Canadian Tire Corporation Limited (OTCPK:CDNAF) Q2 2016 Earnings Conference Call August 4, 2016 1:00 PM ET
Stephen Wetmore - President & CEO
Dean McCann - CFO
Allan MacDonald - President
Mark Petrie - CIBC
Irene Nattel - RBC Capital Markets
Kenric Tyghe - Raymond James
Peter Sklar - BMO Capital Markets
Derek Dley - Canaccord Genuity
Vishal Shreedhar - National Bank
Jim Durran - Barclays
Chris Li - Bank of America
Patricia Baker - Scotiabank
Keith Howlett - Desjardins Securities
Good afternoon. My name is Valerie and I will be your conference operator today. At this time, I would like to welcome everyone to the Canadian Tire Corporation Limited Second Quarter Results Conference Call. [Operator Instructions] After the speakers' remarks there will be a question-and-answer session. [Operator Instructions]
Earlier today, Canadian Tire Corporation Limited released their financial results for the second quarter of 2016. A copy of their earnings disclosure is available on their website and includes cautionary language about forward-looking statements, risks and uncertainties which also apply to the discussion during today's conference call.
I will now turn the call over to Stephen Wetmore, President and CEO. Stephen?
Thank you, operator and thank you to everyone who has joined our call today. Obviously the main purpose of our call is to discuss the second quarter earnings results that we released earlier today so I will start by saying that once again the teams across all our businesses executed well and delivered another strong quarter. I have complete confidence in our executive team and their ability to drive our businesses forward and they have also done a great job in the last few weeks getting me back up to speed on their businesses and the status of our key initiatives. But given the events in the quarter, I think I should concentrate my remarks at a higher level and give you a sense of how I look at our Company and the importance I place on certain facets of our business.
Before I start however, I would like to take this opportunity to thank Michael Medline for his many years of building the Tire, he has been an integral part of our growth story to date and we truly appreciate all he has done. So a few comments about the future. The purpose of our Company or in other words why we come to work is to prepare Canadians for the jobs and joys of life in Canada. Our strategies are always evolving to fulfill this purpose. Staying focused on this purpose has served us well and is in fact the foundation of our current performance. We are a product-driven company and our products must meet the needs of our customers in four primary areas of living, playing, fixing and driving through all of the Canadian seasons. Financial Services plays a critical role in our strategy and it is a valuable offering for our customers setting us apart in our competitive market. Our suite of businesses, our brands and the products we sell represent a mini-marketplace for our customers that opens many possibilities for the future. The right products therefore at the right price and value are essential to our success and you will be seeing us put much greater focus and emphasis on our product development capabilities as we move forward.
Mark's is a great example of our private label product development. In fact, Denver Hayes is our third largest private label behind Mastercraft and MotoMaster and CTR is focused on Woods, CANVAS, FRANK and NOMA, have demonstrated our in-house design capabilities and are very creative and innovative examples of meeting customer demand for unique products. Over the past few years, we have developed products, purchased companies and acquired brands in order to serve the lifecycle and demographics of our customers and this focus creates tremendous opportunity. We can do a much better job however in managing the lifecycle of our customers as they transition with purchases from Sport Chek and Canadian Tire and Mark's and also take advantage of our financing offers.
The development of our loyalty programs and our ability to analyze the data with key insights is another area I believe must have far greater emphasis and an area where we need to acquire and build the talent we need to move quickly. I mention talent because I believe if we have great people and great products then we have established the foundation for success. And the team we have in place is strong. Externally you may not see all of the moves we have made to date or will be making to not only bring in expertise but to train our management with the skills for the future and the skills to make us better, a more efficient retailer which is really the underlying focus of the productivity initiative that Dean has referenced in the past.
However, this foundation of people and products will never reach its potential without our strategies and initiatives focused on the fact that our customers are in control. We no longer dictate the terms of our customer shopping experiences so we must move rapidly to not only an omnichannel offering but to develop new tools and new skills to meet our customers' demands. We have always said we need to have great products that meet the needs of our customers and that the experience of dealing with Canadian Tire in-store and in the communities where we do business was our differentiator. In this new digital world, it is the experience that has radically changed so we must evolve the experience by moving to a one-to-one relationship through personalization and not simply mass-marketing.
I'm not going to list all our major investments from point-of-sale systems at Mark's and FGL to systems that govern our supply chain, how we communicate with our dealers, systems that provide new tools for our merchants and new financial reporting systems but these initiatives are foundational and will allow us to connect with our customers and do business in a very different way over the coming years. Clearly I couldn't talk to you about our priorities for the future without addressing our digital and online presence. We know that to evolve to a true digital physical environment or digital as our Chief Technology Officer, Eugene Roman, likes to say, e-commerce and digital interactions will play an increasingly critical role in how we connect with our customers.
The enterprise has made incredible steps forward over the last 18 months on e-commerce and we are incorporating digital experiences into both our stores and online presence. The journey to become an omnichannel retailer able to satisfy the customer's needs in whatever manner they want to shop has brought about a major shift in culture for the enterprise, building on our test and learn orientation in every banner and creating even greater collaboration within our businesses and with our dealer partners. Right now we have no fewer than 30 e-commerce initiatives underway providing us critical learning on everything from search optimization to website experience to back-end fulfillment options.
Not all of these will be home runs but every one of them is getting us closer to a more sustainable and profitable model. Like every legacy bricks and mortar retailer, timing and approach are critical because these initiatives are complex and reach across many different aspects of the business, we have to be purposeful in how we execute and rollout capabilities. However, a major benefit to being a multi-banner corporation is our ability to test a variety of approaches in a way that doesn't compromise current performance in any one banner.
