NEW YORK, Dec. 5, 2019 /CNW/ -- Report entitled "Kicking The Tire Down The Road" outlines how Canadian Tire Corporation ("CTC") faces 35-50% downside risk to approximately C$77 to C$100 per share. The full contents of the report can be reviewed at www.sprucepointcap.com. Spruce Point believes that Canadian Tire is a challenged brick-and-mortar retailer perceived as a dependable mid-single-digit grower on an increasingly precarious foundation of unsustainable debt and recent financial results dependent on aggressive accounting practices. We also believe the market has failed to realize multiple signals of financial stress.
- Mature Business With Growing Signs Of Strain: While Canadian Tire appears to participate in nearly every retail category, Canada's retail environment continues to become increasingly competitive as U.S. retailers expand in the market and offer lower cost, and free, shipping options. Our research shows CTC is not price competitive and is often located in close proximity, or sometimes in the same shopping center as, competitors. Canadian Tire store count continues to decline while competitors grow their footprints. The market is blissfully ignorant to the Amazon displacement effect that our data shows is accelerating. On CTC's most recent earnings call, management announced a new cost reduction effort. We believe this program is too little and too late and it cannot forestall CTC's inevitable decline. Our analysis illustrates that, based on the Company's current and projected financial situation, CTC may struggle to meet its capital return promises.
- Risk Of Credit Downgrade Due To Overleveraged And Misunderstood Balance Sheet: Multiple rating agencies have warned of a credit downgrade if leverage is not reduced. Our analysis supports the view it will be nearly impossible to delever while maintaining current levels of dividends and share repurchases without selling assets that could reduce earnings. Current leverage of ~3.5x is significantly above rating agency guidance of 2.5x needed to prevent a downgrade and requires debt reduction of ~C$1,600m, but CTC has no free cash flow after promised dividends and buybacks.
- Risky Credit Card Business With Rapidly Deteriorating Credit Card Portfolio: CTC Triangle Rewards Program has been an effort to boost retail sales and drive store traffic at the expense of higher risk lending practices. 68% of recent loan growth has come from moderate and high-risk customer classifications. Net charge-offs for "seasoned" loans, a leading indicator for an increase in future credit losses as loans begin to mature, is at historic highs despite the majority of high-risk growth occurring over the past 12 months. Relative to other Canadian banks, CT Bank delinquencies have performed worse over the past 2 years.
- Aggressive Accounting Practices Are Potentially Misleading Investors By Masking Poor Organic Earnings Growth: CEO Stephen Wetmore has commented on earnings calls about the importance of hitting numbers. Various one-time benefits including altered expected credit losses by modifying model assumptions, changed estimates affecting the present value of loss recoveries, and changes in its depreciation method, have allowed CTC to hit its 10% EPS growth target.
Despite these clear risks, the sell-side has only one sell recommendation on CTC and sees only 11% upside to C$167 in the next 12 months. We believe that investors will be surprised and disappointed by the risk to capital return plans and the poor underlying earnings growth of the business. Spruce Point sees 35% - 50% downside risk in CTC shares when each of these factors is considered.
Spruce Point Capital has a short position in Canadian Tire Corporation (CTC) and stands to benefit if its share price falls.
About Spruce Point Capital
Spruce Point Capital Management, LLC, is a forensic fundamentally-oriented investment manager that focuses on short-selling, value and special situation investment opportunities.
Spruce Point Capital Management
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SOURCE Spruce Point Capital Management, LLC