Canadian Tire Corporation, Limited (CTCA) Earnings Call Transcript & Summary

Okay. We'll now move to Canadian Tire Corporation. The active members in Tire's Triangle loyalty program represent more than 1/4 of the total population in this country. So we'll get especially relevant views on the state of the consumer. Please join me in welcoming CEO, Greg Hicks; and EVP and CFO, Gregory Craig.

All right. Thank to both of you for being here. So I think you know the theme. We're starting with state of the consumer. Based on what you see in your retail business and your credit card data, how would you describe the state of Canadian consumers right now, particularly as it relates to discretionary spending?

Well, first of all, thanks for having us here this morning. This is always an important date in our calendar and good to meet you. Welcome to the file, so to speak. . Yes. I'm not surprised you're leading with that question. It's the first question we get from any investor meeting we have. I guess in general, I would say that we aren't seeing anything materially different show up in the economy, the kind of consumption of the average Canadian household now relative to the last 9 or 12 months. The reality is consumption of discretionary items and categories has been tough. The performance bifurcation between discretionary and essential has been quite wide for us and then kind of more market stability time frames, there's very little difference. And in fact, the portfolio might tilt to a little bit more run rate benefit to discretionary versus essential, given our mix of business tilts to discretionary. What we're seeing in the businesses that we own and the spend across our credit card is just a very cautious, very cautious consumer. The reality is, and this would have been kind of new analysis that we would have put forward earlier this year is what we're seeing is that the consumption weakness in discretionary is agnostic to income. It has everything to do with indebtedness. And so we're seeing 200,000-plus income households spend on a discretionary basis, like $50,000 a household. And where that's manifesting in a material way is in VECTOM markets across Canada, really pronounced in Vancouver and Toronto and think not just the city, the dense urban city, but also the first and second tangential suburb to those cities. It harkens back to significant home turnover activity in the '19 to '21 time frame. So you're seeing a pullback, you're seeing kind of savings rates grow in some of those households as they get prepared for mortgage renewal, mortgage shock, et cetera. I think it's important for us anyway to get a read on spend outside of the businesses we own as well. Actually, let me go back where we do see some benefit in the portfolio and the strategy standing up well and growth on the top line is in the Maritimes. So generally speaking, although there are some pockets of indebtedness at the household level in the Maritimes, it's a much healthier household. And our business is strong in the Maritimes. Maybe not quite at market stability rates, but positive top line and growth in discretionary categories. So again, we feel good about how the strategy stands up in front of the customer and those types of dynamics. When we look to our credit card, $20 billion, $25 billion worth of spend, household spend. We're seeing a lot of red in the file from a total spend standpoint. In general, we're seeing the average Canadian household exercised fairly good discipline and constraint fiscally. They're paying their mortgages, they're paying their credit cards. We would have expected a little bit more aging in the portfolio this year. We've been pleasantly surprised with their dedication to paying their credit cards. And with some monetary easing, you'd hope that, that will only continue on a go-forward basis. Big stalwart spend categories like travel and dining, you're starting to see some year-over-year weakness show up on a week-over-week basis. And we believe there's still a fair amount of inflation in those services. So I think that would when the absolute dollars are starting to show a decline on a year-over-year basis, that's probably a pretty good indicator that the economic activity is down. And so what we're seeing as the year is progressing here is a modest narrowing of the performance bifurcation between discretionary and essential. Anecdote, but I think a pretty good indication of how the average Canadian family is thinking about spend right now. We just have come through the back-to-school season, Sport Chek is -- that's an important kind of micro season for us in that business that we organize around and our kids footwear and backpack business was exceptionally strong and children's apparel, not so strong. So again, if you've got a hole in your shoe or a hole in your backpack, I think mom and dad are viewing that as a need, but Johnny can go to school with a T-shirt that's a size too small or has a rip in it. And so these are the types of choices, I think, that are happening in the average Canadian household. On aggregate, you start to see it, if you're tilting to kind of more discretionary, it's still weakness on the top line, but it's narrowing. So we're tilting to some degree of cautious optimism. And for us, it just means continuing to focus on what we've been focusing on, which is disciplined expense control and real strong margin management to work to accrete earnings in an environment where you can't rely on the top line.

