Canadian Tire: Value Under the Hood

Transcription

1 Canadian Tire: Value Under the Hood May 2006 Pershing Square Capital Management, L.P.

2 Disclaimer Pershing Square Capital Management's ("Pershing") analysis and conclusions regarding Canadian Tire Corporation ( CTC or the Company ) are based on publicly available information. Pershing recognizes that there may be confidential information in the possession of the Company that could lead them to disagree with Pershing s conclusions. The analyses provided include certain estimates and projections prepared with respect to, among other things, the historical and anticipated operating performance of the Company. Such statements, estimates, and projections reflect various assumptions by Pershing concerning anticipated results that are inherently subject to significant economic, competitive, and other uncertainties and contingencies and have been included solely for illustrative purposes. No representations, express or implied, are made as to the accuracy or completeness of such statements, estimates or projections or with respect to any other materials herein. Actual results may vary materially from the estimates and projected results contained herein. Pershing manages funds that are in the business of trading - buying and selling - public securities. It is possible that there will be developments in the future that cause Pershing to change its position regarding the Company and possibly reduce, dispose of, or change the form of its investment in the Company. 1

3 What is Canadian Tire? Largest Canadian general merchandise retailer in reality, a real estate and franchise business Ticker: CTC/A CN Exchange: TSX Recent price: $65 Note: Throughout this presentation, all $ in Canadian. Leading Canadian brand with an 84+ year operating history FY 06E Revenues of $8.3bn and EBITDA of $847mm (1) Enterprise value of $6.3bn and equity value of $5.4bn EV / 07 EBITDA: 6.8x (1) Price / 07 EPS: 13.5x (1) (1) Based on Pershing s estimates. Assumes a $65 stock price for CTC. 2

4 Four Business Segments Canadian Tire Retail Financial Services Marks Work Wearhouse Canadian Tire Petroleum Largest Canadian general merchandise retailer Real estate and franchise business model $3.3bn portfolio 2nd largest MasterCard issuer in Canada Leading specialty apparel retailer Favorable growth trends Canada s largest independent gas retailer % Total EBITDA 66% 21% 10% 3% 3

5 Recent Trading Statistics and Multiples $ in millions, except per share data Summary Financial Data: FY'05A FY'06E FY'07E Gross operating revenue $7,789 $8,287 $8,874 Adjusted EBITDA $770 $847 $924 Margin 9.9% 10.2% 10.4% Recurring EPS $3.84 $4.30 $4.80 Maintenance FCF per share (1) $4.93 $5.77 $6.42 Trading Statistics: FY'05A FY'06E FY'07E EV / EBITDA 8.2x 7.4x 6.8x P / E 16.9x 15.1x 13.5x P / Maint. FCF Yield 7.6% 8.9% 9.9% Note: Projections are based on Pershing s estimates. (1) Maintenance FCF = Net Income + D&A Maintenance capex 4

6 Five Year Stock Price Performance Over the last five years, Canadian Tire s stock price has increased 185%, while its business value has grown at an even higher rate Pershing recently began accumulating shares of CTC /22/01 4/22/02 3/22/03 2/22/04 1/22/05 12/22/05 5

7 Canadian Tire Retail

8 Canadian Tire Retail: Overview 462 general merchandise stores operated by independent dealers across Canada 58 Partsource stores, a smaller format DIY auto parts retail chain with 50+ franchise locations CTC owns the land and building at ~75% of its locations, with the balance principally under long-term leaseholds Major retail categories include Automotive (parts and service), Home Products and Leisure Products 7

9 Canadian Tire Retail: Business Model Real Estate and Franchise business model Canadian Tire Corporation ( CTC ) owns the land and building which is leased to the Associate Dealer (franchisee) for a % of sales Dealer buys all the store FFE and is responsible for all maintenance capex (net lease) CTC s Maint. Capex is less than its D&A, hence Maint. FCF is > NI Dealer buys all of its inventory from CTC and prices subject to CTC maximum price CTC books profit on sale of inventory to dealer Dealer bears substantially all inventory risk Unique business model is not readily evident in the Company s financials, which appear to be like that of a Traditional Retailer 8

