faces the possibility of a fourth straight year of negative free cash flow.

“The company continues to execute its transformation plan, with the goal of eventually generating $350 million in selling, general and administrative cuts,” says Mr. Petrie. “Measures put in place in 2017 generated $150 million in savings, and management expects another $150 million this year, with the remainder expected to fall into fiscal 2019. This is healthy progress, but must be balanced against other selling, general and administrative increases. Net, management conceded that the SG&A savings will likely be exceeded by other cost pressures, notably minimum wage headwinds ($40 million), new stores and general cost inflation.

“Same-store sales (SSS) growth continues to be a struggle, and though Hudson’s Bay and Saks Fifth Avenue remain in positive territory, fourth quarter two-year stacks of -13.5 per cent at Off 5th and -5.4 per cent in Europe are, in our opinion, real causes for concern. The company highlighted that execution issues were a key driver and are being addressed, but at this point it is difficult to have confidence this business will be rebuilt in the near term.”

New leadership at HBC agrees that it needs to improve the execution of HBC’s strategy. While confident that opportunity exists, the analyst says that HBC, following eight straight quarters of EBITDA (earnings before interest, tax, depreciation and amortization) drops, could find this year to be challenging.

Sales growth is a must for real HBC improvement

“Inventory reductions will support working capital improvements and will help stabilize gross margins,” says Mr. Petrie. “However, top-line growth is required for real improvement. HBC will benefit from the absence of Sears Canada and we expect Saks can continue to rebound, but we remain cautious in our expectations for the rest of the business.”

As for possible risks to his one-year target price for HBC, the analyst mentions, among other things, a potential inability to do well in new geography such as the Netherlands, Germany and Belgium as well as possible problems when it comes to accomplishing anticipated on-line sales growth with sufficient margins.

Dollarama

While a stock valuation increase is something that investors usually celebrate, BMO Capital Markets analyst Peter Sklar was forced to admit in a late 2017 research note that Dollarama’s (TSX—DOL) substantial share price appreciation was without rhyme or reason.

Dollarama Inc. operates dollar stores in Canada that sell all items for $4 or less. The company maintains retail operations in every Canadian province.

Mr. Sklar said that this consumer goods stock could see significantly lower levels going forward, providing for more favourable opportunities to buy shares in the company. He downgraded his recommendation to ‘Market Perform’ from ‘Outperform’ and announced a 12-month target share price of $155.

“Following fiscal 2017, we expect an earnings per share growth rate in the mid-teens, resulting from the generation of strong same-store sales growth through increased basket size due to the successful multi-price-point strategy and incremental square footage growth,” said Mr. Sklar.

“We expect an earnings per share growth rate in the mid-teens resulting from the generation of strong same-store sales growth through increased basket size due to the successful multi-price-point strategy and incremental square footage growth,” said Mr. Sklar.

“We believe there will also be modest operating leverage improvement, and the positive impact of share buyback.”

Sales growth is one of Dollarama’s strengths

In a follow up research note on Mar. 29, 2018, Mr. Sklar says that Dollarama modestly beat his expectations when reporting its fiscal 2018 fourth-quarter (period ended Jan. 28, 2018) results.

“The company continues to grow its top line faster than its operating costs, driving earnings per share growth,” he says. “Dollarama reported same-store sales of 5.5 per cent, above our estimate of 3.6 per cent, and driven by strong basket growth of 4.6 per cent.” Mr. Sklar says that Dollarama’s $40-million boost in capital spending will help the company expand its distribution plant.

The analyst says the decision to expand the existing facility rather than to build another location will be less capital intensive, which counts as a positive. The company also announced that its board has approved a three-for-one stock split, subject to shareholders’ approval. If shareholders agree to it, the company will go ahead with a three-for-one stock split in mid-June. The analyst maintains his $152 per share, 12-month target.

This is an edited version of an article that was originally published for subscribers in the May 2018/First Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.

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