Is Canadian Tire Corporation Limited Canada’s Best Retail Stock?

Canadian Tire Corporation Limited (TSX:CTC.A) has evolved into a truly excellent business.

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I spent much time working at a grocery store during my younger years. I then went back into the fray a few years later as a sales rep for a potato chip company. In total, I’ve got a decade of experience in the business and even more time as an observer of the sector.

My conclusion after all these years? Retail is a tough business.

Fixed costs are huge. Traditionally, real estate was a big cost as a retailer would acquire its locations. That attitude has thankfully changed, which frees up capital that can be put to work in the business. Competition is high as well, and not just from traditional sources. Amazon is the big threat, but there are dozens of other websites out there selling the same things that line store shelves.

Many investors look at these challenges and blindly decide to avoid the whole sector, a move I think is short-sighted. Sure, many of Canada’s retailers are struggling, but there are a select few that are killing it and look poised to continue that dominance.

Canadian Tire Corporation Limited (TSX:CTC.A) is one of Canada’s best retailers. Here’s why it’s poised to maintain its strong position for years to come.

Great brands

Canadian Tire’s management team has figured out something very important: it’s better to dominate a smaller niche business than be dominant in a larger segment of the market.

This philosophy has obviously influenced management’s acquisition strategy. Major acquisitions have included Mark’s, Sport Chek, and PartSource. Mark’s has a nice niche business supplying uniforms for people like oilfield workers and healthcare professionals, never mind its main clothing lines. Sport Chek is Canada’s largest sports equipment retailer, and PartSource has quietly become one of Canada’s largest auto parts supply stores.

Same-store sales at these brands are doing pretty well. Sport Chek led the way with an increase of 6.3%. Mark’s was weaker, showing a slight decline of 0.5%, much of which is due to the weakness in the energy sector. Same-store sales from Canadian Tire itself did fine, increasing 3.2%.

Financial services

Selling things to people might not be a great business, but financing those acquisitions sure is. Luckily for investors, Canadian Tire figured this out a long time ago.

The Canadian Tire credit card continues to be popular with Canadians, with total receivables going up 3.3% in 2015. Total revenue for the most recent quarter was $264.5 million from financial services, which translated to $80 million in income before taxes.

Compare that to the retail division, which did nearly $3.1 billion in total revenue for the same period, an amount that translated into $250 million in income before taxes. On a per-dollar basis, financial services is a much more profitable business than retail.

Most of Canadian Tire’s competitors are pure retailers. The financial services division is an important differentiation between it and others in the sector.

Dividend potential

Dividend-growth investors looking for businesses with the ability to raise dividends for years should be checking out Canadian Tire.

The current dividend is $0.57 per share each quarter, good enough for a yield of 1.6%. That represents a payout ratio of just 26.3% of trailing earnings, which is among the lowest in Canada. Even if earnings don’t continue to grow, Canadian Tire can still comfortably increase the dividend.

Analysts believe earnings will indeed grow, and quickly too. Expectations for 2016 are earnings of $9.31 per share, with 2017’s bottom line expected to hit $10.33 per share. If these predictions come true, it’ll represent close to 10% earnings growth–a nice result in a world where growth is becoming increasingly scarce.

Canadian Tire might not be Canada’s best retailer, but it’s certainly up there. It continues to do well in a tough business. I don’t see any indication of this trend coming to an end anytime soon.

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 has no position in any stocks mentioned. David Gardner owns shares of Amazon.com. The Motley Fool owns shares of Amazon.com.

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