10 Not Your Typical Retailer Predominantly real estate and franchise revenues 100% franchised Maintenance capital is the responsibility of the Dealer Stores run by entrepreneurs Substantial real estate assets Strong, low-risk growth opportunity in 20/20 conversions Trades at 6.8x 2007E EBITDA Predominantly real estate and franchise revenues 97% franchised Maintenance capital is the responsibility of the Franchisee Restaurants run by entrepreneurs Substantial real estate assets Strong growth opportunity in US expansion Trades at 12.5x 2007E EBITDA 9

11 Canadian Tire Retail: Real Estate The Company owns substantial real estate Best-in-class retail real estate, given the Company s 84-year old history Owns land and building at ~ 75% of store locations, with the balance principally under long-term leaseholds 20+ strategic sites with higher/better use that are being sold or developed e.g., owns 2 sites totaling 5mm sq ft of FAR of fully-entitled, developable land in Toronto, currently generating no income ~58% of Canadian Tire petroleum stations, often co-located with Canadian Tire Retail stores 10

12 Historical Financial Performance EBITDA growth has been driven by a steady mix of comparable sales growth, square footage growth and margin expansion. $ in millions Operating Data: FY 2002 FY 2003 FY 2004 FY 2005 Comparable store sales 1.4% 3.2% 3.4% 3.0% Ending net retail footage growth 3.1% 3.1% 5.2% 4.9% Financial Data: Revenue $4,339 $4,641 $4,899 $5,108 Growth 3.7% 7.0% 5.6% 4.3% Adjusted EBITDA $386 $404 $472 $523 Margin 8.9% 8.7% 9.6% 10.2% Growth 6.3% 4.7% 16.8% 10.8% 11

13 Growth Acceleration and Margin Opportunity High return square footage expansion opportunities Management plans to expand retail square footage by ~9% per year via converting current store base to the 20/20 format Expands selling space of a typical store by ~20% by converting non-productive warehouse space to retail space Pre-tax unlevered returns on investment of approximately 20% Yet, Wall Street analysts have lowered near-term estimates due to short-term sales and earnings disruption associated with the expansion plan, resulting in a recent stock price decline Overseas outsourcing opportunity In 2005, ~35% of product sold in Canadian Tire was made outside of North America. The Company is targeting ~50% by

14 Canadian Tire Financial Services

15 Canadian Tire Financial Services: Overview Core Financial Services Products ~$3.3bn of ending managed receivables (primarily Canadian Tire MasterCard) 2nd largest MasterCard issuer in Canada represents 5% of Canadian bank card market Loans funded primarily in the securitization market Expanding into other products (loans, mortgages, home equity) Ancillary Businesses Canadian Tire Automotive Assistance Other Warranty & Credit Insurance 14

16 Strong Receivables Growth Growth in receivables and earnings has been driven by increasing average balances per account Gross Average Receivables $ in millions $ in millions Avg. Balance per Account 21% CAGR $3,042 21% CAGR $1,698 $2,573 $1,449 $2,066 $1,164 FY 2003 FY 2004 FY 2005 FY 2003 FY 2004 FY

17 Financial Services Adjusted EBITDA $ in millions 18% CAGR $171 $123 $144 FY 2003 FY 2004 FY

18 Growth Opportunities Further increases in average balances Balance growth driven by private label to MasterCard conversion CTC s customers currently have average balances of $1,619 versus the Canadian credit card average balance of ~$2,450 Expand new businesses Personal term loans Mortgage origination CDs Grow Warranty & Credit Insurance businesses 17

19 Marks Work Wearhouse

20 Marks Work Wearhouse: Overview 334 specialty apparel stores across Canada selling work and industrial clothing/footwear Low fashion content and associated risk ~75% of sales are private label Since FY 2002, EBITDA has grown from $34mm to $82mm in FY 2005 CTC acquired Marks for just $112mm in

