Reitmans Limited: A Neglected Retailer With Significant Upside Potential by Mazi Ume, MaziValue
Note: This article was published on 12/14/2015. All dates and prices mentioned in the article refers to that period. Also, Purchasing is possible in U.S. Dollars (USD) on OTC Markets, or on the Toronto Stock Exchange (TSE) in Canadian Dollars (CAD). For liquidity purposes, I will be buying in Canadian dollars on the TSE. So, all figures listed are in Canadian Dollars, unless otherwise noted. Current USD price is $2.94, and CAD price $4.05 (12/14/2015).
Real Time price: RET.A 4.57 +0.10 2.24%
In April, Li Lu and Bruce Greenwald took part in a discussion at the 13th Annual Columbia China Business Conference. The value investor and professor discussed multiple topics, including the value investing philosophy and the qualities Li looks for when evaluating potential investments. Q3 2021 hedge fund letters, conferences and more How Value Investing Has Read More
|Purchase Price: $4.05 (12/14/2015)||Market Capitalization: $256 million|
|Price Target: $8.10||Enterprise Value: $128 million|
|Upside: 100%||TTM EV/EBITDA: 2.1|
I had mentioned earlier that I was going to expand into the international markets after finding out that I could buy stocks on foreign exchanges with Interactive Brokers. Reitmans is my first victim.
Reitmans (Canada) Limited (OTCMKTS:RTMAF) (TSE:RET.A) is a Women’s specialty retailer, and the largest specialty retailer of plus-sized apparel. The company operates 775 stores under 7 brands:
- Reitmans – Largest women’s apparel specialty chain in Canada.
- Penningtons – Trend-right styles at an affordable price.
- Addition Elle – Latest “must-have” trends with a focus on quality and fit.
- RW & CO – Urban apparel for both men and women.
- Thyme – Maternity focused offering casual, work and nursing fashion accessories.
- SMARTSET – Latest styles in women’s fashions to mix, match and innovate from wear-to-work separates, denim, essentials and accessories.
- Hyba – Affordable activewear and yoga clothes for exercising.
Weakened Smart Set brand
On November 25, 2014, the company announced plans to close all Smart Set stores. The Smart Set branded stores had underperformed for a few years. For fiscal year 2014, Smart Set Incurred losses of $29.5 million, and $10 million for fiscal year 2015. Smart Set revenues for fiscal year 2014 and 2015 were only $95,764 and $88,856. Total Sales for 2015 came in at $939,376 with a net income of $13,415. The abysmal performance of the Smart Set brand over the past few years has offset the solid performance of the other brands. This spurred the price chart you see above.
Falling Crude Oil Prices
The stock has been beaten down this year as a result of the gross margin compressions. The margin compressions are a derivative of the (CAD:USD) exchange rate, the Canadian Dollar’s weakness is a derivative of crude oil prices (WTI Crude Oil prices will be used in this article), which has fallen over 60% since mid-2014. 25% of Canada’s exports is Crude Petroleum, Refined Petroleum, and Petroleum Gas. So, low crude Prices = Weak Canadian Dollar. Reitmans imports 80% of its inventory and settles the transactions in U.S. Dollars, and since most (over 90%) of its operations are in Canada, it sells the inventory in Canadian dollars. They are forced to sell the goods at a lower price than they purchased them, so low crude Prices = Weak Canadian Dollar = Low Reitmans gross margins. The company hedges only 60% of this exposure through FX option contracts.
Strengthening U.S. Dollar
U.S. Dollar to Yen, Pound, Euro, Yuan, and Canadian Dollar (December 2013 – 2015) (Source: Google Finance)
The slowdown in global economies from China’s real-estate bubble, the other three BRIC nations, to weakness in Europe and Japan has sent capital flying to the ‘Safe Haven’ United States. This has also propped up the U.S. Dollar against other major currencies, playing a protagonist role in the inventory issues I mentioned above.
