3 Canadian Retailers to Avoid (and 2 to Buy)

Canadian retail is a tough business. Here are some companies to buy and to avoid.

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It’s a tough time to be a Canadian retailer.

Canadian consumers are essentially tapped out. Our debt-to-disposable-income ratio left 160% in the dust a few months ago, and continues to slowly tick higher. This is one of the highest ratios in the world, much higher than our neighbors to the south.

Canadians have increasingly borrowed to purchase houses. Our homeownership rate has surpassed 70%, and many words have been written about our expensive housing market. If you combine that with wages that are, on a whole, staying flat after inflation, you don’t have a very positive situation for the Canadian consumer. Here are three retailers feeling the pinch as a result.

Target

Last spring, Target (NYSE: TGT) opened up the first of the company’s 127 stores in Canada. Its hopes were high. Canadians who regularly shopped at the company’s stores in the United States were excited for a similar shopping experience within their own borders. Customers were looking forward to Target’s unique mixture of cheap, yet fashionable, items.

And it was a disaster.

Shelves were perpetually empty, and a year later, things haven’t really improved that much. My visit to a local Target store confirmed these reports. My visit also saw significantly more traffic in the Loblaw (TSX: L) store just down the road. Target continues to lose more than $200 million per quarter on its Canadian expansion. And even though a big chunk of its Canadian stores have been open for more than a year, the company still doesn’t release same-store sales numbers.

All of this culminated with the head of Target’s Canadian business losing his job this week. If the company can’t turn around its struggling Canadian stores, it could just decide to shut the whole operation down.

Sears Canada

Another company struggling with sluggish sales is Sears Canada (TSX: SCC), which, at least in this writer’s opinion, isn’t likely to survive another five years.

It has essentially been an ATM for its parent, Sears Holdings (NYSE: SHLD), which holds 51% of the company. Sears Canada has spent most of the past few years selling off most of its valuable real estate, giving shareholders two special dividends in the meantime.

These special dividends are just a distraction from an underlying business that’s in terrible shape. Recent revenues fell more than 11%, and its net loss more than doubled to more than $0.70 per share. It’s little wonder that its parent recently announced that it was putting up Sears Canada for sale.

But who’s going to buy it? It has already sold off its valuable real estate. All that’s left is a shrinking company struggling to stay afloat in a very competitive retail market. It’s unlikely that suitors are going to line up to buy Sears Canada.

Rona

If Canada’s real estate market starts to fall, shareholders in Rona (TSX: RON) will likely see a huge decline in the price of the company’s shares. Canadians just won’t spend money on renovations if there’s any sustained real estate weakness. Building activity will slow as well. Who wants to build a house in a falling market?

Even now, the company is beginning to show cracks. Recent same-store sales have been negative, and the company’s last quarter showed a net loss. Rona is responding by closing non-performing stores, but that won’t be enough if the real estate market really hits the skids. The company’s Quebec stores have been particularly weak, as the underlying economy in the province continues to show weakness. Quebec is Rona’s largest market.

Two retailers to like

It isn’t all bad news for Canada’s retailers, though. There are two that I’m bullish on.

The first is Empire Company (TSX: EMP.A), the parent company of Sobeys and Safeway. Empire is trading at near a 52-week low, has a forward P/E ratio of less than 15 times, and should be able to continue cost-cutting on its new Safeway acquisition. Empire’s shares are much cheaper than those of its competitors. It also should be able to grow its dividend substantially in the future since its payout ratio is so low.

The other retailer I like is a longer-term turnaround play, Reitmans (TSX: RET.A). The company’s shares are heavily owned by its management (which has a track record that spans several decades), and it continues to make money even during the middle of its turnaround. The company’s balance sheet is rock solid, with no debt and almost half its market cap in cash. It’s well prepared to weather these difficult times, while some of its competitors will be forced to close up shop.

The company is trading at close to a 10-year low, making it a terrific buy at these levels if you believe in the turnaround.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Nelson Smith owns shares in Reitmans. 

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