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Published by Raymond James Ltd., a Canadian investment dealer. Please see end of INsight for important disclosures. www.raymondjames.ca
NOVEMBER 25, 2009
Dollarama DOL-TSX
Initiation of Coverage: Dollar for Dollar - Solid Value
Event
We are initiating coverage on Dollarama Inc. (DOL‐TSX) with an OUTPERFORM rating and a $23.00 price target.
Action
Strong operating metrics and continued value retail market dominance support what is a relatively rich valuation. We recommend investors accumulate Dollarama shares at current levels.
Analysis
We believe Dollarama is in an enviable position in both absolute and relative terms, given its square footage growth opportunities, superior relative merchandising competency and continued increases in scale efficiencies. In addition, the multiple (versus single) price point strategy introduced by DOL in February 2009, with price points of $1.25, $1.50 and $2.00 provides incremental flexibility to DOL’s merchandising options as well as an inflation hedge.
We believe these incremental positives largely offset the risk of increased exposure to a broader range of competitors as a result of the switch to a multiple price point strategy, and the consequent impact on the relative value perception and positioning of the dollar store concept. The above factors impute strong incremental sales growth and modest EBITDA margin expansion opportunities, which supports our positive thesis on DOL.
Valuation
We apply a target EV/F2011E EBITDA multiple of 10.5x, and a F2011E EPS P/E multiple of 18.0x in addition to a DCF in our DOL price target calculation. Our EV/EBITDA multiple is supported by the continued deleveraging of DOL’s balance sheet and is essentially in line with Dollar General’s IPO pricing. Our target P/E multiple is at a nominal premium to top‐tier Canadian retailers, which is well supported by DOL’s operating metrics and growth outlook.
The average of our valuation methodologies imputes a $22.66 valuation on DOL. We initiate coverage of Dollarama with an OUTPERFORM rating and a 6‐12 month price target of $23.00.
CONSUMER PRODUCTS & RETAIL
Kenric S. Tyghe, [email protected]
Sara Kohbodi (Associate)[email protected]
RATING & TARGETRATING *Target Price (6-12 mths) *Closing PriceTotal Return to Target 13.9%
MARKET DATAMarket Capitalization ($mln) 1468Current Net Debt ($mln) 386Enterprise Value ($mln) 1855Shares Outstanding (mln, f.d.) 72.7Avg Daily Dollar Volume (3mo, mln) n.a.52 Week Range n.a.
KEY FINANCIAL METRICSFY-Jan 31 2009A 2010E * 2011E *EPS (C$) -0.36 1.02 1.22P/E n.a. 19.8x 16.6xEPS - 1Q -$0.17 0.24 A 0.27EPS - 2Q $0.18 0.62 A 0.29EPS - 3Q -$0.27 0.21 0.33EPS - 4Q -$0.10 0.30 0.33EBITDA ($mln) 154 169 199EV/EBITDA 12.1x 10.9x 9.3xRevenue ($mln) 1,089 1,252 1,381
COMPANY DESCRIPTION
*Note: Introducing New Target, Rating & EstimatesClosing price as of Nov-20-09
All figures in C$, unless otherwise noted.Sources: Raymond James Ltd.,ThomsonOne, CapIQ
With nearly 600 stores, Dollarama Inc. is Canada’s largest value retailer. While approximately 75% of existing stores are located in Ontario and Quebec, the Company is committed to expand its network and increase its presence in the Atlantic and the Western provinces, which currently constitute 10.4% and 15.2% of total store count, respectively.
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OUTPERFORM 2
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Table of Contents Investment Highlights ................................................................... 3 Company Profile........................................................................... 4 Investment Thesis ........................................................................ 6 Players in North American Value Retailing ................................... 16 Key Metrics of North American Value Retailers .......................... 22 Ownership and Management ..................................................... 26 Financial Analysis and Outlook ................................................... 28 Valuation and Recommendation................................................. 29 Risks .......................................................................................... 36
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Investment Highlights
Dominates Canadian Value Retail Landscape Dollarama dominates the Canadian value retail landscape to the point that it defines the space. With a store count in excess of 4 times larger than its nearest competitor, and as the only value retailer with a coast to coast presence, DOL appears poised to extend its dominance still further. DOL, given its corporate owned store model (versus the franchise centric model of the majority of its competitors), delivers a consistency of format and merchandising across its footprint against which its competitors are largely unable to compete. Significant Square Footage Growth Opportunities Despite the 16% CAGR in store count since 1992, we believe significant further square footage growth opportunities exist in both the major urban centres of the Greater Toronto Area (GTA) and Greater Vancouver Regional District (GVRD) and smaller centres across Quebec, Ontario and British Columbia. With a conservative store opening rate of approximately 40 stores per year (over the last 3‐years DOL has opened an average of 55 stores per year), and management’s belief that the Canadian market could support 900‐plus stores from the current approximately 600 stores, DOL’s square footage growth has a significant amount of runway. Solid Operating Metrics While a number of DOL’s key operating metrics, including a consistent store margin contribution of 21% and F2011E EBITDA margin of 14.4%, are industry leading, there remains significant opportunity for improvements in Inventory Velocity and Yield. As DOL implements key technology and systems initiatives (specifically targeting its inventory management capabilities) it is not unreasonable to expect further improvements in DOL’s ROIC through F2012. These technology initiatives impact on inventory velocity will likely be further bolstered by the acceptance of additional payment methods. DOL began accepting debit cards in F3Q09 and is currently running a credit card test program in 73 stores. Brand Awareness Given DOL’s dominant market position and appeal to a relatively wide demographic, it is not surprising that it enjoys enviable brand awareness and a very strong value perception. The combination of strong brand awareness and high perceived value explains DOL’s very high conversion rate of traffic to purchase.
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Company Profile
With nearly 600 stores, Dollarama Inc. (DOL‐TSX) is Canada’s largest value retailer. Founded in 1992, Dollarama has evolved from a family retail business into a large network of stores across Canada. Funds advised by Bain Capital acquired an 80% interest in Dollarama in 2004, while the remainder was owned by members of the founding family and management team prior to its Oct‐09‐09 IPO. The company raised ~$300 mln by listing 17.1 mln shares on the Toronto Stock Exchange on Oct‐09‐09 at $17.50 per share.
Dollarama’s store network expansion represents a compounded annual growth rate of 16%, expanding from 44 stores in 1992 to 585 stores as of Aug‐02‐09. While sales growth closely tracked the store network growth at 16% CAGR, EBITDA increased from $47 mln in 2002 to $161 mln in F1H10, representing an 18% CAGR.
Exhibit 1: Performance Snapshot Source: Company Reports, Raymond James Ltd.
Dollarama’s growth model has relied heavily on the opening of new stores in Ontario and Quebec, where store network concentration is the highest. While 75% of existing stores are located in Ontario and Quebec, the company is committed to expand its network and increase its presence in the Atlantic and the Western provinces to further solidify its position as the Canadian dollar store retailer with a national footprint. The Atlantic and the Western provinces currently constitute 10.4% and 15.2% of total store count, respectively.
