Canadian Tire updated August 20, 2017

Canadian Tire is updated and rated (higher) Buy at $151.46.

I had last updated Canadian Tire on April 1, based on its December 2016 annual results and rated it Weak Buy /Hold at $157.98. Since then it has released Q1 and more recently Q2 earnings which were very strong. On July 5, I mentioned it was worth nibbling on at $144. Given the strong earnings of the first half of 2017 it now appears to be worthy of a (higher) Buy rating (or at least Buy). I may not buy back into this name given that my cash position is relatively modest at this time.

Canadian Tire credit card customers pay a lot of interest

One of the interesting things I saw in the Q2 report is the following:

In the Finance segment, which is largely a credit card operation, the annual revenue as a percentage of the average accounts receivable was 22%. This suggests that the majority of these credit card customers are not paying off their balances each month. Rather, the Canadian Tire MasterCard customers mostly tend to run a balance. The average balance is $2761. This makes sense. The type of consumer who pays off their credit card monthly likely has a credit card from a big bank, often a gold card. The typical Canadian Tire credit card user is apparently not in a position to pay off the card monthly. These would be somewhat higher risk customers. In fact Canadian Tire writes off 5.6% of its credit card receivables yearly to bad debt.

The most lucrative credit card customer is the one who runs a balance and pays the 26% annual interest rate but who pays at least the minimum monthly and never defaults. These people are the bread and butter of the credit card industry. They don’t cost the card company in bad debt. They often don’t cause collection costs because they do pay the monthly minimum. Arguably it is unsavory to be charging these people 26% annual interest. But they incur these debts willingly and other credit card companies charge similar rates. I would advise these people to try to pay off these cards or to shop for a lower interest rate. But meanwhile Canadian Tire alone has 1.9 million such customers.

Customers who pay off their credit cards monthly are also profitable. The profits there come from the fees charged to merchants. But these customers are no where close to as profitable as those that run balances but pay monthly and never default.

Some customers do run up balances and eventually default. Credit card companies clearly lose money on these customers. It takes perhaps 5 to 10 good customers running balances and paying 26% interest to make up for every (average) customer that defaults. While Canadian Tire reveals that it writes off 5.6% of credit card receivables in a year it does not appear to reveal what percentage of the customer base that is. It is likely that some customers pay interest faithfully for years but then later default due to changed circumstances. The worst customer would be the new customer that runs up a balance and then defaults.