August 8, 2010 / 2:32 PM / 7 years ago

BAY STREET-Discretionary consumer stocks may offer good value

* Grocers have done well, despite food price deflation

* Some discretionary stocks seen cheap with room to grow

* Outlook mixed for staples like Shoppers Drug Mart

* Analysts upbeat about Canadian retail sector

By Solarina Ho

TORONTO, Aug 8 (Reuters) - Canadians have to eat in good times and bad, but they don’t have to buy a new snowblower.

That’s simple logic behind the rally in consumer staples during Bay Street’s turbulent second quarter when economists started to fret about a double-dip recession.

Conversely, as investors flocked to the safety of the staples, some discretionary retailers languished. That makes them relative bargains, analysts say, especially with consumers now in the mood to spend.

Canadian Tire Corp (CTCa.TO) is a good example. The retailer, which sells auto supplies, housewares and nonessentials like snowblowers, has turned in decent results and has a reasonably bright earnings outlook, but it got no love from investors this year. The stock has barely budged, and it’s now inexpensive compared with the staples.

By contrast, Loblaw Cos Ltd (L.TO), Canada’s biggest grocer, has risen about 30 percent this year, while Empire Co (EMPa.TO), the owner of Sobeys supermarket chain, has jumped 20 percent. The grocers took off even though the companies were wrestling with food deflation, which typically leads to price-cutting and lower profit margins.

“I do think we’re starting to move into a period where discretionary-type names will begin to take a little bit of flight,” said analyst Robert Cavallo of Mackie Research Capital, who sees more value in discretionary stocks going into the third quarter.

“I think there’s some pretty good value in a name like Canadian Tire as an example, relative to some staples which may have gotten to pretty lofty valuations,” said Cavallo, adding that consumer staples have “really had a good run”.

Leon’s Furniture (LNF.TO) is one retailer that appeals to Paul Gardner, a portfolio manager at Avenue Investment Management.

Leon’s has no debt, cash on the balance sheet and increased dividends, Gardner said. The stock is up over 10 percent this year, but still trading about 14 times earnings, according to StarMine data. For Leon‘s, this is “not overly cheap, but it has room to grow. The Canadian economy is in pretty good shape,” he said.

“Certainly in May and June -- when it looked like the chatter about double dip (recession) was gaining steam -- people were looking for safety,” said Barry Schwartz, vice-president and portfolio manager at Baskin Financial Services.

“The (grocery) sector has performed pretty well, and it’s a pretty good investment considering the volatility of the market over the last year or two,” said Avenue Investment’s Gardner.


Sector Comparison:



For a staple stock like Shoppers Drug Mart SC.TO, which has been hit with uncertainty due to new provincial drug-pricing laws, there is debate over its valuation.

    “We’ve always avoided (it), just because in a sense it’s a black box. You could never figure out the company,” said Gardner. “We think it’s still too expensive.”

    Schwartz disagrees. For investors who are looking to invest long term and are not motivated by quarter-to-quarter growth, he sees value in a company like Shoppers, Canada’s largest drugstore chain.

    “Shoppers Drug Mart’s been kicked to the curb so many times in the past few months, but the earnings are going to be there and the valuation’s never been cheaper,” said Schwartz, who still sees value in staples retailers.

    There are still defensive overtones in the market, and according to a report last month by the Conference Board of Canada, consumers could even scale back spending in coming months as interest rates rise and the economic recovery slows.

    Schwartz also says some discretionary stocks, like Lululemon Athletica LLL.TO -- which specializes in pricey yoga wear -- and Dollarama (DOL.TO) -- a cut-price “dollar” store -- are much too expensive.

    “Dollarama to me is, the valuation is way too expensive. ... The same-store (sales) growth seems to be phenomenal, but you’re paying a pretty penny for that growth,” he said, explaining that high growth always encourages competition.

    The apparel industry is a “fickle business”, said Schwartz, with clothing stores and sporting goods retailers such as Forzani Group FGL.TO considered slightly more risky.

    There is one discretionary stock analysts seem to agree has an upside: Tim Hortons THI.TO.

    While shares of the iconic Canadian coffee shop chain haven’t exactly languished -- they’ve climbed about 10 percent this year -- six out of 13 analysts maintain a “buy” or a “strong buy” on the stock while the remaining seven have a “hold” rating, according to Thomson Reuters I/B/E/S.

    It seems that a cup of Tim’s coffee is the one luxury no Canadian can live without.

    “People are nervous about the economy. If it stumbles, these are good places to hide of course. People can’t live without their Tim Hortons coffee,” Schwartz says. (Editing by Frank McGurty)

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