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Rona CEO Weighs 2013 Asset Sales to Revive Profit Growth

Rona Inc. (RON) will decide this year whether to sell big-box stores outside Quebec as Canada’s largest home-improvement retailer revamps after rejecting a takeover bid from Lowe’s Cos.

The chain is trying to boost profit 15 percent by cutting jobs and shrinking or selling underperforming units. Its review of “non-core” businesses, whose C$1.2 billion ($1.17 billion) in sales make up 25 percent of annual revenue, will be in “quarters rather than years,” acting Chief Executive Officer Dominique Boies said in a phone interview from Rona’s Boucherville, Quebec, headquarters.

Investors who forced out Boies’ predecessor last year are betting the strategy will succeed. Rona now commands a premium to Lowe’s, compared with a 10 percent discount Sept. 17, when the U.S. company withdrew its bid of C$14.50 a share. It also trades at a higher price-earnings ratio than the benchmark S&P/Toronto Stock Exchange Composite Index.

“We feel good about what’s happening,” said Michael Sabia, CEO of Caisse de Depot et Placement du Quebec, Rona’s largest investor. “It’s a tough sector, particularly in the current economic climate. All the more reason why you’ve got to double down, work hard and fast and get things done. Rona is in a turnaround situation. That demands moving quickly and getting the puck in the net.”

Boies, among the candidates for the CEO position, took the job on an interim basis in November after Caisse de Depot and another major stockholder, Invesco Canada, pushed out longtime chief Robert Dutton and engineered a board overhaul amid dissatisfaction with five years of declining profitability.

Trailing Estimates

The margin on Ebitda, or earnings before interest, taxes, depreciation and amortization, dropped to 4.1 percent last year, capping six straight years of declines. Rona’s market value fell 47 percent in the same period to $1.27 billion.

The retailer missed analysts’ earnings estimates in nine of the past 12 quarters, and some investors remain skeptical about the turnaround plan.

The stock fell 0.4 percent to C$11.43 at 11:30 a.m. today in Toronto, taking its decline since the plan was disclosed Feb. 21 to 5.2 percent. As of yesterday, Rona traded at premiums of 73 percent to Lowe’s and 67 percent to Home Depot (HD) as well more than double the price-earnings ratio of the S&P/TSX index.

Rona has to do “a rewiring of the organization, of the administrative functions, and we have to use this flexibility to reinvest in our value proposition to consumers and to dealers,” Boies said. “That’s what we are doing today. We probably lost focus over the years.”

‘Non-Core’ Units

Rona’s “transformational strategy” calls for cutting 200 administrative jobs and boosting Ebitda about 15 percent over two years. In addition to the big-box store network outside Quebec, Rona will consider divesting its commercial and professional division, which sells construction materials to contractors, Boies said. Scotiabank is advising the retailer, he said.

Increased earnings and freed-up capital from the “non- core” units would be reinvested in businesses such as hardware distribution and so-called proximity stores, Rona said. Proximity stores cover about 35,000 square feet on average, while big box stores can be five times as large, Rona said.

The company’s big-box stores in Ontario and Western Canada have annual revenue of about C$750 million, while sales in the commercial and professional division amount to about C$450 million, Boies said.

Deal Valuation

The latter business may fetch as much as C$160 million, Irene Nattel, an RBC Capital Markets analyst, said in a Feb. 18 note. Nattel, who has a sector perform rating on Rona, based the figure on typical Ebitda multiples paid for companies in the Canadian home improvement industry.

“Asset sales are pretty likely, definitely on the commercial and professional side,” Derek Dley, an analyst at Canaccord Genuity, said by telephone from Vancouver. “That’s not a very material portion of their business. It was an extension of their product offering a few years ago that they looked to go after, but clearly it hasn’t returned what they were hoping for.”

Rona may rise to as much as C$13 a share if the company makes “incremental” asset sales such as the commercial and professional unit, James Durran, an analyst at Barclays Plc in Toronto, said in a Feb. 22 note to customers.

U.S. Competitors

Evaluating those businesses, along with improving merchandising, pricing and in-store service, is part of Rona’s effort to fend off rivals such as Home Depot and Lowe’s. The Mooresville, North Carolina-based company has said it wants to supplant Rona as Canada’s largest home-improvement retailer.

The country’s $40 billion market offers “significant opportunity for growth,” Lowe’s CEO Bob Niblock told investors Dec. 5.

Lowe’s, which operates 34 Canadian stores may eventually have more than 100, Niblock said without specifying a timeframe.

Home Depot operates 180 outlets in the country, up from 165 in 2007, said Stephen Holmes, a spokesman for the Atlanta-based retailer.

That competitive pressure is one reason why Rona must “simplify” its business, Boies said. The company wants to improve merchandising, pricing and in-store service, while cutting the number of products it offers to focus on top-selling models, he said.

Limited Patience

Should asset sales occur, Boies said Rona has no plans to use the proceeds to buy back about C$117 million of outstanding debt. The company would probably return some cash to shareholders instead, he said.

The key for Rona will be to show results quickly, said Luc Fournier, a fund manager at Quebec City-based based Industrial Alliance Insurance Financial Services Inc. Fournier said his firm doesn’t own Rona stock because of “unfavorable fundamentals” in the home-renovation industry.

“They don’t have much time,” Fournier said in a telephone interview. “I don’t think people will be patient for three years. One more underperforming quarter and investors will be asking questions. 2015 is a long way away.”

A shrinking home-building market further complicates Rona’s plans. Housing starts are forecast to drop 11 percent this year while sales of existing homes also decline, Canada Mortgage & Housing Corp. said Feb. 22. The pace of new home construction fell to the slowest since 2009 in January, the federal housing agency reported Feb. 8.

Renovation Spending

A “challenging macro environment for renovation spending” is the first reason I.A. Michael Investment Counsel Ltd. sold its entire 3 percent stake in Rona last month, President Irwin Michael said in a Feb. 15 note to investors.

He also cited an expected C$25 million in restructuring costs and political obstacles to a takeover that would benefit investors.

Government and opposition politicians in Quebec joined together last year in a rare show of unity to slam the proposed sale of Rona to Lowe’s, citing the retailer’s “strategic” importance to the provincial economy. Lowe’s withdrew its unsolicited offer for Rona, which had refused to negotiate a friendly deal, in September, when Dutton was still at the helm.

The company will probably announce the name of his successor this month, said Boies, who was hired in August 2011 and previously worked with Royal Bank of Canada and the Caisse. He said he wants to be CEO on a permanent basis to carry out the strategy he helped create.

“I believe in this plan,” Boies said. “I put all my energy and my values into it, and I want to be here for the execution.”

To contact the reporter on this story: Frederic Tomesco in Montreal at tomesco@bloomberg.net

To contact the editor responsible for this story: Ed Dufner at edufner@bloomberg.net

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