Cheap Sofas Offer Port as Oil’s Crash Slams Canada Stocks

Updated on

The search for shelter in Canada’s oil-scarred equity market is taking investors into the discount-shopping aisles.

Shares of retailers including Leon’s Furniture Ltd., which brought the big-box concept to Canada in 1973 with its sprawling showrooms of sofas and mattresses, women’s clothier Reitmans Canada Ltd., and Dollarama Inc. are surging as oil sinks to the lowest since April 2009, dragging Canada’s benchmark index to the worst three-day start to a year since 2007.

Three trends are converging to fuel stock gains for the discounters, investors say: Consumers are saving on fuel and spending at the malls, a lower currency is keeping them at home where their money stretches further and investors are broadening their search for value beyond better-known retailers such as Hudson’s Bay Co.

“If you’re saving money at the gas pump you’ll go out and buy more clothes,” said Bruce Campbell, fund manager at StoneCastle Investment Management Inc. in Kelowna, British Columbia. His firm manages about C$100 million ($84 million), including shares of Alimentation Couche-Tard Inc. and Dollarama.

Those savings could amount to billions for consumers, according to a report from Royal Bank of Canada. A 30 percent drop in crude prices results in about an 18 percent discount at the pump, said Paul Ferley, economist at RBC.

Crude, which first slumped into a bear market in October, has fallen 55 percent from a June high to settle at $48.79 a barrel in New York today.

Based on first-half 2014 spending of about C$48.5 billion on gas, that results in as much as C$8.9 billion staying in Canadians’ wallets, Ferley said.

Spending Boost

“Importantly, this increase in spending does not require households to take on additional debt,” he said in the Jan. 5 report. “In fact, the assumptions above actually imply an increase in the share of disposable income. Households are able to purchase a greater volume of goods and services with the same amount of money.”

While it will take time for the effects of these savings to trickle down into the broader economy, companies like Reitmans and Leon’s are also taking steps on their own to streamline their businesses and improve profitability, Campbell said.

“It’s starting to show up on our radar screens,” he said. “It looks like they’re trying to be more attractive, they’re cutting back on stores and might be able to generate a better bottom line.”

Reitmans in November began closing 107 underperforming Smart Set stores and rebranding some of them, following net reductions of another 55 stores in its second quarter.

Corporate Improvements

The Montreal-based retailer subsequently posted adjusted earnings of 20 Canadian cents a share in the third quarter, almost double the 11-cent average analyst forecast, the first time Reitmans has beaten expectations in a year. Profit more than doubled to C$12.9 million from C$5.8 million a year ago as gross margin improved.

The company also introduced a stock buyback in December, and has rallied 38 percent from a December low. By comparison, the benchmark S&P/TSX Consumer Discretionary Index has risen 2 percent in the same period. Messages left with Chief Executive Officer Jeremy Reitman weren’t returned.

Leon’s, which operates about 300 stores across Canada under various brands including Leon’s and The Brick, has now topped earnings estimates for two straight quarters, the second time it’s beat expectations in 16 quarters, according to data compiled by Bloomberg. The stock is up 15 percent since Dec. 1.

Advertising Hooks

Both Leon’s and Reitmans have highlighted their working-class appeal in advertising campaigns in the past. Canadians are familiar with Reitmans’ long-running “Designed for real life” campaign, featuring fashion designer caricatures lampooning impractical haute couture compared with the company’s more basic offerings.

Leon’s is still working on synergies following its completion of its 2013 acquisition of The Brick, as well as installation of a new computer system that will provide greater efficiencies over the next 15 months, the company said.

“What you’re seeing at the same time is consolidation, and you will continue to see that,” said Stephen Gauthier, chief investment officer at Fin-XO Securities Inc. in Montreal. His firm manages about C$650 million, including Jean Coutu Group Inc., Couche-Tard and North West Co., a retailer in rural communities.

Dollarama, which surged to a record on Dec. 29, is up 10 percent since Dec. 3 after completing a stock split in November. It is on track to open 70 to 80 net new stores in 2015, Larry Rossy, chief executive, said after the company’s third-quarter earnings.

Staying Home

The Canadian dollar, which has dropped 8.9 percent against its U.S. counterpart over the past year, appears to be also keeping shoppers at home. Canadian trips to the U.S. dropped 5.5 percent to a seasonally adjusted 4.38 million in October from year-ago levels, while same-day car trips fell 8 percent in the same period, according to Statistics Canada data. Conversely, travel to Canada from the U.S. rose 1.3 percent, the data show.

Martin Pelletier, managing director and portfolio manager at Calgary-based TriVest Wealth Counsel Ltd., said investors are at risk of chasing past performance if they pick up these types of retail stocks now at expensive prices.

“Buying at these levels is worth exercising some caution,” he said. “You have to look at the growth potential and the risks.”

The price-to-earnings ratio of Reitmans has jumped to a record 139 times earnings this year from about 30 at the beginning of 2014. Valuations for the consumer discretionary benchmark topped the broader S&P/TSX Composite in October and the spread between the two reached the widest since 2009 at the end of the year, according to data compiled by Bloomberg.

Bigger retailers such as Hudson’s Bay, Loblaw Cos. and Metro Inc. have also been surging over the past year amid uncertainty for commodity stocks which makes up about 33 percent of the broad index.

There is still better value in “less cyclical” well-run retailers than in the uncertainty enveloping commodities and financials industries, said Fin-XO’s Gauthier.

“As long as natural resources don’t do well, and we’re starting to see pressure on banks, that’s suddenly half the market that’s out of favor,” Gauthier said. “Now investors have to sell their stocks and then they buy into what? One area is retailers.”