As an example, Sport Chek already using a deliver to home model will be testing a same-day delivery option in the GTA this fall. But Chek has also discovered that pay and pick up in the store, CTR's existing fulfillment model may also be a valuable option to offer customers. CTR is experimenting with extended assortments how to balance paper and digital with its innovative WOW guide while Chek continues to replace a significant percentage of their traditional paper flyer advertising with digital options.
Mark's, who recently launched an enhanced online experience and a new e-commerce site for their Quebec franchise business is seeing a 67% increase year-over-year in online sales. I could go on and on with examples of learning in progress but suffice it to say coordination, timing and implementation of these efforts will be one of the biggest focus areas. I remind you that I canceled our e-commerce initiative back in 2009 when I first came on as CEO because I was not happy with how we were executing. The solution was simply not sustainable and lacked the foundational infrastructure and support system to make it successful. I was concerned about the risk to our brand. That said, I have every confidence that we are on the right track now and that we are living at the right pace for the enterprise to be successful in the e-commerce space over the mid- to long-term. Everything I have mentioned today is perfectly in keeping with the strategy we outlined for you in late 2014.
I look forward to connecting with many of you in the coming months and with that let me turn the call over to Dean.
Thank you, Stephen, and good afternoon, everyone. Before I get into the results, I will take a minute to highlight some of the initiatives executed during the quarter which helped boost our results. Stephen mentioned our WOW guide launched by the Canadian Tire team which is an example of how that team continues to innovate and deliver results. E-commerce transactions have more than doubled since the guide went live and we have seen great momentum in app downloads and visits to our website and other digital properties. Of particular note, CTR once again overcame the significant FX headwinds that we faced this order. This was evident in our improved retail segment gross margin that I will comment on in a moment. Once again, our Mark's banner beat our expectations this quarter by putting up a strong positive comp result. This was despite the challenges we continue to face due to higher FX costs, challenging economic conditions in Alberta as well as the related impact on the high-margin industrial business.
I think you all know, I'm pretty sure you do, I wouldn't normally call attention to awards let alone on the earnings call and let alone a marketing award, but I am proud to announce that our Mark's banner won Canada's first ever Cannes Lions Award in the creative data category for their innovative, real time weather related marketing campaign which ran through the winter months last year. You are welcome, Rick. We know that we have world-class marketing talent in our teams across the Company but it is always nice to see them recognized by experts in the industry as well. At FGL, we opened our fifth Sport Chek flagship store on Robson Street in Vancouver which opened with very strong results and just last week, we opened our sixth Chek flagship at Sureway Gardens in Toronto making it the third one in the important GTA market. We continue to evolve the flagship concept as we learn from previous openings by testing new digital installations and adjusting store plans that tailor the products offered to the local market and by introducing and testing new customer experiences, both online and in-store.
We continue to believe that these stores create a positive brand perception in their market and for the banner as a whole and these latest concepts represent the best of what Chek has to offer today.
In the second quarter, Sport Chek and Canadian Tire also began to execute Olympic and Paralympic sponsorship activities ahead of the Rio Olympics by launching our What it Takes and We All Play for Canada marketing campaigns. We believe that sponsorship of sporting events such as the Olympics is good for Canadians, our athletes and our brand. You will see us continue to invest in supporting this initiative throughout Q3 and we will be actively cheering our athletes on to victory in Rio.
Now turning to the second-quarter results. Diluted EPS was up 14.5% to C$2.46 over the prior year reflecting strong earnings across retail businesses offset by investments in growth initiatives and lower year-over-year earnings at Financial Services. Excluding the effect on revenue of lower gas prices, consolidated revenue increased 4.5% over the prior year reflecting strong sales at FGL and Mark's and higher shipments to dealers at Canadian Tire.
Our retail gross margin rate excluding petroleum was up 55 basis points reflecting the positive impact of initiatives at Canadian Tire focused on improving business performance. I've been calling this work productivity but I need a new name reflecting the fact that it is really about improving our retail business performance and doing so in a permanent and sustainable way. That means examining the inputs to our key processes and bringing new tools, analytics, training and in some cases new people resources to drive a different and better output or business result.
And example, our Canadian Tire team has examined the process used to buy products bringing new information to the decision-making that gives us a more complete picture of product costs, changes in the dynamics of supplier negotiations.
Another area undergoing significant change is the line review process which is how the merchandise team, that is our buyers, assess what products will be offered to consumers in a given merchandise category. This process is now much more comprehensive including an analysis of the market, consumer preference and what costs and pricing approach will be used to arrive at the ultimate product range our customer will be offered.
My last example is the great work underway to change how decisions are made and what products will be promoted in our weekly flyer. The Canadian Tire has revamped the decision-making process using new sources of data and analytics to make much better decisions to optimize the tradeoffs that customer demand and margin on promotion decisions. The rewarding thing is it is working as evidenced by the success to date offsetting the negative impacts of FX on our margin.
The real payoff of these types of initiatives over the long run is significant as even small gains and sustained margin improvement will grow our bottom-line contribution.
Now I do want to point out that while there has been success to date in offsetting FX pressure on the margin, FX remains a meaningful headwind as we head into the second half of the year.
Now turning to operating expenses, they were well managed during the quarter. Our consolidated OpEx as a percentage of revenue ex depreciation and amortization and normalized for petroleum were flat to last year despite significant investments in information technology, marketing costs related to the upcoming Rio Olympics and the WOW guide at Canadian Tire, investments at Financial Services to drive future GAAR growth as well as spending to support retail performance initiatives that we have underway.
