Morningstar | Despite a Sluggish Second Quarter, Our Outlook for Canadian Tire is Intact; Shares Expensive
Soft second-quarter results should lead to a low- to mid-single-digit percentage cut to our CAD 154 per share valuation for no-moat Canadian Tire, but the results do not much alter our long-term view (low-single-digit revenue growth, 13% adjusted EBITDA margin on average for the next decade). Our reaction is more muted than the shares' high-single-digit percentage swoon after the news largely because we had been relatively pessimistic about near-term earnings. Still, we believe the shares are expensive given intense competition that underpins our no-moat rating.Year to date, Canadian Tire posted 3% revenue growth against an 11% normalized adjusted EBITDA margin (our 2018 marks, 5% and 13%, respectively, include the Helly Hansen acquisition that closed in July). While the firm's 3% retail revenue growth in 2018 meets our full-year target, lower-margin petroleum inflows were up 15% and non-fuel revenue rose less than 1% (Canadian Tire's 34% retail gross margin year to date dwarfs its 9% petroleum mark). Still, we are encouraged that management cited cold April weather as the main source of the slowdown, with a double-digit monthly sales slide yielding to improvement in May and June (leading to a 1% second-quarter revenue uptick at Canadian Tire, 2% increase at Mark's, and a modest 2% dip at FGL).
We expect Triangle Rewards, the firm's revamped loyalty program and associated credit card, to boost traffic while providing valuable customer behavior data but are skeptical that the program will materially alter the firm's long-term prospects relative to its peers. With retail switching costs negligible, we expect shoppers will continue to look primarily to product brands rather than seller banners, particularly with digital competition increasing. So, we expect intense competition to persist; supporting this view, management cited competitors' addition of distribution centers in Canada, which we believe presages continued attention from digital and physical rivals.
Canadian Tire Corporation comprises three main business operations, which provides a range of retail goods and services. Co.'s three main business operations are: Retail, which is conducted through a number of banners, including Canadian Tire, Canadian Tire Gas (Petroleum), Mark's, PartSource, and various FGL Sports banners; CT REIT, which is a real estate investment trust engaged in owning, developing and leasing commercial properties; as well as Financial Services, which markets a range of Canadian Tire-branded credit cards, insurance and warranty products and processes credit card transactions with respect to purchases made in Canadian Tire associate stores and Petroleum outlets.
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