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Reitmans: An Owner Operator Business with Messed Up Expectations

December 13, 2013 | About:
Chandan Dubey

Chandan Dubey

99 followers

Reitmans (RTMAF) is a Canadian ladies' wear specialty retailer. The company has six different banners: Reitmans, Smart Set, RW & Co, Thyme Maternity, Penningtons and Addition Elle. Each brand is focused on a particular niche in the market but faces competition in each of its segments.

Key Figures (in CAD$, Fiscal Year 2013)
Sales/Stores: $1B/911
Cash & Investments: $146.9M
Debt/Pension: $7.6M/$18.3M
Price/Shares/Cap: $5.85/66M/$378M
FCF: -$33M

The company is facing competitive pressure from new entrants to the Canadian market, like Target (TGT). It is also facing several problems which can be attributed to bad luck. Meanwhile, the shares have lost 58% of their value during the last nine months.

Several of these problems are short term and possible to fix. Others, like competition from new entrants, are more serious and may pose business risk.

The company has several attractive features. For example, high levels of cash ($146.9 million, August 2013), low debt ($7.7 million, August 2013), significant insider holding (57% of the voting and 7% of the non-voting shares), and a shareholder friendly management with a history of rewarding shareholders with both buybacks and dividends.

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Recent Developments
Reitmans troubles started around the recession of 2008. Its Cassis banner, aimed at women from 40 to 60, was closed in 2011 after nearly five years of disappointing results [newswire].
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In June 2012, the company installed a new warehouse management system. Complications arising from this system caused disruptions in the flow of inventory. The company estimates the loss of EBITDA was between $7 million and $15 million. The company was able to fix the problem quickly. There was no significant impact in the fourth quarter of fiscal year 2013.

Since October 2012, CAD has been in a downward spiral compared to USD. The company buys goods abroad in USD. The cost of the goods sold, hence, has gone up. Unfortunately, due to new entrants in the Canadian retail space, the company has not been able to raise the prices on a commensurate level.

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The capital expenditure of the company has also gone up since 2012. In anticipation of recession, the company had reduced its capex significantly since 2008. The management is now investing in its stores and the capex is returning to the pre-recession levels. For example, the company spent $74 million in 2012 and $84.4 million in 2013.

Retail business is marked by constantly changing fashion trends, a difficult business. Turning around a retail chain is not an easy task. A very good and recent example is J.C. Penney (JCP). The investment would have been futile if the situation were the same. But Reitmans has several things going for it.

Positives
The CEO and CFO of the company are Jeremy Reitman and Stephen Reitman, respectively. The company has a dual shareholding structure. The common shares have one vote each, while the Class A shares have no voting power. The shares are equivalent otherwise. The management owns 57% of the voting shares and 7% of the class A shares. The management/employees of the company also hold 2.37 million share options at an average exercise price of $14.52 each. Each option entitles the holder to purchase one Class A share. The combination of founding family controlled management, and significant shareholding shows that the management's incentives are aligned with the shareholders.

The company turned free cash flow negative (-$33 million) for the first time in 2013. Fortunately, the company has a very strong balance sheet with only $7 million in debt and $147 million in cash and equivalents. This gives it ample time to get through the rough patches. The USD/CAD rate will stabilize and the competitive landscape will become clearer with time.

The company's book value is not tied up in real estate. If we remove the goodwill, intangibles and PPE, the company still has a book value of $4.83 per share. In fact, the company has $301 million in current assets or $4.56 a share. Given the low debt of the company, it seems the downside is small at these prices.

Valuation
The company is valued at a price-to-sales ratio of 0.4. On the other hand, Guess (GES) is trading at a P/S of 1 and Gap (GPS) at 1.1.

As noted earlier, the company has monetizable assets of $4.83 a share. This is a 18% downside at current prices. On the other hand, a 40% discount to the ten year average P/S ratio of 1.2 will imply an upside of 80%.

Risks
Several risks have already been discussed earlier. I also want to point out that the dividend is probably going to be cut in the coming fiscal year. If this turns out to be the case then the shares may fall further. At current prices the company has a dividend yield of 13.42% and the payout ratio stands at 196%. The yield is not sustainable in this situation.

Bottom Line
Reitmans was founded in 1926 and has been paying dividend on its ordinary shares for 62 years. It has a long operating history and a shareholder friendly owner operator management. The company is going through short-term problems and the current prices reflect a very pessimistic view of the situation, not warranted in my opinion.

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 3.8/5 (9 votes)

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