While we have been recording these costs associated with these investments largely as part of our OpEx numbers, much of the benefit is realized in the gross margin line.
As we look ahead to the rest of the year, our goal remains holding OpEx ex depreciation and petroleum in line with revenue growth. However given the continuing investments that we are making to support company-wide operating efficiency initiatives as well as to drive receivables growth at Financial Services and to support the Olympics, we expect the full year 2016 OpEx rate may end up being slightly elevated.
As we mentioned in previous quarters and as expected, our Financial Services income before taxes was down 7.9% versus the prior year largely reflecting the investments made to drive future receivables growth and increasing the allowance for future write-offs. We were pleased to see Financial Services receivable growth pick up in Q2 and we will continue to invest in new accounts and acquisitions to stimulate growth and generate sales for the Canadian Tire banner throughout the remainder of the year while keeping a close eye on the regulatory environment with respect to interchange.
Our consolidated inventory continues to be well-managed across our businesses and the teams have adjusted their buys for the upcoming seasons to take into account any excess inventory they had on hand at the end of last year. Our overall corporate inventory was up roughly C$100 million over the prior year reflecting an increased position at FGL Sports driven by new purchases to support sales growth in new and comp stores, early receipts of inventory for the fall winter season and some carryover from winter which we continue to expect to sell through beginning in the fall. In addition, Mark's inventory was higher primarily due to an increase in casual footwear and denim inventories to support initiatives that drive sales in these categories.
Our second-quarter retail ROIC was 8.32% up 26 basis points over the prior year mainly driven by stronger rolling 12 month earnings at Canadian Tire Retail and a Q2 2016 effective tax rate that was lower. While our tax rate was down in the quarter from our 2016 estimate of 27.5%, we continue to anticipate that we will land close to that number on a full-year basis. Our capital expenditures were C$117 million higher versus 2015. This was primarily due to increased spending on CT REIT third party acquisitions mainly due to the acquisition of the Sears Calgary Distribution Center and higher IT spend.
The increased pace of capital spending in 2015 and 2016 has as expected increased depreciation expense which was up 10.3% versus Q2 2015. And finally, CT REIT issued C$350 million in unsecured debentures during the quarter at very attractive rates which on a consolidated basis increased our adjusted net debt position. So on balance, I would summarize this as a very solid quarter and as we look ahead to the next two quarters, we continue to anticipate foreign exchange headwinds, further investments to drive Financial Services receivable growth and continued investments in IT, digital, productivity and other initiatives to drive growth across our retail businesses.
I would also note that Q3 2015 had a real estate gain of about C$29 million that boosted the quarter and won't be repeated this year which you should be mindful of when considering our upcoming Q3 performance. Despite these factors, we are pleased with the momentum we have heading into the second half of the year.
With that, I will turn things back over to the operator for the Q&A session. Operator?
Thank you. [Operator Instructions] Our first question is from Mark Petrie with CIBC. Please go ahead.
I wanted to ask about your perspectives on capital priorities for the business particularly as CapEx cycles off after the new DC comes in next year and we sort of move through this spurt of square footage growth particularly at CTR. And I wonder if you could just offer some perspective about the relative investment that has been made in e-commerce and how you expect that to play out over the next couple of years. Also if you could offer, Stephen, your perspective on M&A and how you view that within the CTC environment?
It is Stephen. I will give you a couple of comments and then if Dean wants to kick in on the CapEx he can. My schedule of events just so you know was obviously to focus on the quarter and get things -- get up to date here over the last three weeks and starting next week I am going through every dollar of our capital. So that is my focus for the next six or seven weeks because that is what drives our future. I mean I know what we spent our money on in '15 and '16 and it was well spent and as I mentioned in parts of my script, it is absolutely essential infrastructure. And there is no way that we can go about communicating and doing transactions in an e-world unless we have state-of-the-art infrastructure and systems to support it both in terms of our point of sale systems, etc. Some of it obviously has to be carried over into '17 and some of it into '18 but our big numbers here in the last couple of years obviously have been driven by other infrastructure like our DC.
So we are going to get to where we want to be right across the digital world as fast as we possibly can. But again, you can only handle so much and you have to execute on it. It is one thing to build a great site but it is another thing to have the skill set to be able to operate the site the way you would like it to operate. So no sense one getting ahead of the other. So the focus will continue to be on turning us into a state-of-the-art digital player, there is no doubt about that. And part two was M&A. Well, our view of M&A hasn't changed, Mark, from our '14 comments to tell you the truth. What we need to do, we have, as I mentioned at the beginning of my script, products play an extremely important role if not the critical role in offering our customers what they need. And where products through our own development or buying brands or buying companies which we really did when we bought Mark's and we bought Forzani were to buy products for our customers. So we will stay focused on that and we will jump on opportunities as they arise.
Thank you. Our next question is from Irene Nattel with RBC Capital Markets. Please go ahead.
Thanks and good afternoon. Before I get onto my question, just a follow-up from your last comment, Stephen. Does that mean that you would be interested in acquiring brands that make things which is something you have not done in the past or manufacturers that make things which you have not done in the past?
I wouldn't say that we are focused on that part of it. What we are focused on is to ensure that the lifecycle that I referenced in order to ensure that our customers have the products that they want given their lifestyle within life in Canada, within our four main focus areas, if we need customer products in those areas, then we will search for them hard.
In many cases now looking at manufacturing facilities, very difficult to find. The best thing to do is actually to source so our preference would be to find brands that we can either continue to develop or that are substantiated in the marketplace but the manufacturing side of something is not of particular interest. It is not what we are good in.
