Dollarama Inc. (TSX:DOL) is well known for its retail success. Its 30-year rise to a $25 billion retailer has been long hailed as one of Canada’s true success stories. In this article, I will discuss two iconic Canadian retail stocks, Dollarama and Canadian Tire Corporation Ltd. (TSX:CTC.A).
Consumer spending begins to shift
Consumer spending has been a big driver of economic growth in recent years. Today, with higher interest rates taking their toll, this is beginning to change. Given this, retail stocks face a more difficult and complicated future. I mean, the Bank of Canada’s key interest rate is at 5%. This is up from a mere 0.25% only two years ago.
Discretionary spending, in particular, is suffering. There’s simply not as much money as there used to be after consumers take care of their essential expenses, such as mortgage payments and food bills. There are many losers in this new environment, but as always, there are also some winners.
Dollarama
Stocks like Dollarama seem perfectly suited for this new reality. In fact, Dollarama sells a wide variety of products at price points of anywhere between $1 or less and $5. At these price points, shoppers will continue to shop at Dollarama stores even in difficult times. Moreover, a large portion of what Dollarama sells is consumables. These are day-to-day, essential living products.
Yet, I’ve still been a little surprised at just how resilient Dollarama is proving to be. In its latest quarter, the 3 months ended April 30, 2023, results were strong. Revenue increased 21% to $1.3 billion, same store sales increased 17%, and diluted EPS rose 29% to $0.63.
These results were driven by strength across the board. Simply put, Dollarama continued to benefit from sustained demand for affordable, everyday items. Yet, there was a clear sense on the call that management is worried about the remainder of the year and health of the consumer. As a result, their full year sales growth guidance implies comparatively weak sales performance for the rest of the year.
At this point, what we really need to know is what has happened in the quarter ended in July 2023. We will find out on September 13, but the pressures on consumer spending have only intensified. Despite this, Dollarama stock has continued to be unscathed this year. In fact, it’s up 8.6% so far, compared to most other Canadian retailers, which are down.
Besides the obvious risks due to the macro environment, another thing that concerns me with Dollarama stock is its valuation – 27 times this year’s earnings estimate. It has typically been a very highly valued stock, but in my view, this makes it especially vulnerable today.
Canadian Tire
Now let’s look at Canadian Tire. With one of the most recognizable brand names and almost $18 billion in revenue, Canadian Tire has an unrivalled position in the Canadian retail industry. In recent years, we’ve seen Canadian Tire transform itself into a more tech savvy retailer that has diversified its business.
On Canadian Tire’s second quarter conference call, management talked about how the “results mark a turning point in the economy”. A constrained demand environment has weakened sales, especially in discretionary items. This led to a mere 0.1% increase in same-store sales in the quarter and EPS that was slightly lower compared to last year.
The worse part is that the decelerating trends were worsening as the quarter progressed, with June being a really rough month. It’s so bad that the company withdrew its financial guidance as well as its long-term aspirational targets at this time. This is an alarm bell. It signifies the outsized risks to consumer spending at this time.
At least Canadian Tire’s stock has a much lower valuation than Dollarama stock. It’s trading at a mere 11 times this year’s estimated earnings, and the stock is 28% lower than its 2021 highs.
Final thoughts
At this time, I favour Dollarama stock. Despite its rich valuation, I think that the business has proven to be a very resilient one. This macro economic environment will drive many new customers to Dollarama stores in the hopes of cutting down on their expenses.
