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Inside the Market Why analysts are predicting this Canadian retailer’s shares will nearly double within a year

Investors in Canadian retailer Indigo Books & Music Inc. are hoping for another hot-selling holiday season – on the heels of last year’s record performance – to help revive the stock now trading at three-year lows.

Shares of Canada’s largest book retailer have fallen about 30 per cent over the past year amid intensifying competition from giant retailers such as Amazon as well as digital books and magazines. Also weighing on the stock is the cost of an ambitious store renovation program that has eaten into profits, causing the company to miss expectations in its second quarter ended Sept. 29. The company said it has renovated 18 stores since 2016, with plans to complete another eight by the end of March. Indigo has 209 stores, including its first U.S. location that opened last month in New Jersey.

Investors are hoping the renovations, which analysts estimate would add about 20-per-cent revenue growth per location, will pay off longer term. Chief executive officer Heather Reisman acknowledged in the second-quarter report that renovations have had a “temporary impact on sales and profitability.”

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Revenue fell 3.7 per cent to $216.3-million for the second quarter ended Sept. 29, which was below expectations of about $227.5-million. When it reported the results earlier this month, Indigo said that the drop was largely because of the closing of a few low-performing stores and renovations at 12 stores in the quarter. Its net loss widened to $19.1-million or 70 cents per share versus a loss of $4.6-million or 17 cents a year ago, which it said was due to investments in store renovations, the expansion of its distribution facilities as well as minimum wage increases in provinces such as Ontario. Total comparable sales increased a modest 0.7 per cent year-over-year in the quarter.

Both analysts who cover the stock have a “buy” recommendation and an average 12-month price target of $23.25, which implies a gain of about 95 per cent from the current price around $12. On Friday, the stock slipped to $11.94, its lowest level since the fall of 2015, before closing up 6.6 per cent, or 79 cents, at $12.74. The stock traded at a 52-week high of $20.25 in early March, off the momentum of results from last year’s holiday shopping period, which Ms. Reisman described as the “biggest holiday to date.” Indigo reported its highest-ever quarterly revenues of $433.3-million for that holiday season. Analysts are expecting revenue to come in at $428.2-million for the comparable period ending Dec. 30.

While the stock is cheap today, it’s not very liquid, with about 57 per cent held by insiders, and the retail sector remains risky given the intense competition, said Ryan Modesto, chief executive of the independent firm 5i Research. “We like the stores, but not so much the company as an investment,” Mr. Modesto said. “We like growth companies and this isn’t one of them … [but] a value investor probably could make a case for it."

Cormark Securities analyst David McFadgen said he’s still waiting to see the positive impact to overall revenues from the company’s renovation activities, describing the impact on financials as a “short-term issue,” in a Nov. 7 note. Mr. McFadgen, who has a $22 target on the stock, expects growth at the company to continue.

PI Financial analyst Bob Gibson, who has a $24.50 target on the stock, said the company may have been too aggressive in its renovation plans but believes the stock’s recent drop presents a buying opportunity. He cites the company’s further move into the kids and babies market as another opportunity to grow revenues, as well as its recent foray into the United States.

Indigo opened its first U.S. store at The Mall at Short Hills in New Jersey last month. Ms. Reisman told investors in a conference call a year ago that the plan was to open a total of three to five U.S. stores within 24 months to test the market. A company spokesperson told The Globe and Mail on Friday that "We believe there is potential for additional stores in the U.S. and are actively looking at other markets, but we have no news to share on additional locations. We are taking a measured approach, and our focus this time is on our Short Hills location.”

The U.S expansion is both a risk and an opportunity, given the mixed track record of Canadian retailers opening south of the border. “I think Indigo is going to do it prudently and slowly. If it doesn’t work, I think they’ll know pretty quickly,” Mr. Gibson said.

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Peter Imhof, portfolio manager at AGF Investments, doesn’t own the stock, owing in part to its lack of liquidity. While the company has a strong balance sheet, Mr. Imhof also said he would want to see more results from its renovation program before considering buying the stock. “It’s not really a growth story at this point in time,” he said. “I just need to see something else,” that would boost its future sales.

Meantime, he prefers faster-growing retail stocks such as Aritzia Inc. and Canadian Tire Corp., both of which he currently owns.

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