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Home improvement stocks back in vogue
As I have mentioned in the past, every economic cycle looks a little different, and trying to thread the needle from an investment perspective is an exercise in futility. That being said, thus far, the recovery process seems (in North America, at least) to be relatively typical, despite a few bumps along the way. If you subscribe to this theory, and believe that the Canadian economy is indeed on the mend, then consumer discretionary stocks should be at the forefront of your portfolio. Take Rona Inc. for example, a Canadian retailer and distributor of hardware, home improvement and gardening products. Also a recent addition to the portfolio of one John Bragg via the shares he received as partial payment for his coveted Pierceys stores. Notwithstanding Mr. Bragg’s ownership stake, Rona, to me, stands out as a high-quality bet on the Canadian home improvement space, which has faced significant economic headwinds over the past 18-24 months. Despite these headwinds, Rona has persevered well, and is emerging from the carnage in great fundamental condition. The company has grown largely via acquisition over the years, and follows a pretty standard corporate-franchise-affiliate model, in that they own some stores outright, partner with franchisees for others, and rely on affiliates 100 per cent for others. This translates into a Tim Hortons-like business model, or a three-legged stool, comprised of retail profits, royalties and distribution income. Rona has also invested appropriately in maintaining and expanding its asset base over the years, and possesses a modern store footprint and national distribution network. Within Canada, it is currently one of the largest players in the industry. The industry is still fragmented, however, with numerous local and regional businesses competing for market share. Ironically, if you want exposure to this space, Rona is one of the few ways that it can be attained. Most of its competitors are either privately owned, U.S.-based (Lowes, Home Depot), or diversified conglomerates. For this reason, Rona has been rumoured to be a takeover target itself from time to time. In 2010, I expect that the company will have a significant earnings tailwind, attributed in large part to the economic recovery. There is some concern that the home renovation tax credit (which is now gone) artificially boosted sales last year, but if you go back to 2006-07, it was clear that the economic headwinds they faced in 2008-09 likely more than offset this. For example, in 2006, Rona had earnings per share (EPS) of $1.65 and $1.63 in 2007. In 2009, Rona earned $1.19, even with the renovation tax credit in place. Furthermore, management has forecasted EPS to grow in the order of 10-15 per cent for fiscal 2010, from a base of $1.19 in 2009. The mid-point of its forecast would peg EPS at $1.33 for the current year. Given that the company compounded its EPS at a rate of 25 per cent (double the mid-point of its current EPS growth forecast) from 1996 through to 2006 (the last peak), I have comfort in these numbers. Rona has historically generated a return on equity of 15 per cent (10-year average), which is high for a Canadian stock and impressive, given its robust book value. Book value, by the way, is $13.50, which is not much lower than where the shares trade today. At the end of 2009, Rona had debt of around $200 million, only 1.5 times net earnings. Against this, the company also held more than $400 million in real estate (buildings and land) and generated free cash flow north of $150 million. Currently, Rona doesn’t pay a dividend, but that could change soon. Jonathan Norwood is a vice-president and portfolio manager with Louisbourg Investments. In the interest of full disclosure, Louisbourg owns shares in Rona on behalf of some of its clients. source: http://thechronicleherald.ca/Business/1189066.html |
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