3 Stocks to Buy Instead of Roots Corp.

Roots Corp. (TSX:ROOT) went public at a pretty fancy valuation. Here are three alternatives that won’t break the bank.

| More on:

They say the devil is in the details.

Roots Corp. (TSX:ROOT) raised $200 million in its IPO by selling 16.7 million shares to the public at $12 per share. Also, the selling shareholders have given the underwriters up to 30 days after the IPO’s closing date to buy an additional 2.5 million shares on a pro-rata basis, also at $12.

It’s important to note that the company won’t receive any of proceeds from the IPO — a real red flag, in my opinion, when it comes to public offerings. But that’s not even the biggest reason I believe investors should steer clear of Roots stock for the foreseeable future.

The most significant reason for me is that despite its stock being priced at $12, $3 below the midpoint of the targeted range of $14-16, its enterprise value is $624 million, or 14 times its adjusted EBITDA of $45 million.

I can think of at least three Canadian retail stocks (in order of preference) that have a similar valuation and that will be better investments over the long haul.

I’ve said this on more than one occasion, but there is no better Canadian retailer than Lululemon Athletica Inc. (NASDAQ:LULU), which has managed to sidestep the slowdown in retail by product innovation and a CEO focused on the long term.

Barron’s recently featured an article contributed by MKM Partners, a U.S. research firm, that called LULU an outlier in an otherwise terrible retail industry.

“We believe only Lululemon Athletica (rated at Buy, $75 price target) and Coach (COH) (rated at Buy, $59 price target) have radio-frequency identification (RFID), which we view as critical for managing inventory seamlessly across channels,” wrote MKM Partners on October 23.

Lululemon wants to hit $4 billion in revenue by 2020; it’s well on its way. Why buy Roots stock when you can have the best Canadian retailer for about the same valuation and a much stronger balance sheet?

LULU’s enterprise value is 15.2 times its 12-month trailing EBITDA of US$503 million.

In the value and small-cap play of the bunch, I have to go with Indigo Books and Music Inc. (TSX:IDG), whose enterprise value is 4.6 times EBITDA. If CEO Heather Reisman isn’t careful, her private-equity husband (Gerry Schwartz) will make an offer she can’t refuse.

I recently called Indigo the one retail stock to buy before the holidays, and now that I look more closely at its valuation, I’m glad I did. Indigo is a company that just doesn’t get the respect it deserves. Growing at a pace that isn’t much different than Roots, it has better EBITDA than Roots, and like Lululemon, a better balance sheet.

Its stock is one of the better values out there.

Lastly, despite the difficulties Canadian Tire Corporation Limited (TSX:CTC.A) is having growing sales at the legacy brand — 1.4% same-store sales growth in Q2 2017 — the rest of its business is humming along nicely. Mark’s had 4.6% same-store sales growth through the first two quarters of the year and $342 in sales per square foot contributing nicely to the retail segment’s $397 million in EBITDA.

The top line might not be growing at double digits, but the bottom line comes close not to mention it has a decent dividend payout.

Canadian Tire’s enterprise value is just 10.7 times EBITDA making it a better value than Roots.

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 Will Ashworth has no position in any stocks mentioned. 

More on Investing