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Canadian Tire Seeks Savings Ahead of Target Arrival

Canadian Tire Corp. Ltd. (CTC/A), the country’s largest auto-parts and sporting-goods retailer, is planning to wring savings in contract talks with store dealers as competition looms from U.S. discount chain Target Corp. (TGT)

The Toronto-based company is negotiating with its 489 franchisees before the current accord expires on July 1, 2014, and as Target sets to open its first stores in Canada next year. Canadian Tire, which says 50 percent of Canadians shop in its stores each month, declined to discuss details of the talks or the existing contract.

Operating costs equaled 31 percent of Canadian Tire’s sales in 2011, compared with 20 percent for Minneapolis, Minnesota- based Target and 19 percent for Bentonville, Arkansas-based Wal- Mart Stores Inc. (WMT), Mark Petrie, an analyst at CIBC World Markets, wrote in a note Oct. 9.

“Looking at 2011, we estimate that the gap to Wal-Mart and Target would have been roughly C$950 million in operating expenses,” for Canadian Tire, according to Petrie.

Efficiency is going to be a bigger and bigger topic for the Canadian retailer, which sells auto parts, small appliances, hardware and sporting goods, Petrie said in a telephone interview from Toronto.

“Canadian Tire has significant opportunities in terms of improving its operating efficiency,” and a renegotiated dealer contract is among them, Petrie said.

Target’s northern expansion will reduce Canadian Tire’s sales by 1 percent as its faces increased competition in housewares, apparel and seasonal merchandise, Jim Durran, a Barclays Plc analyst wrote in an Oct. 1 note.

Supply Chain

Canadian Tire, which has 1,700 retail and gasoline outlets across the country, disagrees with Petrie’s estimate, said Chief Financial Officer Dean McCann. Canadian Tire’s operating costs are not comparable to Target and Wal-Mart because the latter two include grocery segments and are U.S. companies, he said. Against comparable Canadian rivals, McCann said he’s “very comfortable” with Canadian Tire’s performance.

Negotiations with dealers on supply chain and administration could result in savings, McCann said. Those “are things, as a team -- between the corporation and the dealers -- we can work together to reduce costs,” he said in a telephone interview.

Canadian Tire acts as a wholesaler to dealers, who order products they think will sell best. Stores at Wal-Mart, the world’s largest retailer, and Target are controlled by the corporation.

Dealer Input

The structure means Canadian Tire consults with dealer committees for major decisions, making it harder to remove underperforming dealers, and provides an incentive for dealers to order a surplus of sale merchandise and sell the extra at regular price after the sale ends. That increases margins at the company’s expense, Petrie said in his note.

If the dealers allowed the company to streamline its supply-chain by giving up some control, Canadian Tire could reduce costs, Petrie wrote.

McCann said Canadian Tire won’t reduce dealer autonomy because it’s an advantage having an independent entrepreneur with knowledge of the local market making decisions for each store.

“Any perceived inefficiency is far outweighed by the opportunities, and the proof is in the pudding, we’re still here,” he said. “It’s been extraordinarily effective.”

Canadian Tire will look for cost savings in the new contract, McCann said. There are already mechanisms for removing underperforming dealers, he said.

Ron Baugh, executive director of the Canadian Tire Dealers’ Association, referred questions on the negotiations to the company.

Cost Savings

The last negotiation in 2007 produced as much as $20 million in extra pretax income that the company projected will grow to as much as C$100 million by 2014, according to a Canadian Tire statement at the time. The company didn’t disclose the source of the extra income.

“One of the advantages of Canadian Tire has been the very strong dealer organization in that the dealers have a proprietary interest in their store,” said Stephen Jarislowsky, chief executive officer of Jarislowsky Fraser Ltd., the largest owner of Canadian Tire’s non-voting Class A shares. “You can’t piss off your dealers but you also have to be on top of the pricing.”

Canadian Tire had average revenue growth of 20 percent in the last four quarters and reported about C$3 billion in revenue in the second quarter, for a profit of C$134 million, or C$1.63 a share. Annual revenue growth at Canadian Tire will slow to 1.5 percent in 2013 after Target’s arrival, compared with projected growth of 9.9 percent this year, according to a survey of analysts by Bloomberg News.

Stock Performance

Canadian Tire rose 1.5 percent to C$71.56 at 4:20 p.m. today in Toronto. The shares have gained 8.6 percent this year through yesterday, lagging the 13 percent rise in the Standard & Poor’s/TSX Consumer Discretionary Index. Three-month implied volatility, a measure of expected volatility in the stock over the next three months, has risen to about 19 percent from a low of 15 percent on Aug. 24.

About 60 percent of Canadian Tire’s voting shares are controlled by Martha Billes, daughter of A.J. Billes, who founded the company with his brother in 1922 in Toronto, and her son Owen, the company said in its March 15 proxy circular.

Canadian Tire Corporation Dealer Holdings Ltd., a unit separate from the company which manages dealers’ shares, owns 20.5 percent of the voting stock, the circular said.

Store Expansion

Both Target and Wal-Mart are eroding the advantages of the dealer system as they use more precise market research to build knowledge of individual stores, and adjust pricing accordingly, said Alex Arifuzzaman, a partner at Toronto-based retail consulting firm InterStratics Consultants Inc. and a former financial analyst at Canadian Tire.

When Wal-Mart first entered Canada in 1994, Canadian Tire maintained revenue growth by adding stores, boosting total retail square footage to 30 million by June of this year from 7.1 million, Canadian Tire said. That avenue won’t be available this time, said Arifuzzaman.

“In the past they were able to address the increased competition by growth, by increasing the store network, making the pie bigger for Canadian Tire,” he said. “But now that is not the case, growth is not at the level it was in the past, so that’s the only way they can do it, through operational cost savings.”

To contact the reporter on this story: Ari Altstedter in Toronto at aaltstedter@bloomberg.net

To contact the editor responsible for this story: David Scanlan at dscanlan@bloomberg.net

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