DOO—ZZZ off with these two smoothies

Only a Great White North investment letter could see the relationship between these two Canadian consumer stocks. After a smooth riding day on your Ski-Doo or Sea-Doo, you’ll look forward to a smooth sleeping night on your Sleep Country mattress. And both of them should help give your portfolio a comfortable ride.

With the release of its Q3 results, consumer goods stock BRP Inc. (TSX—DOO) has proved yet again that toys for grownups is a winning proposition.

The Valcourt, Quebec-based power-sports vehicles and propulsion-systems company behind such brands as Ski-Doo, Can-Am and Sea-Doo reported better-than-expected results for the period. It also boosted, albeit by only a smidgen, its guidance for fiscal year 2018 to account for a better-than-anticipated outlook.

“We are rolling forward our valuation to our fiscal 2020 numbers and derive a new target share price of $54, up from $46,” says Desjardins Capital Markets analyst Benoit Poirier, who maintains his ‘Buy’ recommendation.

According to the analyst, BRP’s revenue for the quarter was $1.241 billion, up 15 per cent year over year, versus Desjardins’ projection of $1.146 billion and the consensus estimate of $1.142 billion. Normalized fully diluted earnings per share (EPS) were $1.05, which beat both Desjardins’ estimate of $0.96 and the consensus estimate of $0.95. The EPS performance was largely a function of higher revenue, says Mr. Poirier, which offset a lower-than-anticipated gross margin of 29.5 per cent versus a projected 31.8 per cent.

Due to loftier-than-expected revenue and a reduced tax rate, the company boosted its normalized EPS guidance to between $2.25 and $2.35, compared to between $2.23 and $2.35 previously.

“Popularity of new products requires incremental production capacity—$100 million of additional capex [capital expenditure] over the next two fiscal years,” says Mr. Poirier. “In light of the popularity of its SSVs [side-by-side vehicles], BRP decided to expand its capex envelope by $100 million to increase production capacity and meet demand for its products. Most of this investment will be incurred toward the end of FY2019, which is expected to push capex above $250 million for the year.”

He says Desjardins sticks with its positive stance on the company at current levels, on account of its solid retail sales momentum, and Desjardins’ confidence in the company’s ability to roll out enticing new products and to pick up market share. Mr. Poirier says that investors should acquire the stock.

“Year-round products and solid momentum allows BRP to continue outpacing the industry in all key segments,” says the analyst. “The 20 per cent year-over-year revenue increase in the third quarter was due to a higher volume of SSV sales, mainly attributable to recent product introductions during the most recent Club BRP. Overall, we are pleased by the excellent reaction to these products, and believe it demonstrates management’s ability to innovate in the power-sports business—a key lever to increase market share.”

BRP designs, develops, manufactures, distributes, and markets power-sports vehicles and propulsion systems worldwide.

To sleep perchance to dream—of capital gains

Seen as an attractive risk-to-return stock, CIBC Capital Markets analysts Matt Bank, Mark Petrie, John Zamparo and Krishna Ruthnum maintain their ‘Outperform’ rating for Toronto, Ontario-based consumer goods stock Sleep Country Canada Holdings Inc. (TSX—ZZZ). The analysts give the stock a $40 target share price on the back of noting that the company continues to execute on its runway in same-store-sales.

The company is another one that benefits from the windfall from Sears Canada Inc.’s exit. The analysts note that: “Sleep Country is in the enviable position of posting strong growth in what for most companies would be euphemistically called ‘transition years’. 2017 and 2018 are dented by investments in e-commerce, The Bloom product, office staff, new distribution centres and advertising. Yet we still expect 11 per cent earnings before interest, taxes, depreciation and amortization (EBITDA) growth from the company this year and 18 per cent next year.”

The analysts argue that Sears’ exit will boost 2018 numbers, though much of that cash flow will be reinvested to enter 2019 with a broader customer base and stronger positioning. “We believe Sleep Country will continue to gain share against traditional peers while holding its own in e-commerce and bed-in-a-box. There is an appropriate sense of urgency in executing the online strategy and we believe the strength of the Sleep Country brand and the company’s unparalleled customer reach are powerful assets,” they say.

“Management has cautioned investors not to expect material EBITDA margin increases from here (already up 169 basis points during the years 2013 to 2016), though company messaging tends to be conservative.

“We expect best-in-class revenue growth and mild margin expansion over time. The company is generating significant excess cash flow even after raising the dividend and funding growth. We would not be surprised to see a share buyback in the coming quarters, elevating earnings per share (EPS) growth.

“We adjusted our forecasts to account for the wind-down of Sears and elevated investments in advertising and online with our third quarter note on Nov. 1.

“We still forecast 18 per cent EBITDA growth in 2018, as the Sears windfall more than funds prudent investments. We believe management has re-set expectations after outsized margin increases over the past three years, and is now positioned for another period of strong performance. The company’s messaging has always been conservative and IPO targets proved to be far too low. We remain bullish on the long-term outlook.”

Sleep Country is Canada’s largest mattresses retailer, with over a 25 per cent market share across the country, operating 244 stores under the Sleep Country and Dormez-Vous (in Quebec) banners. Based on 2016 revenue of $524 million, the company ranks first in the Canadian mattress industry.

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

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