It has been a tough couple of years at home-improvement retailer Rona Inc. , as evidenced by the name of its new strategic plan: “New Realities, New Solutions.” Companies at the top of their industries generally have more optimistic slogans available to them.
Unfortunately, the company seems to have rejected another possibility: “We are for sale.” Because a sale seems to offer one of the best possible ways for Rona to unlock shareholder value.
This is not just idle chatter. Rona shares showed signs of life last week after the chief financial officer of U.S. giant Lowe’s Cos. Inc. , asked about a purchase of Rona, said he was open to all options and that Rona is a “very interesting company.”
Rona quickly put out a statement in which it said it is not for sale and “it is not presently of the view that a combination with another corporation would be in the best interests of Rona and its stakeholders.” The share price remains elevated, however, at rumour-fuelled heights.
And that is where it should be, because the Lowe’s theory makes more sense than Rona or others acknowledge.
Let’s set aside for a moment Rona’s denial. I hate to be impertinent, but if you’re a public company, you’re always for sale; it is shareholders, not the management or boards, who will ultimately decide the proper price.
Analyst Mark Petrie of CIBC World Markets Inc., who has a “market weight” rating and a target price of $10.50 on the stock, calls an outright purchase of Rona by Lowe’s “very unlikely.”
Lowe’s, Mr. Petrie says, specializes in big-box stores, and while it has made noise about exploring smaller store formats, Rona has a wide range of sizes, some as small as 5,000 square feet. In addition, Rona is a hybrid retailer/distributor, with an operating model that encompasses company-owned, franchised, affiliated and independent stores.
Says Canaccord Genuity’s Derek Dley: “We believe Lowe’s would have no interest in RONA’s smaller … stores.”
Rona’s “New Realities, New Solutions” plan has it closing and downsizing unproductive big-box stores, mostly in Ontario, while keeping its Quebec locations mostly intact. CIBC’s Mr. Petrie says the Quebec big boxes would hold the greatest appeal to Lowe’s, but since they are Rona’s most profitable locations, the company would be loath to sell them.
To sum up: the whole of Rona’s hybrid model is complicated and unappealing to Lowe’s, while the piece the U.S. retailer would want is too attractive for Rona to sell. Fair enough.
But let’s look at it this way: Lowe’s has an enterprise value of $43.6-billion (U.S.) and about 1,745 locations. That works out to a valuation of about $25-million per store.
Rona’s current enterprise value is just over $1.7-billion (Canadian). It has 80 big box outlets, plus 154 smaller stores, 62 locations catering to commercial customers, and 689 “affiliated” stores. Divide the enterprise value just by the big boxes, and you get over $21-million per location – and all the smaller stores for free.
In short, if Lowe’s wants to expand its Canadian business – which it has said for some time is the case – it can afford to pay the current market value of Rona, keep the biggest stores, and chuck whatever pieces it doesn’t want.
Now, I have no special insight into Lowe’s thinking, nor do I claim that the preceding is a particularly sophisticated valuation.
I do suspect, however, that Rona’s stand-alone prospects remain uncertain. I expressed concern last May that Rona’s problems in the winter of 2010-11 looked more like cause for long-term concern than a buying opportunity, and I was right: The stock was $12 then and was in the low $9 range before the Lowe’s story broke last week.
But while the stock looks cheaper today than it did last year, it’s only because expectations have been reset. The forward price-to-earnings ratio was about 11 at the end of 2011’s second quarter because expected earnings were $1.06; the forward P/E is about 11 today because the expectation is now 90 cents.
If Rona’s new plan delivers results, perhaps the company can indeed provide returns for shareholders while charting an independent course.
Yet before the recent jump, Rona stock had lost nearly one-third of its value over 12 months, while Lowe’s shares rose by more than 20 per cent over the same period. That is the reality, and a sale to Lowe’s provides a solution to the problem.