Ben Axler
December 05, 2019
"Hedge fund manager specializing in forensic financial research"

Why Canadian Tire Corp. (TSE: CTC.A) Has Symptoms Of A Potentially Terminal Illness As A Brick-And-Mortar Retailer

Summary

  • Canadian Tire (CTC) is a brick-and-mortar retailer in Canada that has been slow to move sales online, or develop a flourishing mobile app. The market underappreciates Amazon's growing market share.
  • With revenue growth slowing and debt rising, we believe CTC is making poor choices to increase capital returns to shareholders, instead of focusing on deleveraging and avoiding a credit downgrade.
  • Risky credit card extension magnifies the problem while multiple symptoms emerge, including aggressive accounting changes, assets sales and stretched acquisitions. Cost cutting programs are nebulous, too little and too late.
  • Bay Street analysts see just 11% upside assuming all goes well, but ignore the growing risks, and fail to capture all the explicit and implicit debt obligations. We see intermediate term risk of 30-50% downside, and a terminal 100% downside if sales continue to vanish, a sustain economic correction occurs, cash flow contracts, and debt remains unaddressed.

 

Report Entitled: "Kicking The Tire Down The Road”

Spruce Point is pleased to issue a unique investment research opinion on Canadian Tire Corp. ("CTC" tickers:  OTCPK:CDNAF   / CDNTF  , "the Company"), a Canadian retailer. The report outlines why we believe shares face 30% - 50% downside risk to approximately C$77 to C$100 per share. The full contents are available on our  website . Follow us on Twitter for exclusive updates  @sprucepointcap . Please read our disclaimer below.

Spruce Point believes that Canadian Tire is a challenged brick-and-mortar retailer perceived as a dependable mid-single-digit grower on an increasingly precarious foundation of unsustainable debt and recent financial results dependent on aggressive accounting practices. We also believe the market has failed to realize multiple signals of financial stress.

Mature Business With Growing Signs Of Strain:

While Canadian Tire appears to participate in nearly every retail category, Canada’s retail environment continues to become increasingly competitive as U.S. retailers (  AMZN   LOW   HD   COST   WMT  ) expand in the market and offer lower cost, and free, shipping options. Our research shows CTC is not price competitive and is often located in close proximity, or sometimes in the same shopping center as, competitors. Canadian Tire store count continues to decline while competitors grow their footprints. The market is blissfully ignorant to the Amazon  AMZN  displacement effect that our data shows is accelerating. On CTC’s most recent earnings call, management announced a new cost reduction effort. We believe this program is too little and too late and it cannot forestall CTC’s inevitable decline. Our analysis illustrates that, based on the Company’s current and projected financial situation, CTC may struggle to meet its capital return promises.

Risk Of Credit Downgrade Due To Overleveraged And Misunderstood Balance Sheet:

Multiple rating agencies have warned of a credit downgrade if leverage is not reduced. Our analysis supports the view it will be nearly impossible to delever while maintaining current levels of dividends and share repurchases without selling assets that could reduce earnings. Current leverage of ~3.5x is significantly above rating agency guidance of 2x needed to prevent a downgrade and requires debt reduction of ~C$1,600m, but has no free cash flow after promised dividends and buybacks.

Risky Credit Card Business With Rapidly Deteriorating Credit Card Portfolio:

CTC Triangle Rewards Program has been an effort to boost retail sales and drive store traffic at the expense of higher risk lending practices. 68% of recent loan growth has come from moderate and high-risk customer classifications. Net charge-offs for “seasoned” loans, a leading indicator for an increase in future credit losses as loans begin to mature, is at historic highs despite the majority of high-risk growth over the past 12 months. Relative to other Canadian banks, CT Bank delinquencies have performed worse over the past 2 years.

Aggressive Accounting Practices Are Potentially Misleading Investors By Masking Poor Organic Earnings Growth:

CEO Stephen Wetmore has commented on earnings calls about the importance of hitting numbers. Various one-time benefits including altered expected credit losses by modifying model assumptions, changed estimates affecting the present value of loss recoveries, and changes in its depreciation method, have helped CTC hit its 10% EPS growth target.

Despite these clear risks, the sell-side has only one sell recommendation on CTC and sees only 11% upside to C$167 in the next 12 months. We believe that investors will be surprised and disappointed by the risk to capital return plans and the poor underlying earnings growth of the business. Spruce Point sees 35% - 50% downside risk in CTC shares when each of these factors is considered.

Thank you for your interest in our research and happy holidays.

 

Disclaimer

This research note and our presentation expresses our research opinions. You should assume that as of the publication date of any presentation, report or letter, Spruce Point Capital Management LLC (possibly along with or through our members, partners, affiliates, employees, and/or consultants) along with our subscribers and clients has a short position in all stocks (and are long/short combinations of puts and calls on the stock) covered herein, including without limitation Canadian Tire Corp. (“CTC”), and therefore stand to realize significant gains in the event that the price of its stock declines. Following publication of any presentation, report or letter, we intend to continue transacting in the securities covered therein, and we may be long, short, or neutral at any time hereafter regardless of our initial recommendation. All expressions of opinion are subject to change without notice, and Spruce Point Capital Management does not undertake to update this report or any information contained herein. Spruce Point Capital Management, subscribers and/or consultants shall have no obligation to inform any investor or viewer of this report about their historical, current, and future trading activities.

This research note and our presentation expresses our research opinions, which we have based upon interpretation of certain facts and observations, all of which are based upon publicly available information, and all of which are set out in this research presentation. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward looking statements, expectations, pro forma analyses, estimates, and projections. You should assume these types of statements, expectations, pro forma analyses, estimates, and projections may turn out to be incorrect for reasons beyond Spruce Point Capital Management LLC’s control. This is not investment or accounting advice nor should it be construed as such. Use of Spruce Point Capital Management LLC’s research is at your own risk. You should do your own research and due diligence, with assistance from professional financial, legal and tax experts, before making any investment decision with respect to securities covered herein. All figures assumed to be in US Dollars, unless specified otherwise.

To the best of our ability and belief, as of the date hereof, all information contained herein is accurate and reliable and does not omit to state material facts necessary to make the statements herein not misleading, and all information has been obtained from public sources we believe to be accurate and reliable, and who are not insiders or connected persons of the stock covered herein or who may otherwise owe any fiduciary duty or duty of confidentiality to the issuer, or to any other person or entity that was breached by the transmission of information to Spruce Point Capital Management LLC. However, Spruce Point Capital Management LLC recognizes that there may be non-public information in the possession of CTC or other insiders of CTC that has not been publicly disclosed by CTC. Therefore, such information contained herein is presented “as is,” without warranty of any kind –whether express or implied. Spruce Point Capital Management LLC makes no other representations, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. You should assume all statements made are our opinions, unless sourced as facts where practical.

This report’s estimated fundamental value only represents a best efforts estimate of the potential fundamental valuation of a specific security, and is not expressed as, or implied as, assessments of the quality of a security, a summary of past performance, or an actionable investment strategy for an investor. This is not an offer to sell or a solicitation of an offer to Buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction. Spruce Point Capital Management LLC is not registered as an investment advisor, broker/dealer, or accounting firm.

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