Reitmans Limited – Stock Price Headwinds
The tax-loss selling phenomenon, where investors unload the losing stocks to offset the capital gains for their best performing stocks is also prevalent in Canada. The deadline for selling this year is December 25th. This is because in order for the trade to count for 2015, it has to be settled in 2015, and it takes a few days to settle the trades. The selling pressure should subdue after this date. The ‘January effect’ will most likely be temporary, unless one of the below catalysts fires up.
Catalysts For A Higher Stock Price.
Base Case: U.S. Dollar Stabilization
Reitmans has agreements similar to forward/futures contracts with suppliers where Reitmans agrees to buy inventory ahead of time for xx U.S. Dollars on xx date. As you can see in (Chart 4) below, the inverse relationship between the USDCAD currency pair and the stock price is a result of the higher gross margins Reitmans’ enjoys from a stronger Canadian Dollar as a result of higher crude oil prices. The transaction between Reitmans and its suppliers is settled in U.S. Dollars. Stabilization of the U.S. Dollar, alone, should drive Reitmans back to profitability, because they will no longer have to climb uphill battle of buying an expensive currency with a weak one. In fact, Reitmans enjoyed its best years of profitability from 2003 to 2010, when the price of crude oil surged from $19 to 140, crashed, and then the subsequently recovered as a result of the depreciation of the U.S. Dollar during the Great Recession. The stock went from $3.85 to $25.3 over 4 years, for a staggering CAGR of 60%. We are looking at the same setup here.
Inverse Correlative relationship between Reitmans’ stock price and the USDCAD currency pair.
It gets better – Bull Case: Higher Crude Oil and a Declining U.S. Dollar
So, how likely is a stabilization of the U.S. Dollar? History tells us that a decline is even more probable. The current United States business cycle is already longer than 29 of the previous 33 economic expansions. That is statistically significant. The Strong U.S. Dollar is already hurting U.S Wholesalers, and inventories are piling up (Chart 5).
So what happens when the Fed raises interest rates? It strengthens the U.S. Dollar, making U.S. goods less attractive to the international markets. With almost every other Central Bank devaluing their currencies or lowering rates, this will likely increase the inventory pileup. Higher inventory levels means lower future profits. The United States will most likely go into a recession on some deflationary pressures, and with $18 Trillion in debt and counting, the Federal Reserve will then be forced to pullback the rate hikes and revert to ZIRP. Negative interest rates like the European Central Bank has chosen to do, is a possibility as well. Also, some of the rate-hike anticipation is already built into the USD. If the Federal Reserve, in the near future, decides to revert this decision and move rates back to ZIRP and start QE4 or something along those lines, it could bring the dollar back to earth. That is the best case scenario for Reitmans.
Inverse correlative relationship of the USD/CAD pair and WTI Crude Oil.
WTI crude oil hovers at multi-year lows around $37.6/barrel, it bottomed around $31/barrel in 2009. We can see in the chart below (Chart 5), once crude oil bottomed, the Canadian Dollar took off strengthening against the USD, bottoming around 0.95 CAD/USD in 2011 from a peak of $1.36 CAD/USD in 2009. 25% of Canada’s exports, as I mentioned earlier, is petroleum crude (et al.). USDCAD pair is inversely correlated with the price of crude oil (Chart 5) for that reason. I’m not one to speculate on where oil supply will come from next or where it will be cut from. crude oil trades at rock bottom prices right now, and is likely to only go up from here. U.S. Shale supply will decrease going forward. OPEC won’t play ball, and they know this now. Although total oil production for Canada will most likely decline going forward as OPEC picks up market share and as production reverts to the mean to match Canadian consumption, oil prices will still be integral to the Canadian economy. This means that we are very likely to see a stronger Canadian dollar within the next 24 months (by 2018) as oil trends higher. Also, crude is sold in U.S. Dollar, in the event of a decline in the value of U.S. Dollar, crude oil will trade ‘higher’.