Thank you for clarifying that, Stephen. So my question really again follows on this commentary which is when you look at the Canadian Tire family of banners and operations today, where do you think you do a good job and where do you think you are lacking in that whole lifecycle process? And you also called out loyalty in your opening remarks and if you could expand a little bit on that please in terms of where you would like to see Canadian Tire go in terms of loyalty?
I think our traditional focus and what we have done with certainly Mark's and most definitely with the Canadian Tire Retail is to focus on what we call our active families and that is who our products are most suited for. And we can carry that on quite a time past being an active family so the age group is fairly broad but we would say that that would start somewhere in the late 20s and run into 50s.
When we purchased FGL, we had said at the time that we had purchased it because it gave us access to a younger customer and so therefore for us to be able to connect within what I referenced as our marketplace for life in Canada, for us to be able to connect it as early a stage as is possible, to start developing a relationship with our customers is very, very important to us.
So that is where we would need the most focus is to ensure that we are drawing customers at the earliest possible time within our marketplace. We have never traditionally been excellent at capturing what we would call a concentration on kids. Now Allen and the team have done just that. I think it is spectacular.
And we have never been great probably in keeping them through their teens, and late teens and early 20s. I think Sport Chek can play a huge role in that. They have assortment expansion that they can do, and focus that they can do.
If you are going to tie the complete lifecycle together for a customer, you need something that binds them together and therefore playing the experience, having a loyalty program support our strategy is critically important. So I believe that Duncan would tell you that one of his top priorities is to get an unbelievable experience. He has done it now in store and with e-communications now I believe he would like to push it as hard as he can to draw with as many facets as possible. So loyalty plays a big role in the family.
And then presumably as well that also ties in if you are going to hit the late teens and early 20s that also ties in with the digital strategy and the need to be able to do both e-commerce but also really speak one to one with your customers effectively.
Exactly. I mean one thing that we say all the time in here don't forget is that our most digital business, purely digital business is Mary Turner's business at Financial Services. So it to me is just an integral part of the experience and offering that we have to focus on, on each group of our target customer so they have a big role to play as well.
Thank you. Our next question is from Kenric Tyghe with Raymond James. Please go ahead.
Thank you, good afternoon. Stephen, you touched on the 30 plus e-commerce initiatives. I wonder if you could help me frame up understanding how competitors or whether you look at that down the line in terms of understanding that not all of those 30 initiatives will necessarily work but whether those 30 initiatives to your mind will have you in a competitive or leadership position and whether you benchmark that leadership or competitive position down the line against more traditional bricks and mortar competitors? Or whether it is against more traditionally online only type competitors in terms of how you would benchmark the success of your e-commerce initiatives down the line recognizing obviously a lot of moving parts in that equation and not that all of those initiatives will necessarily stick but certainly try to understand how you will benchmark the success of those initiatives going forward?
Yes, great question because everything that we invest our money in and spend our resources on has to have an objective coming out the other end here as to what we expect. I'll give you an example, Allan and the team at Canadian Tire Retail have gone through 190 different assortments to analyze which ones he believes has to have either a different assortment, a different strategy, most susceptible to online players, both competitive, traditional bricks and mortar, competitive players or pure online plays and then start adjusting our strategy accordingly. So our initiatives are very much down to that detail level and every one of them has to have an expectation here.
So, I don't believe that we should aspire to be the number one digital player in the world. It is an impossible aspiration but I think we have to be extremely creative and innovative in our marketplace again, focused on jobs and joy. But it is a very, very detailed way of approaching our business. Having an excellent platform is somewhat table stakes with the exception that I believe Eugene and his team have built platforms that are sustainable and can be operated at the least amount of cost and the highest flexibility which is really quite unique.
But anyway, it is a very, very detailed approach to the online business.
If I could just switch gears quickly, Dean, you touched on and I think Stephen you have as well, just how critical the Financial Services piece is in this whole equation. And I think you also, Dean, touched on how you have finally seen some GAAR growth here, modest as it was in the quarter. Could you speak to some of the initiatives there with respect to the performance of the Financial Services business and perhaps tie a few of the pieces together in terms of the Financial Services performance and Financial Services overlap in terms of the loyalty side as well?
It is Mary. Let me take that one. So I think where I would start is I think you saw our GAAR growth and our customer count start to decline about 18 months ago when we took some very deliberate action to guard against what was going on in the economy. And I think our results and our write-off rates, the stability in our write-off rates is I think is testament to the success of that strategy. It did however as we thought it would, slow down our growth really to what you saw which was a standstill last quarter. So we are very, very encouraged that we are starting to see that turnaround as you said and it is really being driven by, it is really being driven by our strategy on more effective integration with our retail partners. Our customers really like our value proposition, like the products and services that we offer connected to our retail banners and we are starting to see better customer awareness and understanding of how great a benefit that they can get if they work with Financial Services when they shop at our stores. So what we did this quarter is we had two main focuses. One was a really strong and very much integrated marketing program with Canadian Tire Retail where we did TV, digital, radio, a lot of different components and it was a very-very effective promotional program.
Hopefully you all have seen and learned a bit more about Canadian Tire math from our TV commercial. But as well, we promoted a 24-month no fee, no interest financing program at Canadian Tire Retail and what we saw to that was the highest year-over-year growth in sales on our card at Canadian Tire Retail in over 10 years and that led to higher card sales growth this quarter than we have seen in over two years. So we are starting to see the growth in sales, the growth in new customers and the group in GAAR and it is coming out of being more effective at working with our retail partners. It is good for them, it is driving sales particularly of large ticket items because our customers like in-store financing but it is really, really good for our business too. So I think we have turned the corner, we are going to see some momentum building, we are seeing it in multiple spots in our business but as I probably have said in previous quarters, it does take a bit of time so I think we will start to see the momentum building over the next few quarters.