21 Strong Same Store Sales Strong same store sales growth has led to substantial EBITDA growth $ in millions FY 2003 FY 2004 FY 2005 Same store sales 6.6% 15.1% 17.1% Revenues Growth 19.2% 25.3% Adjusted EBITDA Margin 9.0% 9.9% 12.0% Growth 31.7% 51.9% 20

22 Growth Opportunities Continued same store sales growth due to category expansion Women s Uniforms Healthcare Square footage growth New stores Expanding square footage of existing stores 21

23 Canadian Tire Petroleum

24 Canadian Tire Petroleum Owns/controls 259 gas stations across Canada Operated by independent agents FY 05 Revenues of $1.3bn / only $22mm of EBITDA Negative free cash flow FY 05 EBITDA Capex of ($7)mm Asset value based on ownership of 58% of locations Strategic value in a sale / joint venture transaction 23

25 Pershing s View of Canadian Tire

26 Why Do We Like Canadian Tire? Trades at 6.8x 07E EBITDA, despite its real estate / franchise business model Cheapest real estate/franchise business of which we are aware Component parts are clearly worth more 6.8x EBITDA High return internal growth opportunities 20/20 store conversions Strong same store sales growth at Mark s Shareholder friendly management w/ strong execution history Several embedded options for value creation 25

27 Embedded Options for Value Creation Monetization of credit card portfolio Sale leaseback of core real estate Sale of higher/better use properties Canadian income trust conversion 26

28 Rationale for Credit Card Portfolio Monetization Monetizing the credit card portfolio through an alliance with a major bank would allow CTC to: Sell receivables at a premium to book Maintain a substantial portion of cash flows associated with the credit card business Participate in future credit card income growth Improve balance sheet and credit rating Pursue share buybacks using an estimated $1.3bn in proceeds plus incremental leverage from improved rating Banks are willing to pay a high premium, given their funding advantages and the scarcity of any remaining large portfolios 27

29 Highly Accretive Transaction Canadian Tire could monetize its Credit Card Receivables in a highly accretive transaction After monetizing its Credit Card Portfolio, Canadian Tire could still retain High margin Warranty and Credit Insurance businesses, which are discrete from the Credit Card business Direct relationships with customers afforded by Credit Card business A significant portion of existing Credit Card income and participation in future Credit Card business growth Most major retailers have sold their portfolios in highly accretive transactions 28 Canada

30 Case Study: Sears Canada Credit Card Sale Based on our estimates, we believe Sears Canada monetized its Credit Card Portfolio for a 27x EBIT multiple. $ in millions Managed receivables at sale $2,524 Adjusted pre-tax proceeds (1) $3,320 Premium 31.5% LTM Credit EBIT (2) $182 Less: EBIT retained by SCC (60) Equals: EBIT acquired by JP Morgan Chase $122 Pre-tax proceeds $3,320 EBIT acquired by JP Morgan Chase 122 Transaction Multiple 27.2x (1) See Sears Canada 2005 annual report, p 26. (2) LTM Credit Operating EBIT (Q3 05), adjusted for $20mm of EBIT recorded in merchandising segment. 29

31 Credit Card Monetization: Value Creation Assuming a 20% premium to book (versus SCC transaction at 32%), $50mm of retained credit income and a pro forma 8x EV/EBITDA multiple, the monetization of the Credit Card portfolio could result in ~30% upside for the stock. $ in millions, except per share data FY 2007E Comments 2007E EBITDA less Financial Services $735 Plus: EBITDA from Insurance & Warranty businesses 50 Based on Pershing's estimate of $160-$180mm in revenue Royalties from recurring Credit Arrangement 50 In line with Sears Canada residual EBITDA contribution Pro Forma EBITDA $835 Current Enterprise Value 6,290 Less: After Tax Credit Proceeds (1,226) Assumes 20% premium to gross receivables Pro Forma Enterprise Value 5,064 Pro Forma EV/EBITDA (After Proceeds) 6.1x Appropriate Multiple 8.0x Incremental Value Created $1,615 Incremental Value/Share $19.42 Pro Forma Share Price $84.42 Percent Upside to Current Price 29.9% 30

