Retail therapy versus retail investment: Why buy stuff when you can buy the store?

Oh, don't think we don't know about those shopping bags you've got hidden under the bed. You have been shopping — you know it, we know it and the Canadian government knows it.

Statistics Canada has revealed that the ratio of household debt compared to disposable income is up to a shocking 163%. At the end of 2011, personal lines of credit drawn against mortgages, such as Home Equity Lines of Credit (HELOCs), now represent 50% of outstanding consumer debt. Canadians have got credit and they are not afraid to use it.

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Obviously, you have proven that you like the retail sector as a consumer, but what about as an investor? If you can tear yourself away from your credit card long enough, would it make sense to put some money into a long-term savings account such as a TFSA or an RRSP where you can invest it in the retail sector? In other words, instead of shopping at Restoration Hardware, have you thought about buying shares in Restoration Hardware (RH), so you can actually profit from your fellow shoppers', well, shopping habits?

Trend-spotting

We spoke with Vivian Lo, Vice-President and Portfolio Manager at Aston Hill Financial in Toronto. Vivian co-manages the Aston Hill Growth & Income Fund, in addition to other Aston Hill funds, and is an expert on the retail sector in North America. According to Vivian, the Canadian retail sector is poised for some exciting changes in 2013 and 2014.  Here are two major trends Vivian sees affecting the industry's future growth.

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1) American invasion

In the event you've been living under a rock, you may not have noticed that American retailing giant Target is moving into Canada, with 125 stores set to open in 2013 and more to follow in 2014. The company will be spending $800 million in Canada this year getting ready for the launch. Nordstrom department store has also declared it will open four stores in Canada starting in 2014 through to 2016 and there are rumours that Bloomingdale's may follow suit. Just last year, Dollar Tree bought up all our local Dollar Giant stores in order to give Dollarama a run for its, er, dollar.  J.Crew, Express and Ann Taylor have recently planted their flags on Canadian soil and are already up and running.

Why are Americans so interested in a country they once thought was nothing but a bunch of igloos? Vivian explains that the recent recession has a lot to do with the sudden Northward gaze. The US retail market is so saturated and competitive, that during the recession many retailers were forced to downsize, get more efficient and trim their fat just to survive. "Before the recession they were all about expansion," says Vivian. "Then it became more about retrenchment."

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Now that the American economy is stabilizing, retailers are looking for safe places where they can spread their wings and Canada is looking mighty attractive. For one thing, Vivian points out, our economy has weathered the recession much better than the US's so consumers are still spending, making us a relatively less risky market. Second, as every cross-border shopper knows, retailers charge higher prices in Canada — up to an average of 15% higher partly because there's a lot less competition north of the border. This means a company can make a much bigger profit on an item it sells in Canada versus selling it in the US.

Then there's the matter of our high propensity to spend — just look at that consumer debt ratio. If you're a retailer, why wouldn't you come here?

2) Online shopping tsunami

Natalie Massenet, founder of Net-A-Porter, tells the story of when she first came up with the concept for an online shopping website in 1999. Investors and fashion brands laughed at the idea that women would be willing to buy clothes and shoes without touching them or trying them on. Look who's laughing now. Ms. Massenet sold Net-A-Porter to Richemont Group (CFR), the second-largest luxury holding company in the world, for £350 million.

Now, of course, everyone is in the online game. Retailers call it the "omni-channel" experience, meaning customers (particularly younger shoppers) demand access to seamless transactions and high-quality customer service whether they choose to shop in-store, over the phone, online on their computers or with their mobile devices.  Old-school retailers have had to seriously up their game in IT spending — bringing in new systems and getting their technology not only up to speed, but better than their competitors'. Once a retailer gets their online experience right, the ability for more profit sky-rockets.

Retailing stars

Vivian gave us a few examples of retail companies that she is interested in investing in.  While we can't recommend whether or not these would be right for your portfolio, let this be a guide as to the qualities to look for — and be wary of - when considering an investment in a retail stock.

1) Target Corp (TGT)

Once Target officially descends upon Canada, things are really going to change. All Canadian retailers will feel the initial pinch as consumers race to check out the new store in town.