Thank you. Our next question is from Peter Sklar with BMO Capital Markets. Please go ahead.
Dean, I have a question on the Olympics marketing spend and promotional spend you said that spend started in Q2 and obviously will continue concurrent with the Olympics. Can you give us some idea of order of magnitude of how that is affecting results on a year-over-year basis? Is that like noticeable that it is costing a few cents a share on the quarter or just anything you can say to elaborate on the magnitude of these costs?
That is a tough one, Peter, to give you an order of magnitude. All I would say is in an Olympic quarter, we do focus a portion of our marketing dollars on supporting the Olympics. We think it is great for the brand, we think it is an important thing to do. I know the teams try to fit it within existing budgets as much as they can but I would expect that our marketing line will see a bump associated with that and it makes perfect sense.
Measuring the output of that on sales and so on is a classic challenge for finance folks. 50% of it I know is very effective. The other 50% probably isn't. The problem is trying to figure out which 50 is which and I have a bunch of people shaking their head at me at the moment. But that said, the reality is you will see some tick up in marketing spend I think as we look to support this really important initiative in terms of the business.
And I take it that the marketing spend will be more weighted to Q3 than Q2 concurrent with the events?
Yes, what you saw in Q2 a bit of prep for it as the guys prepare commercials and things like that, the execution though you will see in Q3.
Okay. The other thing I wanted to ask you about if someone could talk about the WOW guide. In your release, you are saying that the WOW guide is having a positive impact on sales. I am just wondering how you know that. Do you say that just based on anecdotally or do you have some way of measuring how people are accessing the WOW guide and then referred to the e-commerce site? I'm just wondering how much you know how the WOW guide is affecting your customer.
Peter, it is Allen. Let me start by saying with our closet full of marketing awards, hopefully we are better than 50% from my esteemed colleague [indiscernible]. Sorry, I couldn't resist.
The WOW guide, we are really pleased with and it is not anecdotal at all. So it is a great question. We are tracking the 2000+ SKUs that appear in the WOW guide and we had sales targets against those. We know where we are at in terms of distribution. We had very specific targets in terms of the kind of sales engagement we would get both visits to our site, visits to our digital site and the success of those products through store.
And then ancillary kind of basket related data. So it would be tough for me to share the particulars but we are really, really pleased. As you would expect, the traditional media was well received, I think it was really well done and we are seeing that in sales and we've got a ton of learning on the digital assets and of course that is always slower to come because it is a bit new.
But the digital version of the WOW guide we have been continuing to add capabilities to since we launched it. Of course another paper edition will be coming out in the fall and I think you will see even further improvement. All around I have nothing but good things to say. I think it was a fantastic investment.
And are you able to measure as the WOW guide refers people to your transactional site?
Yes, we can see the flow through in terms of conversion to e-commerce but what is really important and a little bit tougher to measure is the research online buy in in the store conversion which we also know is strong but it is a little tougher to get at specifically because we can see the correlation between visits to the site and then a corresponding increase in sales at store. So we are also pleased with that although that is a part of the business that is still being refined in terms of being able to measure it to the degree we would like.
Okay, thank you.
Thank you. Our next question is from Derek Dley with Canaccord Genuity.
Thanks. Can you guys just talk a little bit deeper about some of the margin growth initiatives that have benefited you guys here in the last couple of quarters? I noted that Forzania, it looks like the margin was a little bit lower just based on some promotional spending there. So can you maybe just talk a little bit about the dynamics at play in terms of margin growth?
I will start and then I will turn it over to Allen to talk about some of the great work that the CTR guys have been doing. So I think what is important is when thinking about retail efficiency or productivity as we have been calling it, there are a lot of things that are underway that are going to bear fruit down the road here. The reality is that it is not just one thing, I think that is Allan's line typically and it is a host of various things, everything from the types of private branding programs that the guys have been doing to the approach in terms of how they are determining pricing decisions as I mentioned with respect to whether it is the flyer or whether the trade-off in terms of elasticity of demand with respect to pricing on reg products any of those things. Bringing more science and data to those decisions are the kinds of things, and I want to be very clear that the retail teams are doing.
We are taking this on the road. Duncan and team are looking at the types of things that they can do in their businesses and a lot of that coming from the learning that we have had in CTR, but areas like space productivity, those types of initiatives to get more out of the boxes that we have a significant investment in which is all targeted at over time driving up our return on invested capital to a level that quite frankly we can be much more proud of than where we are at today.
This has been really exciting for us because as we started to get the performance of the business at the top line and the margin line a little bit more where we wanted it to be, you can shift your focus to really scrutinizing the business which we like to do. And the productivity initiative has really been translated to, as Dean said, running the business better and it starts with really scrutinizing how we are managing our assets. Are our costs appropriate right from our cost of goods right through the business? And we are finding really, really interesting opportunities coupled with a whole new discipline around performance management. So everything from managing cost changes which in a world of 100,000 SKUs and fluctuating transportation of foreign exchange costs, can get very complex, putting systems and processes in place to be able to manage that and monitor it much more closely has been beneficial.
Managing the costs we are investing in promotions and how we are seeing net increases in the businesses' profitability based on our flyer through to simple things like my explanation about the WOW guide and being able to really manage or to measure the benefit that that is seeing in the business.