That's good color. Gregory, I want to get to the CTFS business. Just a quick housekeeping matter first. Perfect. I was going to ask about the clock. Thank you for that. Write-offs. Should we expect these to continue to increase? And at what point do you think they might plateau?

It's funny as Greg said, the first question we get is the state of the consumer. The second isn't the question that I thought you were going to ask you was more what's the latest update on the strategic review. So let me just say that the review continues. It's a priority for us. But to get to your question, you don't want the review has kind of reminded me of how strong our credit risk capabilities and our resources and our team actually are. To get to your specific question, though, we have a loss rate in the second quarter on a rolling 12 basis, 6.7%. How do we get there? Well, the first thing I would say is the bank team and Greg and I are incredibly comfortable and we're on our expectation around where we thought we would be. But it's important to go back to wind the clock back a little. Canadian Tire Bank has always acquired their customers through our retail stores. It's been a very cost-effective way to obtain loyal Canadian Tire customers. Well, when COVID hit, as you can imagine, we've had store closures quite a bit in that time period, and our acquisition fell fairly significant. Our credit card acquisition fell fairly significantly. So the team started to delve more into kind of the capabilities on the digital side of things. And that gets us to kind of our Investor Day where we announced we're back in business for growing our book of receivables because it's all part of that better connected strategy get more cards in circulation, get more Canadian Tire Money in circulation, you can only redeem back in our family of companies. So we announced kind of going back on the aggressive on acquisition after that, year or so of a pretty significant pause. Well, that was a signal saying, we're expecting higher loss rates as you move forward because the minute you start acquiring more new accounts, new accounts by their very nature are riskier. I just -- you've been in my books for 10 years, Greg has been on for 1.5 hours, you're just lower risk than Greg is I know more about you. I have more of a history. So we knew this write-off rate increase was going to come. I think what exaggerated everything was as we went through that period of increased interest rate increases, we decided the prudent thing to do, probably in the middle of last year was to start to slow the growth in acquisition. So now I think of 2 things. We knew these losses were going to be coming, but we decided to slow the growth. The write-off rates a math formula. It's write-offs divided by average receivables. So as you start to slow your receivables, you're putting more upward pressure on your write-off rate. So we could have telegraphed this and this is working exactly as we would have thought as we move through the cycle. And then again, where I started, that we're very comfortable with the risk capabilities and the expertise. And if the market does deteriorate from here, there's additional actions clearly, the team has in their playbook. And I will just pick up on something Greg said, the early stages of aging. So before you get in kind of the later stages like past due 2 months, 3 months, 4 months, so kind of the really early stages are looking much better than kind of earlier months or vintages. So that does bode, I think -- we think, well for the write-off rate going forward. And the watch item I said on the call was we'll just keep an eye on the unemployment rate. And if that does continue to deteriorate, those additional actions, as I said, we can take to kind of manage the risk accordingly.

Okay. That's helpful. You mentioned loyalty. I'm going to bounce around a little bit, and I will get to that subject. It's an important part of your growth aspirations. I wonder if you think the Triangle program is properly understood by investors. How would you like us to think about its importance to the overall ecosystem? What's its strategic significance to Canadian Tire?

Maybe I take that one.

Yes.