Why it's appealing: Apart from high-end brands at discount prices, Target offers PFresh, a grocery division which allows something consumers love: one-stop shopping. Shareholders love it because it increases the average 'basket size' of goods that shoppers will buy.  Target is also introducing smaller City Target stores in the US for the urban, downtown crowd. The company also has big room to grow its profitability through omni-channel marketing. Currently, only 2% of its revenue comes from online shopping and they are scurrying to improve their IT platform. Finally, there's the Canada quotient: Once the stores open, they will start generating  sales growth for Target.

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The risk: Will we shop or won't we? If Canadians do not contribute as much to Target's profitability as analysts expect, or if Target's plans for an improved IT platform are a bust, these factors could be a drag on the stock's performance.

Share performance: At December 31, 2011 Target shares were $51.22. As of early November 2012, they are around $62.90, for a return of 22.4%. This doesn't include the 2.3% dividend the company pays, which was increased by 20% back in June 2012.

2) La-Z-Boy Inc. (LZB)

No, seriously. This is no longer your father's La-Z-Boy. The company has been transformed, thanks in huge part to Lipstick Jungle star, Brooke Shields, who joined La-Z-Boy as spokesperson in 2010.

Why it's appealing: La-Z-Boy has really grasped the notion of the power of the purse. They have shifted away from marketing to couch potato men and have created holistic shopping experiences that appeal to women, including designers who come to your home to help with design decisions and additional ranges of furniture and upholstery. The company website is interactive and full of Brooke's fashion tips. As a result, the company has found that while men browse, women buy.  With the US housing market in the early stages of recovery now stabilizing and existing home sales improving, Vivian sees La-Z-Boy as a way to indirectly benefit from the improving market conditions. New homes need new furniture!

The risk: While the US economy is stabilizing, it's not entirely out of the woods yet and the Canadian housing market, while a much smaller influence, is slowing down. If the US housing market doesn't pick up the way analysts expect, it could affect consumer's confidence in spending money on luxuries such as redecorating and furnishings.

Share performance: At December 31, 2011 La-Z-Boy shares were $11.90; as of early November 2012, they are trading around $16.53 — that's a 38.9% return.

3) Hudson's Bay Company (HBC)

This company is not yet public, but its IPO is in the works and expected to price on November 19, 2012. Vivian is interested in HBC (which operates the banners Lord & Taylor, Hudson's Bay, and Home Outfitters) as a potential investment candidate because of its great turnaround potential.

Why it's appealing: If La-Z-Boy is no longer your father's easy chair, Hudson's Bay is not your mother's Bay store. "The Bay" was once a hodge-podge of merchandise with no sales staff in sight. With the store now rebranded "Hudson's Bay" and with new layout and lighting, the store is better organized and chock-full of helpful sales people. The American holding company that currently owns HBC has brought in fashionista favourites such as J Brand Jeans, Diane Von Furstenberg, Coach (COH), Burberry (BRBY) and an exclusive contract with British-based Topshop. The IPO will give the company an influx of funds to lower its debt levels while it continues to reinvigorate sales and improve its cost controls, IT platform and omni-channel servicing.

The risk: Will management succeed in its efforts to create a buzzy, busy, profitable HBC? IPO investors must evaluate the share price closely to make sure they don't pay too high a price for a company whose turnaround success is still in its early stages.

Share performance: IPO pending with a $18.50-$21.50 price range.

Canadians: Shopaholics forever?

Vivian points out that economically speaking, Canada has not had too much to worry about for a long while. Now that our shockingly high debt loads have been revealed, things could start to change. Mortgage lending rules have already been tightened in an effort to cool down the housing market and lower personal financial risk.

If the Bank of Canada feels the need to reign in our spending even more by raising interest rates, consumers will feel it — we will have less to spend as more of our money goes to paying interest on our piles of debt. Our shopping halcyon days may come to an end.

Smaller shopping budgets would of course affect the profitability of companies in the retail sector. However, Vivian points out that even in the face of a troubling economy, people still buy essentials and seek out discounts more often. Companies that offer low-pricing and opportunities for bargains typically fare very well. Indeed, we always find something to spend our limited funds on, don't we?

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