Canadian Tire – A Once In A Decade Opportunity – Canadian Tire Corporation, Limited (OTCMKTS:CDNAF)

This article was initially shared last week with members of Loonies, Toonies & More. Although the service focuses on small-to-mid cap companies, the opportunity was too enticing not to share first with premium members. Although numbers may have changed since my initial article, the investment thesis remains.

Today, I am sharing with all members why Canadian Tire Corporation (OTC:CDNTF)(OTCPK:CDNAF)[TSX:CTC.A] is a very attractive investment opportunity. I am talking about a once-in-a-decade opportunity.

Company Overview

I am not going to waste much time here. Canadian Tire is one of Canada’s more recognizable brands.

What you might not know is that Canadian Tire has expanded its footprint in recent years and its family of stores include Partsource, Gas+, FGL Sports (Sport Chek, Hockey Experts, Sports Experts, National Sports, Intersport and Atmosphere) and Mark’s. In total, the company has a network of over 1.700 locations nationwide.

It also has a very success and growing financial arm that provides credit card services.

Furthermore, Canadian Tire has an extensive portfolio of name brands including (but not limited to) Motormaster, Paderno, Mastercraft, Woods, Simoniz, Master Chef and most recently added Helly Hanson to the mix.

Canadian Tire is not a one trick pony. Although it is largely dependent on retail, it has diversity across the retail landscape.

Recent Weakness

Over the past year, Canadian Tire’s share price has struggled. I specifically point out its share price, as the company itself has actually performed quite well.

Since May of last year, its share price has lost almost 17% of its value. A good portion of this loss came in recent weeks after first quarter results that disappointed investors.

The headline from Canadian Press was as follows: Canadian Tire profit misses on lower product shipments.

It’s not wrong, earnings missed by $0.26 and shipments were impacted by the wildly unpredictable winter we experienced. Earnings per share of $1.12 also represented a 4.8% drop over the first quarter of 2018.

This however, is not the whole story. For example, while earnings dropped and it faced supply chain management issues at its namesake Canadian Tire stores, the company still posted consolidated revenue growth of 2.8 per cent.

Likewise, earnings were impacted by three one-time events that make a direct comparison with the first quarter of 2018 difficult. They are as follows:

  • It reduced its stake in the CT REIT from 86% to 76%;
  • It had lower year-over-year (-$12 million) non-strategic real estate sales;
  • Higher financing costs (+12 million) – primarily a result of the Helly Hansen acquisition.

Combined, these three factors accounted for a negative impact to earnings of approximately $0.29 per share. That is a big chunk of earnings wiped out by non-recurring events.

Furthermore, comparable same-store sales growth, a key industry metric, was up 6.1 per cent. It achieved growth across its major flagships – Canadian Tire (7.1%), SportCheck (3.5%) and Mark’s (4.9%).

Outside of a negative headline, does this sound like a company that is struggling to you?

Shareholder friendly

The retailer is also returning excessive cash to shareholders via buybacks and a growing dividend. In November, it announced its intention to spend an additional $300-$400 million on shares for cancellation by the end of fiscal 2019. As of end of the first quarter, it has already repurchased $294 million.

There is one logical reason why its recently announced buyback has progressed so quickly; it views its shares as undervalued at today’s price.

The company is also a Canadian Dividend Aristocrat with an eight-year dividend growth streak. Canadian Tire currently yield’s 2.72% and it has one of the highest dividend growth rates in the country. Over the past three and five years, it has averaged 20% dividend growth.

It has a low payout ratio (33%) and the dividend is also well covered by operational cash flow (38%). Analysts expect earnings to grow by approximately 10% on average over the next few years. As such, the dividend has plenty of room to grow.

Is the stock mis-priced?

Ah, my favourite question. I think you know the answer as I alluded it to it in the introduction. Analysts have a one-year price target of $176.27 per share. At today’s price of $138.54 per share, this implies 27.23% upside. Even the lowest price on the street ($158), is well above today’s price.

Putting analysts thoughts aside, the retailer is trading at levels not seen in almost a decade. This is what makes the current opportunity so attractive.

Have a look at the F.A.S.T. Graphs below:

As you can see, Canadian Tire is trading well below its historical P/E average. The company has not been this cheap since 2011-12 and the financial crisis.

Price Targets

At a 10% growth rate, there is no reason for the company not to trade inline with its historical average of 13.8 times earnings. As such, we will use this as the base case approach. For the worst case, we will use the post-financial crisis low of 10.6, where it bottomed in 2011. As the best case, we will use the market standard of 15 times earnings.

To achieve our price targets, we will use the average 2019 earnings estimate of $12.74 per share. The company has a reliable history of meeting yearly analysts’ consensus. It has met or beat analysts’ one-year earnings estimates in five consecutive years. There is no reason to expect otherwise.

Worst Case

Base Case

Best Case

P/E

10.6

13.8

15

2019 EPS (estimate)

$12.74

$12.74

$12.74

Current Price

$138.54

$138.54

$138.54

Target Price

$135.04

$175.81

$191.10

Upside

-2.52%

26.90%

37.93%

For a stalwart such as Canadian Tire, it is rare to come across such an attractive risk/reward profile (1:8). There is very little downside at today’s prices. All the company has to do is return to trade inline with historical averages, and you are looking at a 27% gain. This just happens to be right inline with analysts’ estimates.

Risks – retail headwinds

There are several headwinds currently facing the retail industry. Ongoing trade wars between countries adds a number of uncertainties and if its goods are caught in the cross hairs, it could have a negative impact on margins.

Likewise, traditional brick-and-motor retailers such as Canadian Tire have come under fire by e-commerce. All traditional retailers are being forced to adapt and aggressively push e-strategies to combat the Amazon’s of the world. To date, the company has been successful in fending off competition, but it is a persistent threat that requires continuous innovation.

The third, and perhaps the greater imminent threat, is weather-related impacts. Canadian Tire’s first quarter results are a testament to the impact un-cooperative weather can have. Seasonal retailers such as Canadian Tire build their supply chain around anticipated seasons. Any shift in seasonality can have a big impact on quarterly results.

Weather-related risks are becoming increasingly frequent and volatile. As such, seasonal supply chain management is one of the biggest headwinds the company currently faces.

Conclusion

Canadian Tire’s performance speaks for itself. This is a retailer that has grown earnings and sales in the mid single digits over the past five years. It is expected to match, if not exceed this level of growth over the next couple of years.

If the company had a negative sales trend, I’d be concerned. However, this is not the case for Canadian Tire. In fact, it appears to be bucking the retail trend with strong comparable same store sales.

It is aggressively returning cash to shareholders through a safe and growing dividend. Since 2014, it has retired 21% of its shares.

At today’s valuation, Canadian Tire is one of the safest bargains in the market.

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Disclosure: I am/we are long CDNTF, CDNAF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.