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Although general merchandise is largely retailed at a single price point of $1.00, Dollarama recently (as of February 2009) introduced $1.25, $1.50 and $2.00 price points, which provides the company with an excellent tool to improve same‐store sales as well as gross profit margins. The chain’s commitment to continuously improve its cost structure implies that management will consistently monitor the targeted mix of merchandise (general merchandise, consumable and seasonal products), making every effort to provide a consistent shopping experience across its store footprint.
DOL currently operates four warehouses and a centralized distribution centre in the province of Quebec, all of which provide it with ~1,373 mln square feet of capacity, sufficient to cost‐effectively service ~150 additional stores. The distribution centre processes some 9,000 pallets per week, and the combined warehouse capacity totals some 110,000 pallets.
Some 89% of DOL’s merchandise is distributed through the company’s distribution centre, and the remaining 11% is directly shipped to the stores by the original suppliers.
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Investment Thesis
North American Value Retailers DOL dominates the Canadian dollar store business, with ~585 locations and $1.2 bln in annual sales. The other notable dollar store retailers in Canada are:
A Buck or Two; 141 franchise stores. Dollar Store With More; 146 franchise stores. Great Canadian Dollar Store; 113 franchised stores. Dollar Giant Inc.; 60 corporate stores. Everything for a Dollar Store; 80 franchise stores.
A Buck or Two has no specific provincial concentration. Dollar Store with More leads Western Canada with 88 stores in British Columbia and Alberta, compared to DOL’s 55 and Dollar Giant’s 43. Great Canadian is neck‐and‐neck with DOL in the Maritimes with 62 stores versus DOL’s 61 stores, and has a limited presence in Western Canada and essentially no presence in either Quebec or Ontario. Dollar Giant’s store footprint is heavily Western Canada focused but has successfully established a presence in Ontario with 19 stores. While Dollar General (DG‐NYSE) is the largest of the U.S. value retailers, it does not dominate the value retail landscape to the same extent that Dollarama does in Canada. According to recent IBISWorld data, DG commands ~21% market share versus Family Dollar (FDO‐NYSE) at ~16%, Dollar Tree (DLTR‐NASDAQ) at ~9%, Big Lots (BIG‐NYSE) at ~6.5% and 99 Cents Only (NDN‐NASDAQ) at ~2.6%. The top 5 value retail chains in the U.S. command ~59% market share versus in Canada, where they command in excess of 80%.
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Macro Overview, Themes and Drivers The Debate: Trade Down or Share of Wallet In our opinion, one of the more material issues in assessing DOL at this point in the cycle, is whether now is the appropriate time to rotate out of defensive value retailers and into more cyclical hardline retailers. That dollar stores, club stores and Wal‐Mart (WMT‐NYSE) all saw increases in traffic through the recession is well documented. The sustainability of this growth is, to our mind, the more relevant consideration at this point and hinges on the basis of the underlying consumer behaviour behind the increase. The question is whether the significant acceleration in same‐store‐sales (SSS) growth experienced by the value retailers is a function of a trade down by consumers during the recession or value retailers securing a greater share of wallet of existing core customers. The Consumer Trade Down Argument The value retailers delivered very strong sales growth through the early 2000’s recession (mild as it was relative to the 2007 – 2009 recession). This growth was attributed to the value retailers merchandising of low priced needs versus wants items, leaving them well insulated through the downturn. Exhibit 2 highlights the relative SSS growth outperformance of the value retailers during, and the decline in momentum coming out of, the recession. Exhibit 2: SSS Growth 1999‐2005 Source: Company Reports, Raymond James Ltd., Raymond James & Associates
SSS % Growth Ticker 1999 2000 2001 2002 2003 2004 2005Family Dollar FDO 7.8% 5.2% 4.1% 5.8% 3.8% 1.8% 2.3%Dollar General DG 6.4% 0.9% 7.3% 5.7% 4.0% 3.1% 2.2%99C Only Store NDN 6.1% 2.0% 5.9% 3.6% 4.5% ‐1.5% ‐0.8%Dollar Tree DLTR 5.0% 5.7% ‐0.1% 1.0% 2.9% 0.5% ‐0.8%Best Buy BBY 13.5% 11.1% 4.9% 1.9% 2.4% 7.1% 4.3%Home Depot HD 10.0% 4.3% 0.7% ‐0.5% 3.8% 5.4% 3.8%Lowes LOW 6.2% 1.2% 2.4% 5.8% 6.7% 6.6% 6.1%PetSmart PETM 4.6% 1.4% 6.5% 9.6% 7.0% 6.3% 4.2%
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If we turn our attention to the 2007 – 2009 recession, the value retailers have continued to deliver the strong retail SSS growth, which has averaged ~4% since 1Q08. The robust sales growth has been achieved despite increasing unemployment levels, which at first blush seems counter intuitive given that it is the core demographic of the value retailers that is often perceived as the most vulnerable during periods of economic weakness. Exhibit 3 illustrates the SSS growth through the most recent recession. Exhibit 3: SSS Growth of U.S. Value Retailers 2007 – 2009 Source: Company Reports, Raymond James, Raymond James & Associates A key tenant of the trade down argument is that as the economy recovers, and given that no‐one aspires to shop at a dollar store, the pace of SSS growth will moderate as consumers revert back to their preferred retailers. This argument, however, is coloured by the question of whether or not the U.S. and Canadian consumer has entered a new era of thrift, and if so, what is the new normal for the consumer, as it relates to the outlook for the value retailers; essentially how long is the collective memory of the consumer (in our opinion, short) and what impact does this have on consumer behaviour and the propensity to trade‐back‐up as the recovery gathers momentum.