I'm glad you asked that question. It's -- we do believe that the Triangle program is a -- is very strategic, and we also believe that it is misunderstood in the market. So I think it's I think it's really easy to think about the Triangle program solely from the standpoint of a consumer loyalty program. So you're thinking about the rewards, you're thinking about the currency in our case, Canadian Tire Money for driving value and generating demand. And that is an absolute critical component to Triangle for us. I mean the reality is we have a value prop that provides up to 4% cash back. We have scalable multiplier functionality and events that kind of layers on top of that. And all of that manifests in kind of one-on-one incentives to customers that have generated hundreds of millions of dollars worth of incremental sales over the course of the last few years. So again, very -- don't get me wrong, extremely critical and important part of the way we go to market from a demand creation standpoint. But we really believe that you've got to look behind the curtains. And Triangle as a management team, we believe is a privileged strategic capability. It is a -- it provides us a wealth of first-party data that allows us to understand the behaviors and preferences of our customers and how those customers and members interact with every single business that we own, inclusive of the bank, and all digital touch points associated with our enterprise. And that golden record, so to speak, of customer provides us a view to be able to model customer lifetime value and profitability at an individual customer level. And give us that understanding around preferences and behaviors and knowledge around those members. And so what do you do with that? Well, you build a highly sophisticated automated system. And that's what we've been working on over the course of the last 2, 3 years, that has AI and machine learning and advanced analytics that allows you to personalize engagements at a member level and allows us to move all of our marketing or not all of our marketing, but a good portion of our marketing away from a one-size-fits-all approach that provides value to the average Canadian. And so when we think about the Triangle program now, we think about it from the standpoint of this continuous learning, automated system that allows us to engage with the customer on a one-on-one basis with highly sophisticated outputs and a P&L at a customer level that really has us understanding elasticity and those things that can provide us better efficiency on the hundreds of millions of dollars of incentive spend that we have in our marketing line item. And then the where we go from here because keep in mind, to Gregory's point, if you go back, context really matters, this loyalty program was only in CTR up until 2018. So 2019, you roll forward with the bank, a critical part of the value proposition. Sport Chek, Mark's. Now we've added Pro Hockey Life and Atmosphere and Party City, Sports Experts, et cetera, et cetera. And many of those businesses had real tough times during COVID and were closed. And so now our data scientists, our analysts are getting a perspective on understanding the value that the system creates for the average member. And what we know to be true now through our analysis is the system is creating more value for each individual component than what a banner could create on its own. So it has us thinking now about how we adjust our op model, our operating model. For years and years and years, we've been operating more akin to a holdco and now with this analysis, we believe there's an opportunity to organize ourselves around the customer and an opco to create even more value for shareholders and for members as we go forward. So very, very privileged, strategic capability. Lots of investment has gone into getting us to where we are now. the model and the automated system is all connected to not only our banners, but also external partners, whether they be CRM or social media platform so that we can put the right messages in front of the customer at the right time and the right channel. And we still have work to do, but I think the heavy lifting is behind us and the model will continuously learn and provide value to -- this is 11 million plus Canadians, right? 70% of Canadian households that we now have an algorithm of understanding for. And so as we move forward, it will be about creating value with that understanding. .

Okay. That's great. I want to come back to strategy. I'll start with an optimistic point of view, let's say, the rate cuts we eventually get do generate the results we're hoping for. What can we expect during the transition to an up cycle at Tire and what changes we'll be seeing?

Yes, maybe I'll take that. And I think it's easy to talk about this from a Canadian Tire retail perspective. Just to give you some practical nuance with the model. Obviously, we go to market different -- different than most with our associate dealer model. The reality of the last 12 months is the dealer confidence is similar to consumer confidence generally speaking. And there we talk about CTC being the canary in the coal mine with respect to the economy, well, they're even ahead of us. So I don't know what the analogy is, but they're ahead of the corporate entity in terms of canary in the coal mine. And so what's happened in the last 12 months in the model? Well, their confidence has not been strong. And so what happens is they pull back. And their consumption from us is weaker than actual consumer demand. And what happens, their inventory draws down, our revenue dries up. Our profitability is attached to the revenue in what we ship to those stores. And so that's kind of how the model works in a downturn. They own the inventory. They own kind of the interest coverage associated with their inventory. So over the last 12 months, they've drawn down their inventory. We think that drawdown has been healthy, but it certainly has impacted us to the point where over the course of the last 12 months, our revenue has been kind of below POS. And so we were on record at the end of Q2 saying with this cautious optimism to home, we think for the balance of the year that, that should normalize. The upcycle works exactly the opposite. And so what's happening now is they're starting to -- they're reading the headlines. They're starting to see where we may have left some sales on the table with that drawdown. We drew down $0.5 billion of inventory in Q2. And we didn't get everything right. So we didn't replenish everything that the dealers would have wanted in season. At the portfolio level, we feel really good. Our service levels were extremely strong, way stronger than they were last year. So I always try and bring them up to the portfolio level. But these kind of little misses of instances whereby we could have attracted more sales at the item level in a store in the region, et cetera, start to manifest in the psyche. And in the -- in that upcycle, the opposite now starts to happen where revenue outpaces consumption and their inventory builds. It's not a -- it's not a light switch. It's more of a dimmer switch. But that is likely what will happen if history repeats itself. And when that will happen definitively is the $64,000 question. But you start to see hints of it already in terms of how they're buying for winter and Christmas, et cetera. And so you think about -- we think about, well, what's our job in that upcycle as you call it. And that is we just need maximum agility in our supply chain. We need to think about where potentially we take some risk where we otherwise wouldn't from an inventory standpoint so that we can be there for them from an in-season management standpoint. We need to bring kind of new products to market and create some excitement that starts to change their psyche. And we need to be there when discretionary demand comes back and gen up demand with our demand creation toolkit. So on the supply chain front, we feel like we're in a better position to do that than we ever have been. We put hundreds of millions of dollars of investment to automate our supply chain over the course of the last 2 years. . We're adding a regionalized distribution center in Vancouver that will open the first few months of the year, which will improve the speed to market turnaround time, et cetera, for a large swath of our Western stores. And we're going to be ready. Our vendor service levels, the global supply chain looks pretty good right now. We've got some domestic challenges that we've been dealing with. But globally, I think the supply chain is sound. So we feel ready to support that upturn when it comes back our way.