32 Sale Leaseback of Core Real Estate Assuming a 7% cap rate, a sale leaseback transaction could create an additional $12 of equity value per share for Canadian Tire. In January 2006, the Company completed a $230mm sale leaseback transaction. $ in millions, except per share data FY 2007E Comments PF Enterprise Value after Credit Sale $6,679 Assumes 8x EV/EBITDA Multiple Assumed pre tax Real Estate Value 2,500 Premium to Net Book Value of ~ $1.8 Billion Less: Cash taxes 126 Assumes 18% Capital Gains Tax Rate After-tax cash proceeds 2,374 Enterprise Value PF for Real Estate sale $4,305 EBITDA pre Sale Leaseback 835 Less: Rent expense at 7.0% cap rate (175) 7.0% cap rate based on current market Adjusted EBITDA 660 Pro Forma EV/EBITDA (after proceeds) 6.5x Appropriate Multiple 8.0x Incremental value created 974 Incremental Equity Value per share $11.71 Assumed share price after credit card sale $84.42 Plus: Incremental value per share $11.71 Pro Forma share price $96.13 Percent upside to current price 47.9% Note: Pre-tax real estate value based on Pershing s estimates. 31

33 Alternative Use Real Estate: Value Creation Based on our estimates, a sale of its fully-entitled non-income generating properties could add an incremental $4 per share of equity value. The Company has recently hired advisors to sell two of its largest such properties. Development Projects Sheppard Avenue Dundas and Kipling Southdown and Lakeshore Description 4 million sq ft 40 acres of Residential / mixed use 1 million sq ft Residential / mixed use 300,000 sq ft Residential / mixed use ~20 Additional Properties Mid point $ in millions, except per share data of Estimate Total Value $400 After-tax value per share $3.94 (1) Share price post credit card sale / sale leaseback $96.13 Plus: Incremental value per share $3.94 Pro Forma share price $ (1) Based on Pershing s estimate of $350mm - $450mm of value. 32

34 Income Trust Conversion Rationale Well known brand with strong retail following Stable, real estate and franchise-based cash flows with limited maintenance capex Reasonable market cap for Trust Market Given current investment opportunities, trust conversion would make most sense when the Company has reached a higher degree of maturity 33

35 Income Trust Conversion: Value Creation Assuming a 7% FCF yield and 90% FCF payout ratio, an income trust conversion could add an incremental $29 per share of equity value to Canadian Tire. $ in millions, except per share data FY 2007E Comments PF Enterprise 8.0x EBITDA after Credit Card sale / Sale Leaseback $5,279 ` Core EBITDA $660 Less: Maintenance Capital Expenditures (100) Distriubution/IT maintenance capital Less: Interest Expense (119) Assumes 3x Debt/EBITDA at 6% Pre-Tax Free Cash Flow $441 % Distribuatble 90.0% Distributable FCF 397 Assumed Yield 7.0% Appropriate yield given comparables Implied TEV 7,655 Assumes 7% yield with 3x Debt/EBITDA leverage Incremental Value Created 2,376 Incremental Equity Value Per Share $28.57 Share price post alternatives $ Post credit card sale, sale leaseback, excess RE sale Plus: Incremental value per share $28.57 Pro Forma share price $ Percent upside to current price 97.9% 34

36 Value Creation Potential $110 Canadian Tire Potential Stock Price $129 98% $100 $90 $80 $84 30% $96 48% $100 54% 98% $70 $60 Recent: $65 Sale of credit card portfolio Sale leaseback transaction Sale of excess real estate Trust conversion 35

37 Investment Takeaways Opportunity to nearly double your money in a low leveraged $5.4bn market cap company Company trades at 6.8x 07E EBITDA but its component parts are worth significantly more Segment Canadian Tire Retail Description Real estate / franchise business model Financial Services Credit card and warranty businesses Marks Work Wearhouse Growth retailer Canadian Tire Petroleum Asset value exceeds its cash flow generating value 36

38 Concluding Thoughts Several catalysts for value maximization Pershing has met with CTC Management, including the recently appointed CEO Management is receptive to shareholder value enhancing initiatives 37