SSS % Growth DG BIG DLTR FDO NDN1Q07 2.4% 4.9% 5.8% 0.9% 2.9%2Q07 3.0% 5.2% 4.4% 0.4% 5.2%3Q07 3.0% ‐0.5% 1.9% 1.5% 6.1%4Q07 0.4% ‐0.6% ‐0.8% 1.0% 2.9%
1Q08 5.4% 3.4% 2.1% ‐1.0% 1.5%2Q08 10.1% 2.8% 6.5% 0.0% ‐0.5%3Q08 10.6% ‐0.2% 6.2% 0.1% 4.7%4Q08 9.4% ‐3.2% 2.2% 5.6% 4.2%
1Q09 13.3% ‐0.5% 9.2% 2.1% 6.2%2Q09 8.6% ‐2.4% 6.8% 6.4% 7.2%3Q09E 7.3% 0.0% 6.5% 6.2% 2.3%4Q09E 7.0% 2.0% 2.5% 1.0% 3.5%
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The Share of Wallet Argument The counter argument to the above is that value retailers’ SSS growth rates have outperformed due to their success in securing an increased share of wallet through a number of key initiatives. These initiatives have included an expansion of the range of consumables, improved in‐stock inventory position and the acceptance of a broader array of payment methods. Supporting the above argument is the reality that coming out of the last recession, while SSS growth weakened, it was more a function of the explosion in store count and square footage growth (among a number of incremental macro and competitor specific factors) through the recession, than consumers necessarily trading up. Through the last recession, publicly traded U.S. value retailers had added in excess of 2,500 stores by the end of 2002 and a further 4,000 locations by the end of 2005. This translated into square footage growth of 31.2% for the big four U.S. value retailers. Exhibit 4 illustrates the magnitude of store count growth from 2000 to 2005 and how it slowed as key markets absorbed the store build‐out. Exhibit 4: New Store Growth (Calendar Year) Source: Company Reports, Raymond James Ltd., Raymond James & Associates
BIG DG DLTR FDO NDN# Y‐o‐Y % Y‐o‐Y % Y‐o‐Y % Y‐o‐Y % Y‐o‐Y % Y‐o‐Y %
2001 250 16.8% 10.8% 14.2% 12.3% 25.5%2002 307 22.8% 3.4% 10.3% 14.6% 11.5% 22.8%2003 331 7.8% 3.6% 9.6% 10.6% 8.9% 25.2%2004 349 5.4% 5.0% 9.3% 8.8% 7.3% 15.9%2005 398 14.0% ‐6.7% 8.3% 6.5% 8.3% 5.9%2006 463 16.3% ‐1.9% 3.8% 10.5% 5.7% 8.2%2007 521 12.5% ‐1.6% ‐0.4% 6.0% 4.2% 5.6%2008 564 8.3% ‐1.0% 2.1% 5.3% 2.2% 7.2%
DOLStore Growth Rate
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Consumables as the Category Value retailers have increasingly focused on the consumables category to drive SSS growth. The higher concentration of consumables in value retailers merchandising mix, which drives incremental sales, traffic and gross profit dollars, also adds significant complexity to store operations. At first blush, a higher percent of consumables in the mix pressures gross profit margins (given the inherently lower margins on food and other consumables) versus the more traditional value retailer merchandise, and the increased complexity that consumables add to the supply chain. As we detail later in this report, the value retailers in the U.S. have proved quite adept at managing the negative margin impact of increased consumables in the merchandising mix. The reality is that the value retailers (from mass merchandisers to dollar stores) have been reporting an increased shift toward basics and consumables and away from more discretionary items. Consumables from the value retailers perspective, while biased toward cleaning (laundry and dishwashing detergents) and personal health (shampoo and toothpaste), have seen a rapid increase in food (candy, soda, canned foods and box items). Given the demographic served by FDO and DG, both have been accepting Supplemental Nutrition Assistance Program (SNAP) (food stamps) and Electronic Benefit Transfers (EBT) as a means on payment since 2007. In order to be eligible to accept food stamps as a form of payment, the retailer must at a minimum sell bread, milk and eggs. Both FDO and DG have and will likely continue to increase consumables despite their already high percentage of the mix. Exhibit 5 illustrates the change in DG and FDO’s merchandising mix from 2006 to 2008. We believe DOL’s consumables as a percentage of mix will top out at 40% given the above dynamics, and as such we see only a nominal increase from the current 37%. In Canada the equivalent welfare benefits are not in the form of food stamps but rather in cash payments.
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Exhibit 5: DG and FDO Merchandising Mix Source: Company Reports, Raymond James Ltd. It is this key difference between the two markets that we believe largely drives the disparity in consumables (specifically perishables) as a percent of the merchandising mix. DOL is also more similar to DLTR in terms of target market demographic (i.e. distinctly more middle‐, than lower‐income). DLTR’s percent of consumables in the mix is significantly lower than both DG and FDO at ~49%. Comparing the current merchandising mix between DOL and its North American peers highlights quite how material the differences are between them, and the opportunities (or threats). The multiple (versus single) price point strategy introduced by DOL in February 2009, with price points of $1.25, $1.50 and $2.00 in addition to the $1.00 (with the exception of candy at $0.65) strategy that the company had followed from F2003 – F2009 provides incremental flexibility to DOL’s merchandising options. The flip side of the new pricing strategy is that it does, in our opinion, raise some interesting questions on the relative value perception and positioning of the ‘dollar store’ concept in consumers’ minds and increase DOL’s exposure to key competitors. Dollar Giant, a significant DOL competitor in Western Canada, moved to a $1.50 on the vast majority of its merchandise shortly after DOL’s move in February. In DOL’s F2Q10 ended August 2009, items selling above the $1.00 threshold represented just 24% of sales. We expect this will increase significantly as DOL changes the composition of its consumables and general merchandising mix, in an effort to retain the increased share of wallet it garnered during the recession.
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The change in strategy most closely mirrors that of DG, which also uses a multiple price point strategy biased towards the $1.00 mark. FDO and BIG, both of which follow a multiple price point strategy, have a significantly higher percentage of products above $1.00 than either DOL or DG, and a higher cap on prices (i.e. a significant number of product prices that exceed $10.00). DLTR and NDO, follow a single price point strategy, of everything for a dollar or less, which was the strategy followed by DOL prior to February 2009. In our opinion the low average ticket inflates the perceived value of dollar stores. The average ticket at DOL is ~$6.93, at FDO and DG it is ~$9.68 and at DLTR it is ~$7.49. In addition, some products within dollar stores are special packs that cannot be found at other retailers, further obfuscating the consumer’s ability to compare prices. As mentioned earlier in the report, while at first blush the increased consumables concentration in the mix initially negatively impacted gross margins of DOL’s peers, the impact has been more than offset by greater buying leverage as value retailers have become ever more significant in the consumables category, and increased their sophistication through increased use of pricing optimization techniques and software. Exhibit 6: North American Value Retailers Gross Margins Source: Company Reports, Raymond James Ltd, Raymond James & Associates A further point of reference in terms of mix is the impact of the target demographic of the key value retailers, which varies both in terms of income band, and urban versus rural mix of stores.
DOL BIG DG DLTR FDO NDN% % % % % %
2002 30.2% 42.2% 28.3% 36.4% 33.5% 40.2%2003 30.8% 41.8% 29.4% 36.4% 33.8% 40.1%2004 26.9% 40.7% 29.5% 35.6% 33.8% 39.0%2005 31.8% 39.1% 28.7% 34.5% 32.9% 37.5%2006 33.7% 39.9% 25.8% 34.2% 33.1% 39.2%2007 34.1% 39.6% 27.8% 34.4% 34.0% 38.4%2008 34.1% 40.0% 29.3% 34.3% 33.6% 39.3%
Gross margin percentage
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Similarities and Subtle Differences of the Business Models and Demographics According to the U.S. Census Bureau, real median U.S. household income declined by 3.6% (from $52,163 to $50,303) between 2007 and 2008, offsetting the gain in income experienced over the past 3 years and coinciding with the recession that started in December 2007. Both DG and FDO are squarely targeted on the low‐middle income demographic, with the emphasis on the low versus middle. In excess of 53% of DG’s customers have household incomes below US$30,000; at FDO the number of households at or below this threshold is 44% according to recent Nielson Homescan data. An estimated 25% of customers at both DG and FDO have average annual income of US$20,000 or less, which is very close to the official U.S. poverty threshold. Exhibit 7: U.S. Poverty Rates
Source: U.S. Census Bureau, Raymond James Ltd
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Dollar Tree as Dollarama’s Closest U.S. Peer DLTR is something of an anomaly in the value retail segment; despite the fact that it is a true dollar store with ~95% of merchandise priced at below $1.00 (NDO follows a similar strategy), its focus is distinctly more middle America or rather the more affluent value retailer customer. This positioning is very similar to that of DOL. In contrast to both DG and FDO, DLTR stores are relatively more concentrated in shopping centres that house Target (TGT‐NYSE) and Best Buy (BBY‐NYSE) with stores and locations designed to appeal to a broader market than FDO. The want versus need focus of DLTR is even more apparent, given its lower relative mix of consumables than either DG or FDO. DLTR consumables as a percentage of merchandising mix in 2008 were 49% versus DG at 69% and FDO at 61% (recall both DG and FDO have significantly higher food offerings in their consumables category given their core demographic and importance of food stamps to this demographic). DOL’s consumables mix in 2008 was closer to 35%. While we expect consumables will continue to increase modestly as a percent of DOL’s mix, the current consumables mix supports a thesis that DOL remains more want (seasonal and general merchandise) than need (consumables) focused. This want focus tends to drive targeted shopping from more affluent customers, while core lower income customers will shop the store. Exhibit 8 highlights the median household income and population density of DOL, DLTR, DG, FDO and Wal‐Mart (WMT‐NYSE).