The only thing I would say, John, just that the notion of kind of what we talked about since Q3, given the uncertain demand environment around controlling the controllables, that's not going to stop. So yes, everything Greg said, which is absolutely -- it's funny, we've both been doing this together for a while because it was a jump ball question. I think I would have answered the exact same way, but I just wanted to kind of reinforce the notion of kind of that margin management, that cost control? And when we talk about inventory, I think we're talking about being more selective, so we would take more inventory risk versus kind of maybe what we did in '20 during the COVID period, right? So just -- it's because I don't want to get kind of out in front of ourselves too much. Like it's still -- we have a cautious optimism, which is true. But we feel very strongly that the discipline we instill in the place is going to long last, the benefits from them are going to be long lasting. And don't want to let our foot up -- off the gas off of that either.

Well, that's good. No conversation about Tire would be complete without addressing dealer network and dealer health. So I'm glad we touched on that. I want to ask the opposite question from a strategy perspective. If you -- if we don't get the economic activity we want from rate cuts, if you see a more prolonged period of tougher conditions for consumers, how does that influence your go-to-market strategy? Do you do anything different from the past 12 months? Is there anything you've learned from the last period of moderation that would inform your strategy for another round of that?

I'll maybe start and Greg will jump in. Yes, it's interesting, right? Like Greg talked about what's key to us strategically around our connection with our customers. That never changes regardless where we are in an economic cycle. That is core to our strategy around connection with customers. So take that as read around what we're trying to achieve here strategically. But again, I go back to Q3, 12 interest rate increases, an uncertain demand environment, and we went to the tone of control, which you can control. And what does that mean from an operating cost perspective and then look at people, we took about a 6% reduction in our open head count, which was clearly not the easy thing to do. On the inventory side of things, we said we've just got too much inventory. And as Greg said, we worked really hard to be as smart as we could with it. Was it perfect? No. But what it allowed us to do is, frankly, close 12 3PLs and get our operating cost structure back where we want it from a supply chain perspective. I think -- so those are 2 big things that I would say from a cost perspective that we've managed through, while at the same time, not destroying our margin rates. I think that's a really important point to make to go down 15% of your inventory, $0.5 billion, but maintain, if not marginally increase our margin rates, really happy with how the teams managed to do that, although we acknowledge there's probably been a few revenue misses as a result around being out of stock in certain places. So I don't think that notion of again, control on what we control. And then on the margin, there are so many levers. We had often get questions about, well, what about the impact of containers or what about the impact of a promotional environment. We could talk to you about 40 different things that we have at our -- there's a mix of art and science, but there's a lot more science behind margin management that I think is probably is well understood. So I don't see those changing if the economic condition gets worse or doesn't change is that you said even if it improves. Now if you're asking me about demand creation, how are we going to do? The team is working really hard on trying to create demand. And I'll give you a few examples of Q3 around pricing is that of Q2. So I think, Greg, maybe you mentioned lawn mowers that might have been in one of meetings, I can't recall now. But anyway, there wasn't a need really to increase discounting on lawn mowers in Q2. I think how much rain we had. It was hard to frankly keep on the floor. So there wasn't much increase in discounting why bother to be candid. If you look at things like outdoor fund like backyard amusement, like a trampoline, I don't know if you could discount that enough to frankly move any more product. I take it discretionary. So I don't -- we did discounting and it didn't really, frankly, work all that much. But we did -- teams tried and learned and validated, frankly, what our assumption was going in. Now an area like home organization, inside the store, did very well with discount. It actually drove sales in that category in the quarter. So we have the team that has an ability to generate demand what the team is working really hard on is my patio for example. Let's not waste the discounting in an area that you're not going to get any benefit for it. So that's what I see moving forward into balance '24 and into '25. Control which you can control and where can we make -- take action to kind of move demand kind of in our favor. That's how I see the future holding.