So we are getting better and better and better across the whole Company. Where I think I am getting really optimistic is proof that we are able to do it, being able to integrate with the team that is a sustainable way of managing the business and as we look forward, I think we have huge opportunities in front of us as Dean mentioned just the productivity of our retail space. And tying back to what Stephen was saying about how we analyzed our other commodity categories, we are going to be able to get much more scientific in terms of how we are monetizing our real estate assets against our categories versus our e-commerce initiatives. That will be a future looking -- a way to look at the business in the future but I think we are developing some really core skills. So across the board I couldn't be happier and I think the whole team is really engaged in analyzing the business in a different way.
And just one more. In terms of the flagships you have added, I believe you are now at six I mean pretty much five for the quarter, now it is six -- flagship Sport Chek I am referring to. Are you starting to see these contribute meaningfully to the same-store sales growth and how many flagships in Canada do you think you could have?
It is Duncan. Thanks for the question. We have pretty aggressive business plans against those flagships especially given the obvious extra investment you need to make in those to have been stand out as they do. Across the board our performance against our own expectations is where we would want it to be. We have not seen erosion of performance of surrounding stores which is a key metric of those being a financial success. I concur with Dean's comments, we think that they really add to the customer experience and lift the brand overall in the market and it is reflective of what our younger customer wants in a shopping experience. In terms of additional flagships, we have six now which I think gives us a good flag footprint across the country, three in the GTA was where we wanted to be. We have talked about whether or not one or two more are needed and below the flagship level, there is a number of stores that we have done some digital renovations to that kind of take general fleet store towards a mini-flagship experience. But I don't think you are going to see a tremendous amount of new flagships. I think the ones that we have are performing very well and the three of them are so new that we want to continue to look at that performance and make sure they do what we want them to do.
Thank you. Our next question is from Vishal Shreedhar with National Bank. Please go ahead.
In terms of the comps in the business lines, was there any inflation in that comp?
So as we look at inflation, we factor in kind of the impact on the overall growth in sales so in other words if you take price up, you are probably going to give up something in terms of volume. So as we look at it in terms of measuring just pure inflation in terms of impact on comps, it wasn't significant in the quarter because of that trade-off as I said. That is not to say that we haven't adjusted pricing in certain areas where competitively we've got the ability to do that. But if you are looking at pure comp, okay, was there -- how much of a factor was just pure taking price up? When you factor in the trade-off of volume and price it wasn't significant. It was really just really good performance. I think there is a bit of that, probably a bit more of that in maybe the Mark's number than certainly in the CTR number.
But in general it is that tradeoff between volume and price that kind of negates if you will the inflation impact in the same store sales number.
Okay, and understand that it wasn't significant overall but will pricing gradually increase conceptually as FX pressures accelerate?
I think to date the teams have been very shall we say measured with respect to how they are approaching pricing. It is sort of competitively driven. And largely speaking, as I said, if we talk about CTR, the approach has been to look at it in terms of impact on volume, elasticity of demand versus moving price up. And really it hasn't been a significant factor in terms of driving comps, it has been more about the nature of the product that is being sold, the great work on brands like CANVAS and NOMA and FRANK and so on, Woods, that the teams have been doing that have basically been the underlying drivers in terms of not only driving demand in the stores but also driving the price per basket or achieve per basket in store.
Okay, and adjusted gross margins in retail were up about 55 basis points if I recall. Last year down about 74; I understand productivity initiatives are continuing to accrue and I think last year, Dean, and I am maybe characterizing this wrong, but there is plus 1, minus 1 situation with some transient hits in the quarter. I would have thought that CTR with the benefit of these productivity initiatives would have closed that gap. I know FGL and FX were a headwind. I just wanted to get your context on that gap relative to last year and why perhaps it wasn't closed. Is it as simple as FGL and FX?
I think FX would be a big factor and if you go back a year and I think this is a point I've been trying to make is around the impact of FX on this Company is more significant certainly than it was a year ago and that goes back to the statements we have been making around the impact of hedging and the glide path to if you will an inevitable, we are tracking towards effectively being at a kind of spot rates. Right? That is the path that we are on here.
Hedging if you go back a year or two has bought the teams time to basically do the kind of things that they have been doing to basically offset largely to date the impacts of FX. So if you go back a year ago, the cost of money for this company in terms of FX was much lower than it is today. And yes, there were some anomalies a year ago but I think if you are comparing to today the fact that we have a retail gross margin on the segment up 55 basis points is a tremendous achievement and in light of the FX headwind that we had to absorb on a year-over-year basis.
Okay, and just last one here, it is a quick one. Given that the margin comps become more and more difficult in retailing and given that FX pressure has accelerated, is that a fair way, a broad way to look at it that we should take into account when we model?
Not sure I understand the question but you are always trying to get me to do your model for you, Vishal. But good for you for trying but I'm not going to give you any help. The reality is though what I would and I did in my comments say is that I would not lose sight of the fact that it is no easy task to continue to offset the headwind associated with FX. And to date, the teams has done a great job of doing that and there is lots of work underway to hopefully continue that. But it is no easy task. So I would not take for granted that on a year-over-year basis the higher if you will cost of FX at this company simply because as I said we are moving to that inevitable status quo where we are in a more current level of cost and money is a formidable task for us to overcome. So I would keep that in mind as you are thinking about going forward.
Thank you. Our next question is from Jim Durran with Barclays. Please go ahead.
Just wanted to go back to sort of the upfront comments by Stephen with respect to emphasis and effort and trying to get e-enabled more quickly. How would the dealer agreement be impacted that? Is it flexible enough to digest the implications of this different channel strategy over the course of time or are you going to need to go back to the dealers and renegotiate the existing contract?
