A New York-based firm with a history of shorting TSX-listed stocks made Canadian Tire Corp. its latest target on Thursday, outlining the challenges the company faces in its “antiquated” retail stores and in eliminating its debt.
In a report, Spruce Point Capital Management argues that Canadian Tire’s issues begin at the retail level, where it faces a threat from Amazon.com Inc. and is at a disadvantage due to its higher prices, lack of free shipping and “old-fashion promotion” strategy, which relies on fliers and Canadian Tire money.
As short sellers, we look for companies with challenged business models and bad balance sheets
Spruce Point founder Ben Axler
Spruce Point believes that Canadian Tire is saving face by making its earnings appear better than they actually are with “accounting tricks.”
But that struggling retail narrative isn’t unique to Canadian Tire. What makes the situation more pressing, the report argues, is the company’s over-leveraged balance sheet.
“As short sellers, we look for companies with challenged business models and bad balance sheets,” Spruce Point founder Ben Axler said. “In the case of Canadian Tire, the debt has been rising, and in fact, there doesn’t seem to be a complete understanding of how much debt the company has.”
In an emailed statement through a spokesperson, Canadian Tire disputed the report’s findings.
“We do not agree with the conclusions in this report, as it contains numerous inaccuracies, which we believe are solely intended to benefit its author,” the statement read. “It would be extremely unfortunate if investors took action based on the report.”
In September, Canadian Tire reported having $7.9 billion in debt. Axler argued that when factors such as lease liabilities, dealer loan guarantees and third-party bank guarantees are added, that number rises to above $11 billion and eclipses the retailer’s market cap.
According to the report, both Moody’s and S&P have warned Canadian Tire that it could downgrade its credit ratings should it fail to deleverage itself. Its management has a goal to reduce leverage to 2.5x by the end of 2020, and to do so, Axler said, would require the company to pay off $1.6 billion.
Axler doesn’t believe they have enough money to deleverage themselves without selling off assets.
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“We think the company has no excess cash to pay down debt because they’ve committed it all to buybacks and dividends,” Axler said. “If you take their cash flow, less their capital requirements, less these contractual payments they have to make, less the payments of the buybacks and the dividend, you’re left a deficit of almost $400 million.”
The business’s bank division puts Canadian Tire at an even greater threat, Axler said, because its credit card customers are higher risk lenders. According to the report, Moody’s warned Canadian Tire this year that the bank could experience higher-than-peer losses during economic stress because of this.
A combination of its debt problems and credit risk could lead Canadian Tire to insolvency if a recession were to occur, Axler said, although he doesn’t know if or when one is coming.
That leaves Canadian Tire in a lose-lose situation, he said.
“It’s a theme we’ve seen where Canadian companies want to ignore the debt load and keep investors happy with dividends for too long when they should be focused on debt reduction and thinking two to three years out,” he said.
Last year, Spruce Point published short reports on two TSX-listed companies in Maxar Technologies Inc. and Dollarama Inc. In the wake of those reports, Maxar’s stock entered a tailspin that saw it plunge nearly 90 per cent in seven months, while Dollarama lost 20 per cent in six weeks before a quick comeback.
Spruce Point isn’t the first notable short seller to announce a position against Canadian Tire. In August, Steve Eisman, best-known for being featured in the movie The Big Short, said he had a short position in the company due to its exposure to Canadian credit markets.
Canadian Tire shares were down about three per cent at $146.46 in Toronto in afternoon trading on Thursday. Spruce Point suggests in their report that shares could fall between 35 and 50 per cent to a low-side target of $77.