The only thing I would add is it goes back to this -- what's the next kind of horizon of opportunity with Triangle is how do you kind of marry that very kind of traditional product discounting approach to your customer understanding. So if we know that there's 0.5 million Canadian households with low indebtedness that should be elastic, how do you turn on your one-on-one algorithms with the right categories and the next best offer engine to stimulate that demand. And so with a lot of data and just interrogating what's happening on the top line of our business over the course of the last 12 months, we're starting to have those conversations, like what if you just had one more trip associated with about 0.5 million. Instead of I'm going to grow this category by 10%; this category by 10% and this category by 10% and these ones are going to go down. It's all going to roll up to something that makes sense for us. it's like go to the household level, go to the member level and think about getting the teams focused on getting another trip and so that's relatively new in terms of our go-to-market strategy.

Okay. I want to conclude on capital allocation. So a couple -- 2-part question here, I suppose, in the context of being involved with exploring an asset sale. How are you balancing demands on capital? And how should we think about pausing the buyback program? .

Yes. I think the first thing I would say is, look, I mean, Canadian Tire, before Greg and I and Greg and I have been consistent as well with a long-term philosophy on a balanced approach to capital allocation hasn't changed in our tenure. I will acknowledge in the short term, there's some differences due to, frankly, buying the shares back for a Canadian Tire Bank. So that's increased our leverage more than we would have liked it to our normal kind of levels. So that's the reason why we've kind of been on pause from a share buyback perspective. But if I go back to kind of a long-term philosophical discussion, it hasn't changed. . First priority is invest in the business. We want to be around another 100 years and have a really strong asset for the management teams in the future to come. And I think we've got a really strong track record of return of capital, either through dividends or share buybacks over that last 10 to 15-year period as well. It's part of the story. We know it's important to investors. And I'll just remind everybody around free cash flow. If you look at retail last year, which was a tougher year from a profitability perspective. The retail business still generate $1.1 billion of free cash. You add to that kind of the dividends we receive from the REIT and from financial services to $1.6 billion, which is more than enough to kind of fund kind of the all of the elements of our capital allocation -- of a [ calculation ] stool -- legs in the stool for '24.

Okay. And then as a follow-up to that, what is the right level of leverage for your business? .

Yes. I'd like us to get -- I think we both would really like this $900 million that we've taken on to be off. We feel with that, that will put us pretty close to the right level of leverage for CTC.

Okay. Maybe we could fit one quick one in. Dividend -- any reason to think differently moving forward than historical?

As I've said, I mean, I think stay tuned. I think you know that Q3 is typically when we -- as part of our Q3 disclosures, kind of mentioned that again, we know it's an important part of the story. So we will take our recommendation through to the Board and look to announce what that will be in the Q3. But I just would remind everybody around kind of the free cash flow generation that the business has in -- even in a tougher year like '23, and you've seen some of the improvements in '24 already around profitability for the first half of the year.

Okay. Great. We'll have to leave it there. I appreciate the insights. So thank you for joining us.

Thank you.