A stronger Canadian dollar equates to higher gross margins for Reitmans, since they source their inventory from China, and settle the transactions in U.S. Dollars. In the FY ending 01/2009 (U.S. Recession), Reitmans generated 70 million in Free Cash Flow (FCF), paid out $50 million in Dividends, repurchased $8 million worth of shares. In the FY Ending 01/2010, Reitmans generated $113 million FCF, paying $49 million in dividends, and repurchasing $40 million worth of shares, returning $90 million to shareholders. It gets better. In FY ending 01/2011 Reitmans generated 147 Cash Flow From Operations (CFFO) and $100 million in FCF, paying out $50 million in dividends, and repurchased $30 million worth of shares, returning $80 million to shareholders. CEO is clearly shareholder friendly. This is a company whose enterprise value is only $128 million! The company only pays a 5% right now, but that should increase as the operations improve since management plans to payout 50% to 75% of Cash Flow from Operations (CFFO). This is deep value at its finest, I will skip competitor analysis for that reason.
Smart Set shut down. Hello, Hyba.
We have had higher oil prices, however, Reitmans has been in decline for the past 4 years. Smart Set has been the catalyst behind that, and management is almost done fixing the problem. Smart Set losses fostered the gross margin decline prior to the 2014 crude oil woes and the sinking Canadian Dollar. Management announced that they were going to completely shut down the Smart Set Brand. They have closed down most of them so far, and plan on converting the rest of them into Hyba, the newly introduced fitness brand, or one of the other brands mentioned above. There is a fitness craze sweeping across the millennial demographic right now, and Reitmans is in the perfect position to take advantage of that. Management can leverage current distribution channels, as well as the targeted demographics of plus-size women to sell Hyba products. The brand has the potential to replace the losses from Smart Set with incremental profits. Management expects to close the Smart Set chapter by January 2017.
The Fundamentals are surprisingly sound.
Reitmans reported Q3 earnings on December 3rd.
Q3 Sales Increased 0.8% despite management’s shutting down of 8% or 65 stores. Comparable store sales were up 7.6% of course. E-commerce sales up 72.2% (minuscule percentage of Sales). Gross Margins were hit, again, by the strong dollar and decreased 8.6% to $138 million with a net loss of $291 thousand.
Sales for the YTD fiscal year were $695.0 million, a y/y decrease of 1.2% from 703. Primarily due to the closures of the Smart Set stores. Same store sales increased 3.9% with total number of stores increasing 1.3%. E-commerce sales increased 77.7%. Gross profit decreased $25.9 million or 6.1% to $397.3 million as compared with $423.2 million for year to date fiscal 2015. The CADUSD pair was responsible for 70% of the decrease in gross profits. My guess is that the some of the unaccounted decrease in gross margin can be attributed to the closure of the Smart Set stores, and the discounted inventory being sold at fire-sale prices, and the remainder, to the weak retail environment. Inventories Q/Q are up 15%.
Cash Balance and Employee Stock Options
With $150 million in cash/equivalents, and no cash burn, Reitmans is well capitalized to weather the crude oil and weak retail storm. FCF TTM sits at $6.3 million despite the headwinds. Management also paid out $12.8 million in dividends (about 5% on today’s price), bought back repurchased $5 million worth of shares, and paid $1.8 million towards the minuscule mortgage debt.
Another positive is that 3.9 million shares have been issued to the employees as stock options. The weighted average exercise price for these options is $9.6. The current share price is 42% of that price at 4.05. Management has every incentive to get the stock price above the $9.6 level.
I did run my Discounted Cash flow model on this, with very reasonable assumptions (5% profit margins terminally, for ex.), I arrived at a value of $12.15 or 200% above the current price. Peak profit margins were 10.8% in 2008, which I believe is a possibility again, since Smart Set will be fully shutdown over the next 12 months, and the Canadian Dollar will most likely trend higher as oil goes higher. In order to keep this brief, I will just tag on a conservative 2.5x 2008 peak EBITDA of $210 million for a target market cap of $525 million / price target of $8.1 / 100% upside. I will happily ride the momentum train when it comes, however. Time frame for this to play out is 24 months.
Mazi Ume is a recent college graduate with a passion for investing. His blog mazivalue.com offers free investment theses to its readers. He tracks his performance through interactive brokers with the goal of beating the market. He has been successful thus far in 2016, posting a positive return picking small cap stocks while the Russel 2000 and S&P 500 indexes bleed red.