The contract is very flexible from that point of view. We recognize, Jim and we concluded it in 2014 that we probably should have started the next date and negotiate the next one because the world is changing so fast. Where we did extremely well, I mean we took almost two years to negotiate that contract. During the negotiation stage, we, during that period of time we had a point team from the dealers that were negotiating and a point team on our side, Jim Christie and Ken Silver and all issues seem to get dumped into the point team's consideration during that period of time. And it was a different way of managing the business so they knew they had to solve those problems before we could ever do the problems as they were arising at the time before we could ever sign a new contract.
It became an extremely efficient way of actually managing new issues. At that time we were launching loyalty programs and trying to do different tests, et cetera, with the loyalty programs and promotions. So we have continued with that format and I think those players can solve just about any issue that comes at us. We always have and I am quite certain we can handle it. The thing I always try to tell everybody inside and tell everybody else is that through the decades I suspect the dealers have made a well they have a far larger contribution to the success of the company than anybody ever realizes. They keep us on track when we have young MBAs that want to run off and do things and make mistakes and you can't do it when you have the dealers there.
And so we are going to end up as fast as we should move and we're going to end up with a really good solution by the time that we do it that will be fully tested and operational and maintains our brand customer satisfaction. So I think we are fine.
And sort of a follow on to that, I guess from a CapEx or SG&A expense standpoint, am I wrong in sort of viewing it that any sort of acceleration or expansion of the initiative is more of an expense hit than a CapEx hit at this juncture?
Don't interpret my remarks that I'm turning up the heat here because we are on a pretty aggressive path on all our initiatives. I just wanted you to know how important these things are and how fast we are actually moving. So if we can move more quickly in certain areas, Jim, we will but it is not a situation where you should say oh my, they are going to spend another 100 million next year to try to crank things up. We have to have financial performance so it is one thing, we always look at the numbers in the following way that if we put great numbers up, we are in control. And if you don't have good numbers then the outside world ends up being in control. So if we want to stay in our agenda we have to continue to hit our numbers.
So I guess the last question I have on the same subject and I'm going to say don't answer it and we never get to this point. But amongst the various initiatives you have got, I mean look, I think where investors are going to be sitting right now is A, to the question I previously asked, is there any risk to the buyback initiative as a result of any increase in CapEx versus the 625 to 650 general guidance no number? Number two, also part of that obviously on the expense side and then so the final question becomes a much more conceptual and vague one obviously which is how long do you think it is going to be until you are sitting here going okay, in the context of where I thought we needed to be today, we are there. Sure there is always new stuff that comes along and we have to keep on going but how long do you feel it is going to be before you can sit here and say, You, know, I think within reason in the context of the marketplace we are where we need to be and yes, we need to continue to make progress.
We continue and will. There is nothing to take us off that this philosophical look at our financial resources than using a balanced approach to it. I think it is the right way we set this up for years now, we are generating good cash out of the business. We have a very, very strong balance sheet, excellent ratings, maybe too strong in some way. So our view of the future is no different than it was before. Now we give guidance through a fiscal year and we usually tell you what we are going to do in the November period and we are on track to update you in November. As far as -- I have some things that you always have to have these things I guess sitting in my chair that you want to accomplish over certain timeframes. So when we hit those ones I will let you know. I don't believe that I am waiting like to say oh my God, we finally arrived and everything is okay and the world is not changing any more.
It is just going to continue to change on us and so we will be moving ahead all the time, do our best to try to tell you what those major initiatives are as we come across them so you know that we have accomplished them. I would have told you two, three years ago that I can't wait to get a new point of sales system in at Mark's and I can't wait to get a new one in at FGL and I can't wait to get CTR updated. They are coming along. We will have two-thirds of that done pretty soon. And now that is the starting point of generating data being able to analyze things that we could never analyze before. Anyway, we will take you through all of those, Jim, if that kind of -- you told me one day that we should run our stores without any people in them. I can't accomplish that one. I think it is a good idea but I can't do that one. I think it is a great idea.
Thank you. Our next question is from Chris Li, with Bank of America. Please go ahead.
Good afternoon. You have just passed the halfway point on your three-year growth strategy that you set out back in late 2014 at your investor day. And as I look at some of your aspirational sales target, you are right on track with CTR, Mark's you are below but that is understandable because of Alberta and FGL, you are trading a little bit below your 9% target. And so my question is on FGL Sports, would love to hear first, do you think there is an opportunity for retail sales growth to accelerate in the back half to get you closer to that 9% target? And number two, if so, would you share with us how you plan to get there?
Sure, it is Duncan here, Chris. I think overall we are pleased with the retail sales growth that we are seeing, the core categories that we care about are performing the way that you would want them especially when you look at athletic and casual clothing, athletic and casual footwear, we are seeing all the trends heading in the right direction. Those are higher margin categories which we like as well. I don't think Dean would let me comment on what I think we are going to do in the back part of the year. I think if you look at the trend that we have had over the last four, six, eight quarters, we are heading to where we want to be.
That is helpful and maybe a quick one for Dean just more of a clarification. Can you help us understand a little bit the impact on the accounting change that you had on the gross margin when you reclassified some of the e-commerce expense freight cost that are now in cost of goods sales versus SG&A before? What was the impact of that change on gross margin?
It wasn't significant. It was the right way to do it and we can take that one off-line with you but I wouldn't get hung up on it. I've talked to a number of folks about that, it is not significant but we did highlight it because it was a different way of doing it.
Really it is a function of bringing, we had that service if you will outsourced in terms of e-commerce fulfillment for FGL and we brought it in house so it used to be an operating expense down in SG&A and now we treat it the same as we do with any other fulfillment expenses and put it through cost of goods. But it is just not a big factor in the whole scheme of things and it will rinse through over the course of the next four quarters. I wouldn't get [indiscernible] about it.
