May 16, 2015 Canadian Tire

Canadian Tire is updated and rated Buy at $133.55

It just released earnings which were exceptionally strong in terms of same-store sales.

We have been rating it a (lower) Buy since last year (May 10, 2014 at $111.29). It has done better than I would have expected. Prior to that we were rating it in the Strong Buy range in 2011, 2012 and 2013 including at just $52.40 in August 2011.

In Q1 I expected that earnings would suffer due to the fact that it sold 20% of its lucrative credit business to Scotia Bank effective October 1, 2014. That did occur to some degree and after adjusting for gains on real estate sales adjusted earnings per share were down 8% on the quarter. (The company however did not adjust for this and claims earnings per share were flat and some analysts appear willing to overlook the drop in earnings due to this sale in any case). I also worried that with the sharply lower Canadian dollar this company which imports most of its goods was going to have to raise prices or see profit declines. However this does not seem to have happened probably due to currency hedging. Possibly, some of the same-store sales rise was simply due to price increases rather than volume but the company has not indicated that such is the case. The company has not revealed the extent to which it is hedged and has alluded to the fact that its buyers can somehow largely offset the currency impact but has not explained how.

I was a bit hesitant to raise this to a Buy but the same-store sales growth does support a higher rating. Possibly we were too conservative in our rating over the past year.

Keep in in mind that stock has almost doubled from where it stood in early 2013 when we rated it a (lower) strong Buy at $68.65. The price had not done much for several years and then started a steep rise in early 2013 which has continued. I suspect that the big money has now been made. It represents 5.1% of my portfolio. I find myself with mixed feelings about how well the stock has done because it once represented over 20% of my portfolio and I sold most of it too quickly on the way up.

While the stock does seem to merit a Buy rating there are some risks in terms of the lower Canadian dollar and possible higher credit losses on its credit card operation.