Iconic Retailer Showdown: What's the Better Investment?

I’ve been taking a closer look at some of Canada’s big retail stocks lately.

There’s a few reasons. Firstly, valuations are looking pretty compelling, which has the other additional benefit of increasing the dividend yield. Many of these retailers have a demonstrated history of dividend growth and solid long-term performance. These companies also have very visible moats and many have successfully pivoted into other areas like financial services.

Also, both the retailers we’ll look at today have history on their side. Canadian Tire (TSX:CTC.A) has been around for 100 years this year, a fact their marketing department won’t let us forget. And North West Company (TSX:NWC) has been around since the 1600s, the second-oldest company in Canada after Hudson’s Bay. Both have a demonstrated ability to adapt as the market around them changes.

Without further adieu, let’s take a closer look at each and reveal which one I like better today.

Canadian Tire

Canadian Tire doesn’t need much of an intro. Something like 95% of Canadians live within spitting distance of a Canadian Tire store. The company has also made a few marquee acquisitions over the years, bringing brands like Sport Chek, Mark’s, PartSource, and Party City in house.

The company has been slowly building a vertically integrated business model, with approximately 40% of all sales soon coming from owned brands. A chain like Mark’s, for instance, has more than 60% of all sales coming from these owned brands. This is a big advantage, especially in an inflationary environment.

The company has also been investing heavily into its Triangle rewards program, which meshes really nicely with the banking division. Like with every loyalty program, CTC has discovered loyalty members spend more than non members. Some 11 million Canadians are Triangle members, versus about 33 million adult Canadians. This makes Triangle the second-largest loyalty program in Canada, trailing only PC Optimum. Additionally, Triangle has the advantage of being available at other Canadian Tire banners.

Banking is a big part of Canadian Tire’s business. In 2021, the company generated just shy of $19 per share in normalized earnings. Approximately 25% of that number came from the financial services division. Analysts are concerned about this, like they always are when the economy starts to turn.

Financial services are a key aspect to Canadian Tire’s overall strategy. Growing loyalty members means selling more of these folks a credit card. The company then collects data on these members, using that to offer them deals on things they already buy. The two basically go hand in hand, and credit card users give the company an outlook on the overall economy. That’s valuable info.

Management has gone on record saying they expect the overall strategy to lead to earnings growth. The company projects it’ll grow earnings to $25 per share by 2024. To put that into context, the stock trades at just $153.80 today. The market is either taking a short-term outlook on this company (the likely answer, IMO) or doesn’t have much confidence in the medium-term earnings outlook. Analysts project a little over $19 per share in 2023 earnings and approximately $21 per share in 2024, so they are expecting some growth. Just not quite as much as the company expects. Even if you don’t believe the earnings growth thesis, the stock trades at just 8x trailing earnings. The valuation is incredibly low.

Canadian Tire has also posted excellent dividend growth over the last decade plus. In 2010, it paid just $0.21 per share for a quarterly dividend. These days the quarterly payout is $1.625. That works out to an annual payout ratio of approximately 40% of earnings, which should translate into solid dividend growth going forward. It also means there’s virtually zero risk of the 4.2% dividend being cut.

I enjoy dividend growth, but I heart me a good share buyback. Canadian Tire has delivered over the years, with total shares outstanding decreasing from 81 million a decade ago to approximately 59 million today. It has repurchased some 2 million shares over the last year, and I’d expect management to announce another NCIB in November when the current one expires.

Here’s a graph of the share buyback over the last handful of years.

Canadian Tire has also posted solid long-term total returns, with the stock delivering a CAGR of approximately 10% per year since 2012.

North West Company

Canadian Tire has a solid moat, with a century’s worth of effort to get locations in the best spots. But I’d argue North West Company has it beat in this department, with this company building out stores in remote communities in Northern Canada, Alaska, and other such locations. Most of these communities simply aren’t big enough for competition to move in.

NWC did exceptionally well during COVID, as folks in remote communities were more isolated than the rest of us. Same-store sales rocketed up double digits, with those gains largely maintained today thanks to inflation. Recent results have shown food sales holding up with general merchandise sales decreasing. With Amazon offering free shipping to Prime members even in remote communities, I’d expect this part of North West’s business to continue to suffer.

One of the downfalls to North West’s business strategy is it doesn’t offer as much in growth potential. There are only a certain number of remote communities, and most people aren’t exactly clamouring to move to the coldest part of nowhere. This also makes it difficult for NWC to attract and retain staff.

The good part about the company’s business is it translates into both higher margins — which generally sit in the 5% range, much higher than other grocers — and higher returns on invested capital. NWC stores also offer other ancillary services like post offices and financial services. It’s a better business than most other retailers. But that doesn’t make it an exceptionally good business.

Canadian Tire has it beat on both share buybacks and dividend growth. NWC has delivered on the latter, with the annual payout increasing by approximately 3-4% per year over the last half decade. That’s about all you can expect. There’s been a token effort to buy back shares, but the number basically hasn’t budged since 2017.

Earnings growth has been solid, with the bottom line basically doubling since 2017 on a per share basis. COVID helped on this front, of course. Analysts are less bullish going forward, with EPS expected to decrease from more than $3 per share to the $2.50 per share range for fiscal 2023 and 2024. At the current $36 share price that translates into a P/E of 14-15x. That’s not bad — especially when compared to other grocers — but is basically double Canadian Tire’s P/E.

The bottom line

North West Company would be a solid choice for someone looking for a steady dividend without a whole lot of growth. I’m all for companies like that, but I’d like to pay a little less than 15x earnings for it.

Canadian Tire offers the better growth story at a much better valuation. Sure, it has near-term risks in banking and a slowing consumer, but the company is well prepared to thrive over the long-term. It has invested heavily in its online presence and is a major player in that part of retailing.

If Canadian Tire can achieve its target of $25 per share in earnings in 2024 and the stock trades at 15x earnings, we’re looking at a $375 stock in a couple years. That’s approximately an 150% return in 24-36 months, plus dividends. As for downside, I don’t see a whole lot. The worst case scenario is largely priced in today.

Disclosure: No position in either Canadian Tire or North West Company today, but will take a much closer look at Canadian Tire in the upcoming days.