Recently Pat McKeough responded to a Member of his Inner Circle who wanted his opinion on one of the biggest liquor store operators in North America.
Last month Liquor Stores NA closed a deal for a $103 million investment from Aurora Cannabis which the liquor operator will use to launch a series of retail cannabis outlets. As Pat points out, this deal comes in the wake of several challenges, including stalled growth in the company’s core market due to new provincial regulations, and a proxy fight the company lost to an activist investor.
Q: Good day, Pat. Would you give me your opinion of Liquor Stores N.A. Ltd. (TSE: LIQ)? Thanks.
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A: LIQUOR STORES N.A. LTD. (symbol LIQ on Toronto; www.liquorstoresgp.ca) is North America’s largest publicly traded liquor store operator, with 231 outlets. Of that total, 200 are in Canada—168 in Alberta and 32 in B.C. In the U.S., the company has 22 stores in Alaska, and one in Connecticut.
Liquor Stores’ banners include Liquor Depot, Liquor Barn, Brown Jug, Wine and Beyond, and Wine Cellars.
The company’s sales increased 4.9% from $630.1 million in 2012 to $661.0 million in 2013, and then 5.0% in 2014, to $694.2 million. Sales rose 7.5% to $746.4 million in 2015 and 9.6% to $817.7 million in 2016. Most of this growth was achieved through acquisitions in the U.S.
Earnings fell from $0.82 a share (or a total of $18.8 million) in 2012 to $0.49 a share (or $11.3 million) in 2013. They then improved to $0.54 a share (or $12.7 million) in 2014. Excluding one-time items, the company made $0.57 a share (or $15.7 million) for 2015, with earnings falling to $0.46 a share (or $15.1 million) in 2016.
In June 2017, activist investor PointNorth Capital won a proxy fight that saw six of eight members of the company’s board of directors replaced. The new board adopted a strategic plan for Liquor Stores, which abandons its strategy of growing sales through U.S. acquisitions and re-focuses on its core markets of Alberta, B.C., and Alaska.
The company has since negotiated the sale of 15 stores in Kentucky, 2 stores in New Jersey, and one in Connecticut. The company will close its U.S. head office, eliminating the need for U.S.-based executives.
Liquor Store expects that these transactions will cut its long-term debt by as much as $47 million. The loss of cash flow due to the sale of those U.S. assets should mainly be offset by the company’s savings in operating and administrative expenses.
For the three months ended September 30, 2017, Liquor Stores’ sales were down 2.1%, to $204.4 million from $208.8 million. Disregarding one-time items, including writing down its U.S. assets, the company made $0.14 a share. That’s 12.5% lower than the $0.16 a year earlier.
Liquor Stores’ long-term debt was $143.3 million as of September 30, 2017, or a high 43.3% of its market cap.
Growth stocks: Some existing liquor outlets will be converted to cannabis sales
The company has acknowledged that growth for its core Alberta business has stalled. The province’s laws regulating the minimum distance between liquor stores have been relaxed, which has added to the number of competitors.
To offset that, Liquor Stores has accepted a $103.5 million investment from Aurora Cannabis (symbol ACB on Toronto) in exchange for a 19.9% interest in the company. Aurora is an Alberta-based licensed producer of medical cannabis. With additional investments, Aurora can raise its interest in Liquor Stores to 40%.
Liquor Stores intends to use the initial proceeds to establish and launch a brand of cannabis retail outlets in Western Canada. To do that, it will convert some of its existing liquor retail outlets into cannabis retail outlets, but also establish new cannabis retail outlets. The Federal government is on track to legalize marijuana later this year. Alberta will permit sales in private retail stores. B.C. will sell cannabis in government-owned stores. Saskatchewan plans to permit the sale of cannabis in a limited number of private stores.
Liquor Stores will also use a portion of the proceeds to renovate some of its existing liquor store outlets.
The stock trades at 23.0 times Liquor Stores’ forecast 2018 earnings of $0.52 a share. The company pays a monthly dividend of $0.03 a share for an annual yield of 3.0%. In December it announced a fourth quarter dividend of $0.09 a share.
While the dividend payout adds appeal, Liquor Stores’ high debt, uncertain growth plans in a new area, and ongoing competitive pressures add considerable risk.
Inner Circle recommendation: We don’t recommend Liquor Stores N.A.
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