By GABRIEL LOWENBERG. Special to The Globe and Mail, Published Monday, May 6th, 2013.
When Canadian Tire Corp. Ltd. reports earnings this Friday, you can count on the usual debate about whether the retailer matched earnings and revenue expectations, and whether the stock looks cheap or expensive based on its current valuation.
Unfortunately, it’s a debate that misses a key part of the picture.
As my Bay Street mentor, Ira Gluskin, once said, valuation is the weakest argument for buying or selling a stock, because anyone can look up a stock’s price-to-earnings ratio and its return on assets. You won’t spot many bargains by fixating on what everyone else is looking at.
A better way to evaluate a stock begins by examining the embedded competitive business advantage that a company either has or doesn’t. That advantage represents a de facto moat around the corporate castle – a barrier that either prevents customers from leaving or impedes the competition’s ability to steal customers. With such an advantage, a company can effectively overprice its services without alienating its client base – the key to creating excess returns for its shareholders.
I believe Canadian Tire has a big and enduring moat around its business, which is why the stock (CTC.A) makes up a significant portion of many of my clients’ portfolios.
The retailer is under-appreciated in North American capital markets, given its size (more than 1,700 retail and gas station outlets), sales (2012 gross revenues in excess of $11-billion), and the hidden real estate value it has yet to unlock.
Canadian Tire may not have the sex appeal of other retailers, but its choice locations in prime areas of many Canadian cities – and the sheer scale of the business – yield a clear competitive advantage.
What holds for buying real estate – location, location, and location – also holds for retail operations, especially for the large box stores that Canadian Tire controls. Some 90 per cent of Canadians live within 15 minutes of a store, making it easy for them to shop at the retailer.
The real estate those stores sit on is worth billions of dollars, but the full value is not reflected on the balance sheet, in my opinion.
Here is my math: The retailer owns approximately 70 per cent of its real estate, or nearly 20 million square feet of selling space under the Canadian Tire banner. That figure excludes storage and distribution facilities and its other retail formats. If we add another 25 per cent in sq. ft space for other retail, storage and distribution facilities, you get about 25 million sq. ft of owned space.
Assuming a blended average rent of $12 per square foot, that 25 million square feet equals $300-million per year paid to Canadian Tire by lessees. We can value that cash flow by using a “cap” rate of 6.1 per cent – the rate of return that an owner of a property would expect to derive from the property.
On that basis, Canadian Tire stores and distribution facilities have a value of nearly $4.9-billion ($300-million divided by 6.1 per cent). That, as it happens, is very close to the $5-billion (including fixtures, land and improvements) that the company says is the cost of its real estate assets.
But here’s the interesting thing: The retailer’s annual report says net book value for all its real estate is just under $3.5-billion, after depreciation.
I find it hard to believe that this portfolio managed to decline in value in the past 15 years, while all other real estate assets were climbing handsomely.
The difference between the $3.5-billion carrying cost of the real estate and the $5-billion apparent value that I arrive at is $1.5-billion.
After debt, that translates into almost $20 per share in hidden value – value that has yet to be unlocked by management for the benefit of shareholders.
The current share price does not properly reflect the value of these real-estate assets.
Skeptics maintain that Home Depot, Wal-Mart and Lowes will eventually crush Canadian Tire, because consumers will be willing to drive 40 minutes to these outlets, despite the traffic, and walk 400 yards from their car to the store. I say consumers will settle for a shorter drive and less inconvenience, where they can reliably get what they need in short order. Location, location, location.
If I’m right, Canadian Tire’s share price will creep to $100 per share over the next two years.
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