CANADIAN TIRE CORP. $50 (Toronto symbol CTC.A; Conservative Growth Portfolio, Consumer sector; Shares outstanding: 81.6 million; Market cap: $4.1 billion; Price-to-sales ratio: 0.5; SI Rating: Above Average) operates 476 stores that sell automotive, household and sporting goods. These account for around 60% of the company’s revenue, and 45% of its earnings. Canadian Tire also owns other retail chains, including 374 Mark’s Work Wearhouse casual-clothing stores, 274 gas stations (many have car washes and convenience stores) and 87 Part-Source auto-parts stores.

Mainly on the strength of its store renovations, Canadian Tire’s sales rose 29.2%, from $7.1 billion in 2004 to $9.1 billion in 2008.

Earnings jumped 43.1%, from $3.53 a share (or a total of $291.5 million) in 2004 to $5.05 a share (or $411.7 million) in 2007. The retailer’s 2008 earnings fell to $374.2 million, or $4.59 a share, because of writedowns of currency hedging contracts and gains on the sale of property and equipment. Without these non-recurring items, the company would have earned $572.5 million, or $4.85 a share.

Canadian Tire plans to build on the success of its store renovations with two new retail concepts. The first, called “Smart stores,” features layouts that make it easier for the company to move faster-selling seasonal merchandise to prominent areas in the store. This quick response to changes in local tastes and buying patterns should help Canadian Tire maximize its sales and profits.

Smart stores also devote more space to household staples, including foods like milk, bread, eggs and frozen dinners. This should help lift sales and encourage repeat visits to the stores.

Smart stores generate higher sales

Based on early tests, the Smart stores have generated same-store sales that are 6% to 8% higher than before the conversion. The company currently has four Smart stores, and plans to convert 35 more to this format.

Canadian Tire calls its second new store concept “Small Market.” Designed for smaller rural communities, these stores are about a quarter of the size of a Smart store. Like Smart stores, they focus on high-volume items. Many will also include a gas station and a Mark’s clothing outlet. So far, Canadian Tire has opened five Small Market stores. It plans to open four more by the end of the year.

Aside from these new store concepts, Canadian Tire recently opened a new $240-million distribution centre near Montreal. This facility should make make it easier for the retailer to quickly ship merchandise to its stores in Ontario, Quebec and eastern Canada. The new distribution centre will also let the company close two smaller ones.

The company’s financial-services division has been another area of growth over the past few years. This business mainly issues Canadian Tire-branded MasterCard credit cards, but it also offers personal loans, residential mortgages and savings accounts. Last year, this division accounted for 9% of Canadian Tire’s revenue, but 35% of its earnings.

Credit crisis increases risk

To cut its risk, Canadian Tire typically sells its credit-card receivables to third parties. However, demand for new securities backed by credit-card loans has dried up because of the credit crisis. This has forced Canadian Tire to hold on to these loans, at least until conditions improve. However, strong demand for Guaranteed Investment Certificates and high-interest savings accounts should continue to give the company enough cash to keep making loans for now.

Canadian Tire’s customers seem to be embracing its cards; the company’s credit-card receivables rose 3.7% in the first quarter of 2009 from a year earlier, thanks to a 5.8% rise in average balances.

However, the recession and rising unemployment mean fewer people are paying their bills on time. This prompted Canadian Tire to write off 6.52% of its credit-card loans in the quarter, up from 5.83% a year earlier. In an attempt to contain these losses, the company has cut credit limits and raised credit-card interest rates. These measures should help keep these write-offs between 5% and 6% of all of its loans.

When the economy rebounds, Canadian Tire may look to sell or spin off its finance division. This would let it focus on retailing, though it would probably keep a small part of the division so it could participate in any future growth at less risk.

Real estate is an overlooked asset

Canadian Tire is also unlocking more of its value by making better use of its real estate. It originally paid a total of $2 billion for these properties, so they’re probably worth more today.

Last year, the company sold and leased back 13 stores. That generated a $66.8-million gain. It still owns over 70% of its stores, so there’s plenty of opportunity to do more of these deals.

The stock trades at 12.2 times this year’s forecast earnings of $4.09 a share. That’s low considering that the company owns one the best-known brands in Canada. Its famous “Canadian Tire money” loyalty program also continues to attract new shoppers. Moreover, its stores are less than a 15-minute drive for 90% of the Canadian population. All of these factors give it a big advantage in the highly competitive retailing industry. The $0.84
dividend yields 1.7%.

Canadian Tire is a buy.