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Exhibit 8: DOL Relative Population and Income Demographics Source: Company Reports, Raymond James Ltd. We provide a more detailed summary on DLTR’s key metrics and each of DOL’s North American peers later in the report.
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Players in North American Value Retailing
Dollarama (DOL‐TSX)
DOL with ~585 stores is in excess of 4 times larger than its nearest competitor, Dollar Store with More at 135 stores and is the largest value retailer in Canada. DOL is the only value retailer with a presence in all 10 provinces, with 75% of stores based in Ontario (232) and Quebec (211).
DOL’s store prototype is approximately 10,000 square feet gross. DOL recently switched to a multi‐point price strategy with approximately 24% of merchandise priced at more than a $1.00.
Given DOL’s target demographic of middle Canada and greater focus on wants versus needs, DOL’s merchandising mix is materially different from either DG or FDO, and more closely mirrors that of DLTR. DOL’s percent of consumables in its merchandising mix is ~37% versus DLTR at 49%, DG at 69% and FDO at 61%. DOL’s merchandising mix is illustrated in Exhibit 9. Exhibit 9: DOL Consumables and the Merchandising Mix
Source: Company Reports, Raymond James Ltd and Raymond James & Associates In addition, DOL benefits from both superior buying power and sourcing reach versus its Canadian peers due to its relative size and presence. DOL’s buying advantage provides it with access to a broader array of vendors, which facilitates its ability to bring new and DOL‐specific product to market quicker than its competitors. On the sourcing front, 58% of DOL merchandise is sourced offshore, with no single supplier accounting for more than 6% of purchases which imputes low supplier concentration and risk. DOL is, in our opinion, far and away the most adept of the Canadian value retailers in its offshore sourcing capabilities, and continues to successfully leverage this competency.
2008 Merchandise Mix
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Dollar General (DG‐NYSE) DG is the largest U.S. value retailer, with 8,577 stores in 35 states. DG was acquired in 2007 by KKR in a $7.2 bln deal that valued DG at an estimated 12.3x EV/EBITDA. DG’s F2007 EBITDA was $478 mln and improved to $860 mln in F2008. DG’s $21.00 IPO price on Nov‐12‐09, its enterprise value of $10.8 bln and LTM (last twelve months) EBITDA of $1.1 bln, imputes a 10.0x EV/EBITDA multiple. DOL’s LTM EV/EBITDA multiple based on its IPO price of $17.50 was 11.0x. DG’s store prototype is approximately 8,000 square feet gross. DG follows a multi‐point price strategy with in excess of 68% of merchandise priced at more than a $1.00. DG’s store base remains more rural than urban despite the increased focus on, and development of, its urban footprint. DG targets low and low‐middle income households and its largest and closest competitor is FDO. While DG’s share of wallet from lower income families with less than $25,000 has been growing, 20% of its revenues growth has been attributed to ~22% of customers with household incomes in excess of $70,000. Given its position as a convenience niche next to the grocers and Wal‐Mart, DG’s consumables offering as a percent of the merchandising mix is the highest of the North American Value retailers. DG’s merchandising mix is illustrated in Exhibit 10. Exhibit 10: DG Consumables and the Merchandising Mix Source: Company Reports, Raymond James Ltd and Raymond James & Associates
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Family Dollar (FDO‐NYSE) FDO is the second largest U.S. value retailer with 6,625 stores in 44 states, with a store base that remains more urban than rural. FDO continues to re‐align space to more profitable categories namely food and paper products (away from apparel and footwear). Through 4Q09, ~48% of FDO’s store base was realigned, and consumables had increased to 64% of mix, from 61% in F2008 and will likely trend higher as FDO completes its in‐store realignment. FDO’s store prototype at 8,000 square feet is equivalent to DG. FDO follows a multi‐point price strategy with products that range for under $1.00 to $10.00 with ~79% of items selling above the $1.00 mark. Given its position and focus on the low income customer and acceptance of SNAP (food stamps) in ~60% of stores currently, FDO’s food as a percent of consumables is higher than its peers. FDO is second only to DG in terms of consumables as a percent of merchandising mix, which is underpinned by its serving of a materially lower income demographic than DLTR, and a significantly greater focus on needs versus wants. FDO’s merchandising mix is illustrated in Exhibit 11. Exhibit 11: FDO Consumables and the Merchandising Mix Source: Company Reports, Raymond James Ltd.
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Consumables General Merchandise Seasonal/Electronics
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Dollar Tree (DLTR‐NASDAQ) DLTR is the third largest U.S. value retailer with ~3,750 stores in 48 states, and is distinctly more Middle America than either DG or FDO, a reality reflected both in its merchandising mix and its store location and feel. In addition, we believe that DLTR is DOL’s most relevant peer given its market position, merchandising mix and store prototype. Clearly, DLTR with less than half the stores of DG does not dominate the value retail landscape in terms of store count as DOL does in Canada. DLTR’s store prototype at 10,000 square feet is the largest of the big 3 value retailers, and is further differentiated by a strategy of locating in high volume shopping centres (adjacent to anchors such as Target). Recall that both DG and FDO store footprints are heavily weighted toward second tier space. In addition, unlike either of it two larger competitors, DLTR follows a single price point strategy of $1.00. It is the largest value retailer to pursue this strategy, which has necessitated a certain amount of de‐contenting on occasion in order to protect its margins on select items. DLTR’s merchandising mix is materially different from either DG or FDO. DLTR’s percentage of consumables in its merchandising mix is 49% versus DG at 69% and FDO at 61%. DLTR’s merchandising mix is illustrated in Exhibit 12. Exhibit 12: DLTR Consumables and the Merchandising Mix Source: Company Reports, Raymond James Ltd.
