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Contra Guys: We think this retail stock will eventually nearly triple

Amid a brutal retail environment, this Canadian name is making solid progress on its recovery.

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Canadian retail is tough and the past couple of years have been particularly gruesome for bricks and mortar locations. Among the vanquished in this country were Aeropostale, Ben Moss, Blacks, Costa Blanca, Danier Leather, Grand & Toy, H20 Plus, Jacob, Mexx, Sony and Target. Other corporations that have scaled back dramatically include Chapters/Indigo, French Connection, Guess, Sears, Staples and The Gap. And this isn't even a comprehensive list.

Amid the fray, the stock price of Reitmans (Canada) Ltd. (RET.A) was chopped by roughly half. Stiff competition, the tepid consumer, and the falling dollar all combined to hurt this corporation that has been part of the Canadian landscape since 1926. The woebegone loonie was particularly harsh as the company sources products in U.S. currency but sells them in Canadian dollars. This had a $36.4-million impact on revenues that fell to $937.2-million in the company's most recent fiscal year ended Jan. 31.

Reitmans' Smart Set division also turned out to be not the sharpest knife in the drawer. After a series of attempts to reinvigorate the banner, which catered to younger consumers, the plug was pulled. The severance related to staff reductions plus the aforementioned issues turned a respectable 2014 profit for Reitmans of $12.5-million into a $24.7-million loss for 2015. Some shareholders worried that the dividend, which had been slashed two years earlier, might be hacked again or possibly eliminated.

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Amidst the gloom we saw opportunity and added Reitmans to both Contra portfolios at $3.81. Why you may ask? As contrarian investors we like cheap, and the valuations certainly checked that box. The balance sheet was strong, as this is a retailer with zero debt. High insider ownership is important to us, which suits this company to a tee. Our perception was that the dividend, which offers a 5.2-per-cent yield, was sustainable.

While the top line revenue was contracting due to the store closures, sales reductions slowed and management appeared to be making solid progress on the turnaround. Same store sales were rising and e-commerce revenues boomed. Expense reduction efforts continued thanks to vendor consolidation and the development of a sourcing unit to reduce supplier costs. An enterprise-wide initiative to deploy improved technology is on track for completion next year. The launch of Hyba, a new athletic leisurewear brand, helped replace some of the Smart Set locations although, to be frank, we have some reservations on whether this chain will be successful. That market appears pretty saturated to us.

The turnaround efforts showed up in encouraging results in the second-quarter financial release this month. Revenue increased for the second quarter in a row, same store sales and e-commerce advanced at a solid pace, gross margins improved, and the bottom line was a healthy $9.2-million versus a slight net loss in the prior year quarter. This sent the shares from under $4.60 to the $6 mark within days of the news.

While we are pleased with the 50-per-cent rally year to date, the stock is a far cry from our sell target north of $16 or where it was a decade ago when it peaked over $25. Before it has a chance to return to that rarefied atmosphere, Reitmans needs to finesse the currency winds, push its e-commerce platform, and rationalize its store footprint and banner distribution. Most importantly, the retailer must sync with the fashions that consumers want to buy. That's an order as tall as our sell target!

Benj Gallander and Ben Stadelmann are co-editors of Contra the Heard Investment Letter.

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