Thank you. Our next question is from Patricia Baker, with Scotiabank. Please go ahead.
Thank you very much for taking my question. I see the 2 o'clock mark has gone so I thought I wasn't going to be able to get in here.
Stephen, my first question really is for you and it may rehash some of what you were discussing with Jim but I still want to ask the question. I want to get back to your opening remarks and reference a remark that you made and you pointed I think to a goal and the importance of really getting to one-on-one personalization and sort of call that out as the goal for as you move to become a more, a better or a true omni or digital player in the marketplace.
I am just curious about whether or not that kind of thinking and the goal for one-on-one personalization has always been there in your efforts for Canadian Tire to become a true digital player or is that a new evolution in the thinking? And in either case, where have you seen this done well and who should we think of you as maybe benchmarking to get to that true one-on-one personalization?
What I'm trying to get across I guess is the importance of the way we used to run the business in many ways that we used product as the thing that we wanted to be the best at and I think our differentiator was the overall Canadian Tire experience. And while product remains, I think the world is changing in the way that our customers experience Canadian Tire and therefore, we have. So when they, rather than being only impressed by television ads, radio ads, by things that we do in the community and only impressed by walking into our stores, they are now, we now communicate with them predominantly actually through digital. So therefore, our whole experience has been and will radically change.
So, the experience now becomes rather than a mass market experience through the tactics I just described to a one-on-one experience, it is how the individual is experiencing us through all touch points and that requires an enormous, enormous amount of expertise. I have come across small companies that I believe do this extremely well. I think I have come across companies in the United States that are online players that have developed a customer relationship, I've come across some small ones in Canada that it is quite extraordinary how they have got identity and their customers trust them and they have never ever seen them. This is all a virtual business almost. And so that skill set, that is the thing I'm trying to differentiate between the investment and what you have in your head. And so that is what I am referencing that if we can get good at that, we can create the next generation of our products delivered for your life in Canada from an early age to a very old age. That is what my reference was.
Okay. Thank you. Just a very quick follow-up, Dean, one of the real highlights of the quarter was that massive turn in the same-store sales at Mark's Work Warehouse. It was quite impressive to see. Is there anything unusual or strange that happened there or are they on a new trajectory?
Patricia, it is Rick here. I will answer that. We were up against a pretty solid quarter in Q2 last year with a 2.9 comp so to come up to 4.6 was quite good. We still however feel the negative impacts of the oil in Alberta. But really what did it for us we had, we continued our focus on casual footwear and the casual apparel categories led by denim and we also had a little boost in Northern Alberta the week before Fort McMurray re-opened where people kind of loaded up to get some cleanup here before they moved back up there so that was kind of I would say a little bit of a one-time pop.
But as far as going forward, we don't give guidance but I do expect to feel still the effects of the price of oil in the province of Alberta and so we will consequently still feel some headwinds in the industrial segment and of course in FX; but I also still expect to see some continued success in our casual categories, both clothing and footwear especially led by denim.
Thank you. Our last question is from Keith Howlett with Desjardins Securities. Please go ahead
I will risk flogging a dead horse here but I just wanted to speak about the strategic plan which was a three-year plan introduced in late 2014 and I guess one half of the way through the plan, the Board has made a CEO change. So I am just trying to get a sense of where the progress maybe or the direction maybe off or a variant to what the Board had in mind a year and a half ago?
As the Board stated at the time of announcing the change, it was their long-term view of the complexity and what they saw ahead and the skill set that they wanted to take on the challenge. And we tried to be very specific at the time to say that -- and I will reiterate it, that there is not an issue with the Company. We are on track. The medium-term plans that we set for ourselves are on track. We are very pleased with where we have invested and that our strategy stays intact. And so I can only reference you back to what they said at the time and it is not something that you should believe that has a short-term impact.
Just if I could follow with that and I think it is probably dangerous to have yard posts on something this complex long-term, but when would you sort of anticipate achieving a world-class digital platform?
The world-class digital platform and innovation that we have referenced over the last couple of years was in relation to us playing our own game I believe if I got the reference accurate. And we always try to reference it in that way so that we know our limits, what we can do and what we can't do. But innovation has to play a foundational part of that. So with what we do and with what our customers expect of us, I think we can meet their expectations in hopefully in a world-class way. Having said that, I have no intention of asking the organization to go out and beat Amazon on an innovation play. I am not into that investing in drones and things.
Is it fair to say we are on the right road and we are progressing to where we need to be for our particular business?
I am very pleased with it. It always, always is complex. I'm not saying that and we mentioned even with the 30 initiatives that we are going to have some that fail and test and learn environment. I would encourage that greatly. I think we all feel that way that we have to stay out there and try things. We will, we will have more successes than failures but in a research environment, a failure is as good as a success so it tells us what we should and shouldn't do.
So we are going to push it very, very hard. We will meet our customer's expectations, I firmly believe that and we will always keep you posted. I mean this is not a secret, the stuff that we do most of it is public. And we try things and do test trials and things like that. So I just, this is one of the most exciting times that I have ever been in in any of the industries I have worked in. This is absolutely spectacular and the most challenging part of this is that it hasn't been done before. That is what the whole management team is excited about. There is no model.
In 1992, when Walmart came here we had to build more stores. We knew how to build more stores it wasn't like we will get greater access, this is a totally different challenge and we are going to be very successful at it.
Thank you. This will conclude today's call. A webcast of the conference call will be archived on Canadian Tire Corporation Limited investor relations website for 12 months. Please contact Lisa Greartix or any member of the IR team if there are follow-up questions regarding today's call or the materials provided. You may now disconnect.
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