2008 Merchandise Mix
5.5%
45.8%
48.7%
Consumables General Merchandise Seasonal
2006 Merchandise Mix
7.9%
44.9%
47.2%
Consumables General Merchandise Seasonal
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Big Lots (BIG‐NYSE) BIG, cast as a value retailer is the next largest in the space with ~1,340 stores in 47 states, and a differentiated business model centred on overrun, closeout, and discontinued products from in excess of 300 vendors from around the world. In contrast to its more traditional value retailer competitors, some 69% of BIG’s merchandising mix is discretionary items. BIG’s target demographic is also more upper middle and focused on customers with a $50,000‐plus income and a discounter mentality. A further differentiator between BIG’s model and a typical dollar store is that it does not accept food stamps and is not in the perishable foods business (recall that DG and FDO are both actively expanding their perishable food offerings and business hours, in order to become even stronger competitors in the convenience food retail niche). Given its target demographic and the fact that BIG is not in the perishable food segment, its consumables merchandising mix at ~31% is significantly lower than that of its peers. BIG’s merchandising mix is illustrated in Exhibit 13. Exhibit 13: BIG Consumables and the Merchandising Mix Source: Company Reports, Raymond James Ltd.
2006 Merchandise Mix
25.9%
27.8%46.3%
Consumables General Merchandise Seasonal/Hardlines
2008 Merchandise Mix
26.5%
30.4%
43.1%
Consumables General Merchandise Seasonal/Hardlines
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99 Cents Only (NDN‐NYSE) NDN, the smallest of the “Big 5” U.S. value retailers, is best described as a deep discount grocery store, with ~282 stores in 4 states. Despite a problem plagued entry into the Texas market in June 2003, the store footprint remains heavily weighted toward California. NDN has long struggled with company specific execution gaffes, most notably its entry into the over‐stored Texas dollar store market, weak financial controls and IT infrastructure. While NDN’s single price point strategy mirrors that of DLTR, the merchandising mix and opportunistic buying programs are key differentiators. In excess of 50% of NDN’s purchases are opportunistic buying of overruns and closeouts. NDN offers an attractive channel for manufacturers given that it never advertises branded merchandise which allows the manufacturers to avoid any channel conflict with full‐price customers. We estimate that in excess of 68% (the highest of any of the value retailers) of the merchandising mix is consumables (including a significant perishables foods offering). Unlike the other value retailers, NDN’s system constraints are such that it is unable to provide its sales mix by category.
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Key Metrics of North American Value Retailers Despite the increased sales contribution from consumables, sales per square foot, margins and inventory productivity are improving for most of the value retail sector. While the merchandise, real estate, operating strategies and competitive environments of these companies vary, the rate of change and trends in these key financial and operating metrics is, we believe, instructive relative to our DOL thesis. Sales per Square Foot Sales per square foot (sales productivity) continues to improve for the value retailers due to a number of company specific initiatives, including acceptance of alternate payment methods (credit, debit, food stamps), expansion of the consumable mix and strengthening of their discretionary offerings. DOL began accepting debit cards (which currently account for ~29% of sales) in F3Q09. The average debit card ticket is 2.5x the average cash ticket. In addition DOL is currently piloting a credit card program in 73 stores, which will further expand the accepted payment forms once rolled out across the entire store footprint. The acceptance of credit cards once fully implemented, will likely facilitate a further increase in DOL’s average ticket size. Exhibit 14 highlights the sales per square foot change on a calendar year basis for the value retailers. DLTR’s relative performance from 2000 to 2007 was, we believe, negatively impacted by the transition to its 10,000 square foot prototype and NDN by its disastrous entry into Texas in 2003. Exhibit 14: North American Value Retailers Sales / Avg. Square Foot Source: Company Reports, Raymond James Ltd., Raymond James & Associates
BIG DG DLTR FDO NDN$ Y‐o‐Y % Y‐o‐Y % Y‐o‐Y % Y‐o‐Y % Y‐o‐Y % Y‐o‐Y %
2003 0.7% 2.2% ‐9.0% 3.0% ‐3.8%2004 235.16$ ‐3.3% 1.4% ‐9.6% 1.4% ‐12.4%2005 255.89$ 8.8% 4.2% 2.2% ‐7.5% 1.8% ‐4.1%2006 260.41$ 1.8% 7.2% 0.3% 1.9% 3.0% 1.8%2007 245.83$ ‐5.6% ‐0.7% 2.8% ‐1.9% 1.8% 3.5%2008 246.52$ 0.3% 0.6% 7.9% 1.3% ‐0.8% 2.5%
DOLSales/Avg.Sq.Ft.
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Gross Profit per Square Foot Gross margin rates and perhaps importantly gross margin per square foot for the value retailers has been improving despite the growth in contribution from lower margin consumables. The unfavourable mix impact on gross margins has been more than offset by a number of margin expansion catalysts. The key margin expansion catalysts include greater buying leverage as the value retailers have become increasingly relevant players in the consumables space (which has translated into better mark‐ups), and growing use of pricing optimization tools and software. In our opinion, DOL, while tracking to plan on a full SAP and point of sale (POS) scanning rollouts (January 2011) among other key IT initiatives, is behind the systems and inventory optimization curve relative to its North American value retail peers. The current IT and logistics enhancement initiatives offer further gross margin expansion opportunities for DOL. Exhibit 15: North American Value Retailers Gross Profit / Avg. Square Foot Source: Company Reports, Raymond James Ltd., Raymond James & Associates Operating Expense per Square Foot In the value retail segment, specifically for the single price formats (DLTR, NDN and until recently DOL), continuously finding ways to manage down operating expenses is an imperative, as there is no way to pass through cost increases. That DLTR, as the largest of the pure dollar stores has been the most successful of the U.S. value retailers at managing expense margins for best in class performance should not come as a surprise, given the economies of scale from their larger store prototype rollout among other initiatives. What is a surprise is the extent to which DOL’s expense margins (while still relatively impressive in both absolute and relative terms) increased 384 bps over the same period to 20.3% from 16.5% (excluding the Bain & Company management fees).
BIG DLTR FDO NDN DG$ Y‐o‐Y % $ $ $ $ $
2004 63.31$ 42.14$ 59.33$ 40.27$ 82.36$ 46.45$ 2005 81.40$ 28.6% 42.20$ 53.30$ 39.88$ N/A 46.18$ 2006 87.80$ 7.9% 46.15$ 53.77$ 41.37$ 75.74$ 41.65$ 2007 83.80$ ‐4.6% 45.55$ 53.11$ 43.20$ 80.63$ 46.14$ 2008 84.18$ 0.5% 46.22$ 53.53$ 42.35$ 81.89$ 52.45$
Gross Profit/Avg.Sq.Ft.
DOL
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As DOL accelerates it expansion in the GTA and GVRD, we expect that the realities of higher square footage rental, logistics and labour costs will continue to pressure G&A margins. Exhibit 16 details the change in operating expense per average square foot of the value retailers. Exhibit 16: North American Value Retailers Operating Expense / Avg. Sq.Ft. Source: Company Reports, Raymond James Ltd., Raymond James & Associates Inventory Productivity Inventory represents ~45% of the assets (net of cash and goodwill) at DOL versus ~40% at the U.S. value retailers; inventory productivity is hence critical. The key inventory productivity measures are inventory velocity (revenue generated from each dollar of inventory) and inventory yield (gross profit from each dollar of inventory). The largest improvements in sales productivity and return on invested capital (ROIC) have been achieved by DG and FDO. This should not come as a surprise given the magnitude of the U.S. recession, their value proposition and target demographic, and the quantum of benefit from their refined pricing and inventory control strategies. Inventory velocity has improved at all the U.S. value retailers as illustrated in Exhibit 17. This improved velocity has been driven by the following:
Elimination of unproductive SKUs
Increased sophistication of the inventory replenishment technology and systems has improved in‐stock levels of productive SKUs and reduced the safety stock requirement.
