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Warning: Consumer Discretionary Stocks Face Major Potential Problems

The state of the Canadian consumer in Canada continues to get worse. Rising consumer debt levels with only minimal GDP gains is an unsustainable problem. It seems like almost every week, new headlines about the Canadian consumer are everywhere.

In the last five years, Canada’s GDP has grown at a compounded annual growth rate of 1.52%. The rise in GDP has been driven predominantly by an increase in household consumption, which accounts for almost 60% of GDP. During that time, household debt to GDP increased from around 92% in 2014 to over 100% in 2019.

When the oil industry was hit in 2014/2015, the Bank of Canada was forced to lower interest rates to help relieve Albertans and get them access to credit. This helped slightly at the time but has also extended the credit cycle in Canada.

Unfortunately, because the conditions in Alberta have not really progressed, average non-mortgage debt levels in Alberta are the highest in Canada. Additionally, when the Bank of Canada lowered interest rates, it was experienced by consumers all across Canada. This has allowed consumers in provinces that were not really affected to continually take on very cheap debt.

The increase in debt loads on Canadians has been setting up a major problem for the economy. Not only has the massive amount of credit being spent really increased the money supply and driven inflation; It has also put Canadians into an all-time record high in regard to household debt to income.

Household debt to disposable income is now at a staggering 179%. It is no wonder why the average Canadian is spending almost 15% of their income on debt payments. Just last week, it was reported that almost half of Canadians are less than $200 away from insolvency. Meanwhile, more than half of all Canadians don’t have a plan on how to get out of debt.

This will prove to be a major strain going forward if consumption stops growing. Canada relies on consumption for a major part of its GDP. A reduction in spending by consumers to pay off debt or save will make it very difficult for Canada to continue to grow the economy.

Two companies that could be affected by a slowdown in consumer spending are Restaurant Brands International (TSX:QSR)(NYSE:QSR) and BRP (TSX:DOO)(NASDAQ:DOOO).

Restaurant Brands International

Restaurant Brands, the owner of Tim Hortons, Burger King, and Popeyes Chicken, faces a couple potential headwinds going forward. Firstly, with the rise in income lately, it has been starting to impact wage rates in Canada driving them higher. Restaurant Brands will have a hard time dealing with these higher wage rates, as that makes up a large majority of its costs.

Moreover, Restaurant Brands’s stable of restaurant franchises are all very consumer discretionary. This implies that a slowdown in discretionary spending by consumers as they pay down their debt or save will most likely impact sales numbers across the entire portfolio of brands.

BRP

BRP will also be impacted by a slowdown in consumer growth, but for different reasons. BRP designs and sells ATVs, side-by-sides, snowmobiles, and personal watercraft. These items mostly rely on financing for consumers to purchase. A slowdown in consumers taking on debt or a reduction in available credit by lenders could be a big issue for BRP.

The bottom line

Investors should tread carefully as Canada’s economic future has a lot of unknowns. Due to the high level of consumer debt, investors should pay close attention to the data coming out in the near future. It would be wise to avoid the consumer discretionary space for the time being.

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Fool contributor Daniel Da Costa has no position in any of the stocks mentioned. The Motley Fool owns shares of RESTAURANT BRANDS INTERNATIONAL INC and has the following options: short October 2019 $82 calls on Restaurant Brands International.

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