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Reitmans' dominance helps it take on retail sector's hurdles Add to ...

From smart, affordable officewear to softly ruffled maternity outfits, Reitmans (Canada) Ltd. sells more women's specialty apparel than any other Canadian retailer.

But it hasn't done a very good job selling investors on its stock. Sales have grown about 12 per cent over the last five years, profit has risen 11 per cent and cash levels have almost doubled, allowing a dividend payout of 4.4 per cent - and that is likely to increase this year. Yet, the share price is 12-per-cent lower today than it was five years ago, making the stock look like a shrewd buy for savvy shoppers.

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Analysts praise the 85-year-old retailer's brand, its management and its dominant market position, achieved with seven banners that include Penningtons, Addition Elle and Thyme Maternity. But the weak economy has made the last few years challenging for the retail sector, which now faces a new set of constraints as the recovery takes hold. Rising wage inflation in China, where much apparel is manufactured, and increasing commodity prices, such as cotton and oil, are adding to companies' costs.

All these factors have weighed on Reitmans stock. And the company faces an additional challenge that concerns investors: Competition from larger international rivals who are expanding into Canada, spurred by a relatively healthy Canadian consumer and low barriers to entry. The new arrivals include U.S.-based Forever 21, H&M of Sweden and Zara of Spain. The U.S. discount giant Target Corp. plans to open its first stores in Canada by 2013.

"These are serious competitors," says Neil Linsdell, an analyst with Versant Partners Inc. in Montreal. "Don't make the mistake of down playing them."

He is expecting Reitmans' revenue to be essentially flat when the company posts year-end results on Wednesday, thanks to lingering caution among shoppers. "I'm not too excited about the fourth quarter," he admits.

Yet longer-term investors are likely to be impressed by the pricing power and cost-cutting advantages that come with Reitmans' leadership position.

It's Cheap

Mr. Linsdell, who rates the shares a "buy" with a 12-month price target of $22, says he has more confidence for the current fiscal year. Revenue should rise by almost 5 per cent, and, even more importantly, earnings before interest, taxes, depreciation and amortization (EBITDA) should continue their gains, he says.

Reitmans' EBITDA margin of 15.8 per cent last quarter should rise to 17.7 per cent for the full year, which represents one of the strongest margins in the business. U.S. retailers average just 11 per cent and the average for Canadian merchants that he follows is 8 per cent, Mr. Linsdell says. When Reitmans shares are valued based on EBITDA margins, they are inexpensive compared with the rest of the sector, he adds.

The Montreal-based retailer manages to keep costs low with economies of scale. It operates almost 1,000 stores across the country, which gives it bargaining power with landlords and a consistent customer base. It also has a well-tuned supply chain, assisted by a purchasing office in Hong Kong that helps keep the company closely connected with local suppliers.

These characteristics have helped Reitmans through recent trying economic times. But along with the rest of the retail industry, the company faces a new challenge of passing higher costs on to its consumers. During its last quarterly presentation in December, Reitmans warned about the effects of rising cotton prices. "A recent surge in the price of cotton to record-high prices along with a significant shortage of supply is anticipated to place strains on certain product margins," it said.

John Morris, an analyst with BMO Nesbitt Burns Inc., warns that "a pall of uncertainty hangs over the retail sector in the face of impending price hikes." Clothing merchants are starting to raise prices on the racks for the first time in 20 years to offset spiralling wage and materials costs, and they don't know how consumers will react, he says.

'Smoke And Mirrors'

"Retailers are likely to be stealthy in how and where they raise prices," he wrote in a report this month. They will likely create a "smoke-and-mirrors effect" to mask hikes, offering compelling pricing through coupons, in-store signage and e-mail offers.

His research suggests that many retailers have already begun pushing up prices, not because they have to but because they want to test consumer reaction before the fall shopping season.

In this environment, Mr. Morris is cautious about Reitmans' fortunes, questioning how the merchant will spur growth and manage cost pressures. He downgraded the shares to "market perform" after the company missed third-quarter earnings expectations, and has a price target of $17 on the stock.

Mr. Linsdell, however, sees both internal and external growth opportunities for Reitmans in today's challenging environment. Three of Reitmans' banners are still relatively small. Smart Set, RW & Co. and Cassis offer the best growth potential within the company, while acquisitions remain a likelihood for driving further expansion, he says.

He cites Boutique Jacob Inc., which received court protection last fall, as one firm he thinks chairman and chief executive officer Jeremy Reitman is interested in at the right price. The lingerie retailer La Vie en Rose, partially owned by Caisse de dépôt et placement du Québec, is another potential target, he adds.

Reitmans hasn't offered much insight into its acquisition strategy. But the company points to several ways it is trying to stay ahead of the competition and seed further growth. These steps include making significant investments recently in store expansion and renovations, IT system enhancements and an upgrade to its merchandising and supply chain operations.

Key Numbers:

Latest nine-month revenue: $800.8-million

Year-over-year increase: 1.6 per cent

Latest nine-month profit: $75.6-million

Year-over-year increase: 42 per cent

Stores: 979

Dividend yield

Common (RET/TSX): 4.8 per cent

Class A non-voting (RET.A/TSX): 4.4 per cent

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