Acceptance of additional forms of payment (debit and credit cards)
In contrast to its U.S. peers, DOL inventory velocity has been soft, due in part, we believe, to its relatively late introduction of additional payment methods in the form of debit cards and perhaps more importantly the limitations of its current inventory control and optimization infrastructure. DOL’s manual inventory counts worked well in the past, but are simply inadequate relative
BIG DLTR FDO NDN DG$ Y‐o‐Y % Y‐o‐Y % Y‐o‐Y % Y‐o‐Y % Y‐o‐Y % Y‐o‐Y %
2004 39.76$ ‐5.4% ‐7.9% 2.9% 3.9% 3.5%2005 43.15$ 8.5% ‐0.7% ‐7.4% 5.5% N/A 1.7%2006 45.89$ 6.3% 1.6% 2.6% 4.0% 0.5% 4.6%2007 47.64$ 3.8% ‐5.2% ‐0.9% 5.4% 7.1% 7.3%2008 50.17$ 5.3% 1.0% 0.3% ‐0.6% 4.4% 4.7%
Operating Expense/Avg.Sq.Ft
DOL
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to best in class value retailers. DOL management has a number of in‐progress systems initiatives, specifically targeting improved inventory management capabilities. DOL has attached universal product codes (UPC) to approximately 50% of its merchandise items and continues to build‐out the requisite systems infrastructure for a January 2011 POS system implementation date. Successful rollout and implantation of these initiatives is, in our opinion, an imperative, given DOL’s poor inventory velocity performance relative to its U.S. value retail peers. Exhibit 17: North American Value Retailers Inventory Velocity/Avg. sq. ft Source: Company Reports, Raymond James Ltd., Raymond James & Associates We are of the opinion that an improvement in inventory velocity, on the back of its in‐process technology and systems deployments (recall POS scanning capability is scheduled to be fully rolled by January 2011), combined with the possibility of a full credit card rollout, represents a material opportunity for DOL to further improve its ROIC, which is essentially in line with majority of its peers but significantly lags that of industry leader (DG) at >19%. However, inventory yield improvements will, we believe, be harder for DOL to secure, given that the key driver of the improvement of this metric for the U.S. value retailers has been the marked increase in consumables mix. Essentially, the incremental revenue growth (increased consumables mix drives increased traffic) has more than offset the lower margin of consumables. Given that we expect DOL’s consumables in the mix to remain within a range of 35% – 40% through our forecast window the efficiency gains for the POS rollout are critical. The estimated annual cost savings from the POS initiative of $15 ‐ $20 mln are, we believe, the single largest lever for improvements in DOL’s ROIC, given that we expect inventory yield will likely remain range bound through our forecast window to F2011. Exhibit 18 illustrates the value retailers’ historical ROIC estimates.
BIG DG DLTR FDO NDN$ Y‐o‐Y % Y‐o‐Y % Y‐o‐Y % Y‐o‐Y % Y‐o‐Y % Y‐o‐Y %
2003 2.9% 4.5% ‐10.1% 3.3% ‐4.3%2004 ‐5.7% ‐2.0% ‐5.7% ‐1.2% ‐17.6%2005 3.9% 4.7% 8.7% ‐3.4% 0.1%2006 5.55$ 17.1% ‐1.4% 12.5% 6.5% 6.5%2007 5.34$ ‐3.8% 1.8% 19.3% 7.3% 7.5% ‐2.6%2008 4.86$ ‐8.9% 4.2% 6.1% 2.4% 2.4% 8.4%
DOLInventory Velocity
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Exhibit 18: North American Value Retailers ROICs Source: Company Reports, Raymond James Ltd., Raymond James & Associates
Ownership and Management
As of Nov‐02‐09, the directors and executive officers, as a group, directly or indirectly, owned ~12.4 mln common shares, representing ~17% of shares outstanding. As of Oct‐08‐09 and following the completion of Dollarama’s Initial Public Offering, Funds advised by Bain Capital (Bain Dollarama (Luxembourg) One) represent ~58% ownership of common shares outstanding on a fully diluted basis. Mr. Larry Rossy, founder and CEO, has ~12% interest through his direct and indirect holdings and is the largest individual holder.
% Δ bp % % % % %2004 8.0% 10.7% 13.0% 7.4% 12.7%2005 9.8% 8.6% 10.3% 10.9% 4.1% 12.0%2006 10.7% 80 11.4% 10.5% 11.0% 4.0% 7.8%2007 9.0% ‐164 9.7% 10.5% 11.4% 3.1% 13.8%2008 10.7% 172 10.4% 10.8% 11.1% 3.5% 16.9%
DGFDO NDNROIC (%)
DOL BIG DLTR
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Exhibit 19: Senior Management Profiles Source: Company Reports, Raymond James Ltd. Exhibit 20: Shareholders Summary Source: Company Reports, Raymond James Ltd.
Bain Dollarama (Luxembourg) One S.à.r.l. 42,219,575 58.1%Total Institutions and Others 18,121,297 24.9%Top Management & Insiders 12,351,063 17.0%
Total Shares Outstanding ‐ Diluted 72,691,935 100.0%
Senior Management Position Description
Rossy, Larry Chief Executive Officer and Director
Mr. Rossy founded Dollarama in 1992, when he made a strategic decision to implementthe ʺDollar Storeʺ concept, with a focus on the expansion of its retail network. As theCompanyʹs CEO, his responsibilities entail new store development and site selection aswell as overseeing the overall management of the organization. Mr. Rossy is also amember of Dollaramaʹs Board of Directors.
Nomicos, Nicholas SVP, Interim Chief Financial and Secretary, Director
As an operating partner at Bain Capital since 1999, Mr. Nomicos serves as Senior VicePresident, Interim CFO and Secretary. Mr. Nomicos has held various senior positions atOak Industries, a component manufacturing conglomerate serving telecommunicationand appliance control industries. He is a Director of Dollarama, and well as a member ofBombardier Recreational Productsʹ Board of Directors.
Rossy, Neil SVP, Merchandising, Director Mr. Rossy serves as Senior Vice President, Merchandising, responsible for overseeingwarehouse construction and store fixture design, as well as merchandising and creatinghouse brands. He also serves as a Director.
Gonthier, Stephane Chief Operating Officer Since September 2007, Mr. Gonthier has been the serving as Chief Operating Officer.Prior to joining Dollarama, he held various senior positions at Alimentation Couche‐Tard(ATDʹB‐TSX) from 1998 to 2007.
Assaly, Leonard SVP, Information Technology and Logistics
A veteran in the retail industry, Mr. Assaly has held various executive positions with theCompany since 1973. As Senior Vice President, Information Technology, he isresponsible for designing and overseeing the development and implementation ofsoftware applications.
Robillard, Geoffrey SVP, Import Division Mr. Robillard serves as Senior Vice President and was the owner and President of ArisImport from 1973 to 2004, which assisted Dollarama in establishing direct overseassourcing capabilities. His responsibilities entail coordinating and managing the entireprocess of sourcing internationally, and working with buyers to choose merchandise.
