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Investors take hammer to Rona in wake of Lowe's invasion news
But some analysts say don't be hasty, the arrival of chain could be good news
By CAROLYN LEITCH
Friday, June 10, 2005 Page B11
INVESTMENT REPORTER

News that marquee home improvement retailer Lowe's Cos. Inc. is shopping for locations in Canada has sent shares of homegrown Rona Inc. reeling.

But perhaps investors have been too hasty in hitting the sell button: Some analysts say the arrival of Lowe's is good news for Rona shareholders -- at least for a few years.

Yesterday, Rona shares rose 78 cents to $25.33 on the Toronto Stock Exchange, meaning the stock has tumbled 5.7 per cent since The Globe and Mail reported on June 2 that Lowe's, the No. 2 U.S. home improvement warehouse chain after Home Depot Inc., plans to open big-box stores in Canada, starting in the Toronto region.

When Lowe's confirmed the strategy on Monday, Rona shares fell 7.1 per cent to mark the stock's worst one-day performance since it began publicly trading in 2002. All in all, the news has knocked more than 11 per cent from Rona's market capitalization.

The selloff appears to be overdone in the opinion of Desjardins Securities analyst Keith Howlett, who upgraded the stock to "buy" from "hold" as a result. He is maintaining his 12-month price target of $26. Mr. Howlett says his estimates for Rona's profits over the next two to three years are likely to increase, not decrease.

In a note to clients, the analyst says Lowe's impending arrival, which was confirmed by the company this week, may accelerate Rona's own store-opening plans and acquisitions.

For now Mr. Howlett is keeping his 2005 estimate at $1.45 a share and his 2006 estimate at $1.65, but he says those forecasts could rise if Rona steps up store openings.

He also suggests that the New Brunswick-based Irving family, which controls Kent Building Supplies, could consider selling the chain to Rona in light of Lowe's pending arrival.

Mr. Howlett has looked at the proliferation of Lowe's, Home Depot and Menards outlets in states such as Indiana and Michigan and figures that Canada could support about 400 big-box stores, or double the current number.

But the analyst cautions that Rona's strategy, which includes different store formats for different markets, could be tested when Lowe's gets up to speed in about five years -- or if the Canadian homeowner's obsession with buying and bettering houses cools off.

He also points out that Rona's stock price-to-earnings ratio of about 17.3 times this year's profit estimates is approximately on par with the valuations of its U.S. rivals. As a result of the uncertainties and the fairly rich stock price, he has tagged Rona shares "high risk."

At Canaccord Capital, analyst Benoît Caron says the magnitude of the recent selloff is exaggerated. He points out that Lowe's arrival will involve only six to 10 stores in Ontario for a start.

The Canadian home improvement retail market is valued at about $30-billion a year, Mr. Caron says, and, if it keeps growing at 4 per cent to 5 per cent a year, it would be worth $37-billion by the end of 2010.

"We believe Rona is at least four to five years away from feeling any pain from Lowe's northern expansion plans," he says in a note.

Mr. Caron points out that the market has not doled out harsh treatment to the shares of Sears Canada or Canadian Tire, even though the retailers sell power tools, paint, gardening supplies and other items that people use to fix up their homes.

He adds that Rona's most lucrative market is in Quebec, and he believes Lowe's is more likely to venture into Western Canada before it tackles Rona on its home turf.

He figures that Rona's strategy of operating under specialized banners, such as Rona Home and Garden big-box stores and the Lansing name, may shield it from more intense competition. Of the 16 big-box stores Rona operates in Ontario, he believes Lowe's poses a threat only to the eight located in Greater Toronto and, to a lesser extent, the seven Lansing stores.

In a sense, he says, the battle for Ontario's mega-outlet format has already been won by Home Depot Canada. Rona, meanwhile, won the battle for Quebec when it acquired Reno-Dépôt and its prime locations in Montreal. Mr. Caron is maintaining his "buy" recommendation with a 12-month target price of $27 on Rona shares.

But CIBC World Markets analyst Kathleen Wong says Rona shares could languish for the next couple of months to a year. She lowered her 12-to-18-month price target to $25 from $26 and kept her "sector performer" weighting.

While Ms. Wong believes the home improvement boom has some room to run -- helped in part by a recent reduction in mortgage insurance premiums -- she says investors could compress the P/E multiple of Rona in coming months because of the worry that competition is heating up.

Nuts and bolts

Since The Globe and Mail reported on June 2 that U.S. home improvement chain Lowe's plans to enter Canada, the shares of Rona Inc. have fallen 6% per cent. But some analysts are still positive on the stock.