Vox

Rona forecast cloudy, despite sunshine ahead

The Globe and Mail

An employee price points at Rona at Dix30 in Brossard, Quebec on April 8, 2008. (Christinne Muschi/Christinne Muschi/ The Globe and Mail)

Okay, cold winter, late spring, that’s fair.

Home improvement products seller Rona Inc., said the weather was the primary reason for its first-quarter disaster: a loss of 13 cents a share, when analysts expected a 3-cent loss, and a same-store sales decline of 12.6 per cent.

“At the beginning of March, the whole company was set for a great spring season,” chief executive officer Robert Dutton said on the company’s quarterly conference call. “Unfortunately, spring did not show up.”

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Investors whacked nearly 8 per cent from Rona’s shares after the report earlier this month, and the stock has yet to recover. But bargain-hunting investors who want to give it a free pass on the recent results need to take a step back. Rather than a seasonal blip, Rona’s recent results may suggest longer-term challenges.

To be fair, poor weather was also cited as a factor by U.S. home-improvement behemoths Home Depot Inc. and Lowe’s Cos. Inc., each of which has a Canadian presence and significant operations in the northern United States, which also had a chilly spring.

Yet Lowe’s was able to report a same-store sales decline of just 3.3 per cent, while Home Depot came in at just 0.6 per cent down.

RBC Dominion Securities Inc. analyst Irene Nattel says Rona missed sales in the spring of 2010 when warm weather arrived early and key products hadn’t arrived in stores; to avoid the problem, the company advanced delivery of its springtime products this year, only to have them sit in stores unsold.

Bad luck, one supposes. But that’s caused an inventory buildup that has analysts concerned about the prospect of profit-crushing markdown sales in the coming months, something the company says isn’t likely to happen.

More troubling to analysts was how the weather-related sales issues have already created big profitability problems. The company incurred high labour costs from staffers who stood around with few customers to serve. Plus, says TD Securities analyst Jessy Hayem, Rona stepped up its sales promotions, “seemingly unsuccessfully,” further hurting profitability.

EBITDA, or earnings before interest, taxes, depreciation and amortization, fell 77 per cent, and its EBITDA margin dropped to 0.88 per cent from 3.63 per cent in the prior year’s first quarter.

Fixing the Problem

While the company had supposedly moved on from its “PEP” plan of productivity, efficiency and profitability to a more growth- and revenue-driven “New World” program, management announced a series of steps that will likely put a damper on the top-line gains.

The company plans to cut capital expenditures by $25-million, take “a more selective approach for acquisitions,” and engage in the “disposal of non-core land and assets,” which Ms. Nattel of RBC says includes land bought with an eye toward opening new locations. (Rona has just under 300 corporate and franchised stores, plus another 665 affiliated stores, some using the Rona name, that it distributes products to.)

At the same time Rona is retrenching, its U.S. competitors continue to eye Canada. Home Depot, which already had 179 Canadian stores in late January, said it expanded its gross profit margins in Canada in its most recent fiscal year. (It didn’t give a Canada-only number, but Home Depot’s companywide gross margin was 34.3 per cent last year, about five percentage points higher than Rona’s.)

Lowe’s, which had just 24 stores in Canada at the end of its last fiscal year in January, says about one-quarter of its 25 to 30 new locations this year will be Canadian.

How Cheap?

With the recent decline in price, Rona is currently trading at 12.3 times the current-year earnings-per-share estimate from Scotia Capital Inc. analyst Anthony Zicha, who notes that’s in line with the historical average. Mr. Zicha has a “buy” rating because 12 times his 2012 estimate is $15, a gain of more than 25 per cent from current levels.

It is however, much cheaper than Lowe's and Home Depot, which are priced at premiums of 36.5 per cent and 41.7 per cent, respectively, to Rona.

There is a reason for that: While Lowe’s recent results are seen as more of a temporary blip, and Home Depot is picking up steam, Rona risks posting its fifth consecutive year of declining earnings-per-share, notes Ms. Nattel of RBC. And, she adds, the recently closed first quarter was Rona’s fifth consecutive earnings miss.

Eventually, even here in Canada, the weather warms up. This summer, however, the heat will be on Rona’s management to deliver for investors.

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