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Financial Analysis and Outlook
We believe that DOL’s growth, and more specifically the SSS acceleration through the recession was more a function of a traffic growth from an increased share of wallet from its core consumers and the lift in average ticket prices from the introduction of the multi‐point price strategy, than from a material trade down by Canadian consumers. Our share of wallet argument is, in our opinion, supported by the fact that the depth of the recession in Canada was less severe than it was in the U.S. by a number of key measures, and the core lower‐middle – middle consumer targeted by DOL is of a different income demographic to the core (and more economically sensitive) low income consumer of DG and FDO. On the above basis, and consistent with the key drivers of our investment thesis we have detailed our DOL estimates below. A number of anomalies, including but not limited to the one‐time IPO related expenses and previously included interest expense related to preferred shares (eliminated with using a portion of the IPO proceeds), limit the merits of using EPS growth comparisons for F2010 and F2011, supporting our belief that EBITDA growth is the more relevant metric through our forecast window. Revenues
Our F2010, F2011 and F2012 revenue estimates assume SSS growth of 7.2%, 4.2% and 4.1% for revenue of $1,252 mln, $1,381 mln, and $1,515 mln, respectively. SSS growth comps in the first half of F2011 will be tough, given the positive impact of the multi‐price strategy in F1H10 on sales. We expect net new store openings of 47 stores in F2010, 44 stores in F2011 and 50 stores in F2012. The moderation of new store growth rates to the mid‐high single digit range is due in part to the nature of the real estate markets in the Western Canada, which we believe will impede the pace of DOL’s site selection. Gross Margin We believe that positive impact of the multi‐price point strategy will be partially offset limited improvements in inventory yields as DOL’s POS system is only scheduled to go live in January 2011. Consequently, our gross margin estimates are relatively conservative at 34.3%, 34.4%, and 34.6%, in F2010, F2011, and F2012, respectively.
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Our gross margin estimates drive gross profit of $427.1 mln, $475.2 mln and $524.4 mln in F2010, F2011 and F2012, respectively. EBITDA Our F2010E EBITDA of $169.5 mln and F2011E EBITDA of $199.0 mln for year‐over‐year growth of 10.4% and 17.4%, respectively, exclude F3Q10 impact on SG&A of IPO related expenses. For F2012, our EBITDA estimate is $216.5 mln. Our SG&A dollars for F2010E, F2011E and F2012E are $257.6 mln, $276.0 mln, and $307.7 mln for SG&A margins of 20.6%, 19.9%, and 20.3%, respectively. EPS Our EPS estimates for F2010, F2011 and F2012 are $1.02, $1.22 and $1.39, respectively. As previously mentioned, a number of anomalies limit the merits of using EPS growth comparisons for F2010 and F2011.
Valuation and Recommendation
Our DOL valuation is derived from the average of our P/E, EV/F2011E EBITDA and DCF valuations. Given DOL’s relatively strong free cash flow generation and low maintenance capex due to the nature of the underlying business model, the use of a DCF model is well supported. We have also used a P/E based valuation to further triangulate our imputed value on DOL. EV/EBITDA Valuation Methodology While we are cautious on the sustainability of the improved EBITDA margins and would be more comfortable if we had a number of additional quarters to augment the margin expansion thesis, an argument could reasonably be made that the company and market specific differentiators alone warrant a premium relative to the peer group. On this basis, applying a 10.5x multiple to our F2011E EBITDA imputes a valuation on DOL of $23.50. Given what is a relatively conservative multiple that we apply to DOL, we have provided a sensitivity table in Exhibit 21 for a range of EBITDA multiples from 9.5x–11.5x for imputed valuations of $20.75 ‐ $26.24 based on our F2011E EBITDA of $199 mln.
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Exhibit 21: EV/EBITDA Sensitivity Matrix Source: Raymond James Ltd. P/E Valuation Methodology We apply a target F2011E EPS P/E multiple of 18.0x, which is at a nominal premium to top‐tier Canadian retailers. Exhibit 22 depicts our sensitivity matrix for a range of P/E multiples from 17.0x to 19.0x for imputed valuations of $20.70 ‐ $23.14 based on our F2011E EPS of $1.22. Exhibit 22: P/E Sensitivity Matrix Source: Raymond James Ltd. Discounted Cash Flow Our DCF assumes an 9.4% cost of equity based on the 10‐year GOC bond (risk free rate), a relatively high 6.0% spread given the risks of accelerated Western Canada expansion, a beta of 1.0 and a 10.0% cost of debt to derive our 9.7% weighted average cost of capital (WACC). We have assumed a 2.0% terminal growth rate given what is a relatively mature value retail space. On the basis of above assumptions our DCF imputes a valuation of $22.55 for DOL. Exhibit 23 below depicts the sensitivity matrix for a terminal growth rate between 1.0% and 3.0% and a WACC between 8.7% and 10.7%.
24.87$ 9.5x 10.0x 10.5x 11.0x 11.5x
189$ 19.44$ 20.75$ 22.05$ 23.35$ 24.66$ 194$ 20.10$ 21.44$ 22.77$ 24.11$ 25.45$
199$ 20.75$ 22.13$ 23.50$ 24.87$ 26.24$
204$ 21.41$ 22.81$ 24.22$ 25.63$ 27.04$ 209$ 22.06$ 23.50$ 24.95$ 26.39$ 27.83$ EB
ITDA, $ʹm
lns
$21.92 17.0x 17.5x 18.0x 18.5x 19.0x
1.12$ 19.00$ 19.56$ 20.12$ 20.68$ 21.24$ 1.17$ 19.85$ 20.44$ 21.02$ 21.61$ 22.19$
1.22$ 20.70$ 21.31$ 21.92$ 22.53$ 23.14$
1.27$ 21.55$ 22.19$ 22.82$ 23.46$ 24.09$ 1.32$ 22.40$ 23.06$ 23.72$ 24.38$ 25.04$
EPS ($)
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Exhibit 23: DCF Sensitivity Matrix Source: Raymond James Ltd. DOL Valuation and Price Target The average of our valuation methodologies imputes a $22.66 valuation on DOL. We initiate coverage of Dollarama with an OUTPERFORM rating and a 6‐12 month price target of $23.00.
Terminal Growth Rate$22.55 1.0% 1.5% 2.0% 2.5% 3.0%8.7% $23.14 $24.48 $26.03 $27.83 $29.94
9.2% $21.68 $22.84 $24.17 $25.69 $27.46
9.7% $20.38 $21.40 $22.55 $23.86 $25.36
10.2% $19.23 $20.12 $21.13 $22.26 $23.5510.7% $18.20 $18.99 $19.87 $20.86 $21.98D
iscoun
t Rate
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Exhibit 24: DOL’s Income Statement (C$ ‘000) Source: Company Reports, Raymond James Ltd.
