Retail-focus Stocks With Long-term Appeal

It’s easy to enter the retail industry, and easy to go broke in it if your business concept fails to build and maintain a loyal clientele. However, the industry provides highly rewarding investment opportunities if you stick as we do with well-established companies that have strong brands and other hidden or little appreciated assets.

Canadian Tire is a good example. Its famous “Canadian Tire Money” and big new stores continue to encourage repeat visits.

Loblaw has stumbled lately, but its recent setback follows a dozen years of huge gains. Investments in new inventory systems and unique food products should help it thrive again.

RioCan is a real estate investment trust, but many of its tenants are among Canada’s top retailers. Its low-rise power malls have huge expansion potential, particularly since higher population densities help cities cut traffic congestion and pollution.

CANADIAN TIRE CORP. $79 (Toronto symbol CTC.A; Conservative Growth Portfolio, Consumer sector; Shares outstanding: 81.5 million; Market cap: $6.4 billion; SI Rating: Above average) operates 468 retail stores that specialize in automotive, household and sporting goods. It also operates gas stations, casual clothing stores (Mark’s Work Wearhouse) and auto parts stores (PartSource).

Most of the company success in the past few years is due to a major upgrade of its stores that made them more attractive to shoppers. Thanks to this plan, income before unusual items in the first quarter of 2007 grew 24.2%, to $0.82 a share from $0.66. Revenue rose 5.9%, to $1.8 billion from $1.7 billion.

These re-modeled stores now account for 78% of Canadian Tire’s total chain. The company now plans to base all of its new stores on its Concept 20/20 format, which features better lighting and wider aisles than its older store designs. The format is also more flexible, so local store managers quickly replace slow-selling goods with faster-selling merchandise.

Customers tend to remain in Concept 20/20 stores about 40% longer than they did in the older store format. That helps explain why same-store sales at Concept 20/20 stores rose 6.6% in the first quarter, compared with 1.3% for the overall chain.

Canadian Tire continues to expand its financial services division, which now accounts for 10% of its total revenue. Besides loyalty credit cards, the company offers mortgages, personal loans, insurance and savings accounts. Canadian Tires cuts its credit risk by selling up to 80% of its loans to third parties.

The stock trades at 16.1 times the $4.91 a share it should earn in 2007. The $0.74 dividend yields 0.9%.

Canadian Tire is a buy.

LOBLAW COMPANIES LTD. $50 (Toronto symbol L; Conservative Growth Portfolio, Consumer sector; Shares outstanding: 274.2 million; Market cap: $13.7 billion; SI Rating: Above average) is Canada’s largest supermarket operator, with over 1,500 stores under several banners including Loblaws, No Frills and Provigo.

In the past few years, Loblaw has re-modeled many of its stores to handle a wider selection of non-food merchandise, such as clothing and household goods. The company felt these moves would help it compete with Wal-Mart, which is now carrying more grocery items in its stores.

As part of the plan, Loblaw also restructured its warehousing and distribution, but this is taking longer than forecast and has led to shortages at some stores. Loblaw now plans to cut its non-food merchandise, and streamline its inventory systems.

If you exclude restructuring costs, Loblaw earned $0.46 a share in the three months ended March 24, 2007, down 14.8% from $0.54 a year earlier. Sales rose 3.3%, to $6.3 billion from $6.1 billion, while same-store sales grew 2.4%.

Strong price competition, particularly in Ontario and Quebec, has forced Loblaw to cut prices. That will hurt the company’s ability to hit its sales growth targets for 2007. It will take Loblaw several more months to complete its restructuring, but the savings should help it compete over the next few years.

The stock trades at 19.3 times the $2.59 a share it should earn in 2007, but its earnings are depressed due to restructuring costs. The $0.84 dividend is probably safe, and yields 1.7%.

Loblaw is a hold.

RIOCAN REAL ESTATE INVESTMENT TRUST $25 (Toronto symbol REI.UN; Aggressive Growth Portfolio, Manufacturing & Industry sector; Units outstanding: 208.0 million; Market cap: $5.4 billion; SI Rating: Average) manages over 200 retail properties in Canada. It specializes in big-box style outdoor malls with plenty of parking space.

RioCan is slowly cutting its exposure to pure retail properties. For example, it recently formed a joint venture with two seniors housing REITs to build a new mixed-use complex in Mississauga, Ontario. It’s also building a retail/residential development in Toronto.

The trust recently completed the largest acquisition in its history. In February 2007, it paid $223 million for a major office/retail complex in midtown Toronto. Thanks to strong growth in the surrounding neighbourhoods, RioCan feels that the retail component of this complex (25% of total area) will become a major contributor to its future cash flow.

To put the purchase price in context, RioCan earned $0.18 a unit (total $37.4 million) in the first quarter of 2007, down 10.0% from $0.20 a unit ($39.0 million) a year earlier. Revenue rose 9.6%, to $174.5 million from $159.2 million.

RioCan is focusing its future development on six high-growth markets — Toronto, Ottawa, Montreal, Calgary, Edmonton and Vancouver. These six cities account for roughly two-thirds of RioCan’s revenue. Although land costs more in these markets than other areas, RioCan feels their strong growth prospects offset the higher building costs.

RioCan’s $1.32 distribution yields 5.3%, and the units trade at 17.0 times its forecast 2007 profit of $1.47 a unit.

RioCan is a buy.