Dollarama Inc. F2008A F2009A F2010E F2011E F2012E(Year ended January/31)
Sales 972,352$ 1,089,011$ 1,251,907$ 1,380,721$ 1,514,651$ Y‐o‐Y % Change 9.5% 12.0% 15.0% 10.4% 9.7%
Cost of sales and expensesCost of sales 640,885$ 717,141$ 824,829$ 905,699$ 990,399$
Gross Margins 331,467$ 371,870$ 427,078$ 475,163$ 524,409$
Gross Margins % 34.1% 34.1% 34.3% 34.4% 34.6%Gross Margins % y/y improvement (basis points) 37 6 11 16 21
G&A 188,429$ 221,612$ 257,594$ 275,990$ 307,708$ EBITDA 146,288$ 153,568$ 169,483$ 199,031$ 216,545$
EBITDA Margin % 15.0% 14.1% 13.5% 14.4% 14.3% Y‐o‐Y % Change 0.2% 5.0% 10.4% 17.4% 8.8%
Amortization 18,389$ 21,818$ 24,844$ 20,711$ 22,720$ EBIT ‐ Operating income 124,649$ 128,440$ 144,640$ 178,462$ 193,981$
EBIT % 12.8% 11.8% 11.6% 12.9% 12.8%
Interest expense on long‐term debt 72,053$ 61,192$ 51,104$ 34,471$ 28,619$ Interest expense on amounts due to shareholders 23,027$ 25,709$ 23,645$ 17,515$ 17,515$ Foreign exchange loss (gain) on derivative & debt (34,411)$ 44,793$ (28,834)$ ‐$ ‐$
EBT‐ Earnings (loss) before income taxes 63,980$ (3,254)$ 98,725$ 126,475$ 147,847$
EBT % 6.6% ‐0.3% 7.9% 9.2% 9.8%
Provision for income taxes 13,935$ 12,250$ 24,479$ 37,943$ 46,941$ Net earnings (loss) for the year 50,045$ (15,504)$ 74,246$ 88,533$ 100,905$
Net earnings (loss) for the year % of sales 5.1% ‐1.4% 5.9% 6.4% 6.7%
Basic net earnings (loss) per common share 1.18$ (0.36)$ 1.02$ 1.22$ 1.39$ Diluted net earnings (loss) per common share 1.17$ (0.36)$ 1.02$ 1.22$ 1.39$
Basic shares outstanding 42,481,546 42,575,817 72,491,935 72,491,935 72,491,935 Diluted shares outstanding 42,600,000 42,575,817 72,691,935 72,691,935 72,691,935
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Exhibit 25: DOL’s Statement of Cash Flows (C$ ‘000) Source: Company Reports, Raymond James Ltd.
Dollarama Inc. F2008A F2009A F2010E F2011E F2012E(Year ended January/31)
Operating activities
Net earnings (loss) for the year 50,045 (15,504) 74,246 88,533 100,905
Adjustments for:Amortization of property and equipment 18,094 22,310 25,131 20,982 22,991 Amortization of intangible assets 3,521 2,267 1,809 1,809 1,809 Change in fair value of derivatives 74,748 (84,437) 60,896 ‐ ‐ Amortization of financing costs 6,340 5,802 2,484 ‐ ‐ Foreign exchange loss (gain) on long‐term debt (118,777) 143,512 (94,213) ‐ ‐ Amortization of unfavourable lease rights (3,226) (2,759) (2,096) (2,080) (2,080) Deferred lease inducements 2,312 2,276 912 ‐ ‐ Deferred leasing costs (450) (575) (50) ‐ ‐ Amortization of deferred leasing costs 161 245 157 ‐ ‐ Deferred tenant allowances 3,806 2,643 1,833 ‐ ‐ Amortization of deferred tenant allowances (1,024) (1,343) (818) ‐ ‐ Stock‐based compensation 1,312 741 616 616 616 Capitalized interest on long‐term debt ‐ 20,760 13,030 ‐ ‐ Capitalized interest expense for amounts due to shareholders 21,297 23,852 9,748 ‐ ‐ Future income taxes 13,581 9,136 5,860 ‐ ‐ Other 223 38 14 ‐ ‐
71,963 128,964 99,559 109,859 124,241 Changes in non‐cash working capital components (20,647) (12,179) (13,904) (26,010) (24,551) CFO 51,316 116,785 85,654 83,850 99,690
Investing activities
Purchase of property and equipment (45,994) (40,502) (34,211) (34,211) (34,211) Proceeds on disposal of property and equipment 432 189 9 ‐ ‐ Net settlement of derivative financial instruments ‐ (9,415) ‐ ‐ ‐
(45,562) (49,728) (34,202) (34,211) (34,211)
Financing activities
Increase (decrease) in amounts due to shareholders 626 ‐ (70,100) ‐ ‐ Increase (decrease) in common shares 1,374 ‐ ‐ ‐ ‐ Financing costs (506) (208) 20,700 ‐ ‐ IPO of Common Shares ‐ ‐ 279,300 ‐ ‐ Proceeds on long‐term debt ‐ ‐ ‐ ‐ ‐ Repayment of long‐term debt (28,734) (26,920) (238,312) (50,000) (55,000)
(27,240) (27,128) (8,412) (50,000) (55,000)
Increase (decrease) in cash and cash equivalents (21,486) 39,929 43,040 (361) 10,479 Cash and cash equivalents – Beginning of year 47,775 26,289 66,218 109,258 108,897 Cash and cash equivalents – End of year 26,289 66,218 109,258 108,897 119,376
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Exhibit 26: DOL’s Balance Sheet (C$ ‘000) Source: Company Reports, Raymond James Ltd.
Dollarama Inc. F2008A F2009A F2010E F2011E F2012E(Year ended January/31)
Assets
CurrentCash and cash equivalents 26,289 66,218 109,258 108,897 119,376 Accounts receivable 3,363 2,998 1,573 1,731 1,899 Income taxes recoverable 4,003 ‐ ‐ ‐ ‐ Deposits and prepaid expenses 11,519 4,710 5,710 5,710 5,710 Merchandise inventories 198,500 249,644 292,679 325,205 355,882 Derivative financial instruments ‐ 33,175 1,769 1,769 1,769
243,674 356,745 410,989 443,311 484,636
Property and equipment 111,936 129,878 139,975 155,284 168,585 Goodwill 727,782 727,782 727,782 727,782 727,782 Other intangible assets 117,147 115,210 113,294 111,485 109,676 Derivative financial instruments ‐ 33,423 5,598 5,598 5,598 Total assets 1,200,539 1,363,038 1,397,638 1,443,461 1,496,277
Liabilities
CurrentAccounts payable 22,256 39,729 60,056 66,730 73,025 Accrued expenses and other 43,062 37,760 43,361 43,361 43,361 Income taxes payable ‐ 5,692 8,469 8,469 8,469 Derivative financial instruments 94,239 ‐ 72,702 72,702 72,702 Current portion of long‐term debt 25,734 15,302 38,204 38,204 38,204
185,291 98,483 222,792 229,466 235,761
Long‐term debt 653,006 806,384 463,189 413,189 358,189 Due to shareholders 231,736 256,077 199,274 199,274 199,274 Future income taxes 41,188 71,759 54,887 54,887 54,887 Other liabilities 27,281 28,098 28,969 28,969 28,969
1,138,502 1,260,801 969,111 925,785 877,080
Shareholdersʹ equity
Capital stock 35,304 35,304 335,304 335,304 335,304 Contributed surplus 10,071 10,354 10,703 11,319 11,935 Retained earnings 21,655 16,022 90,268 178,800 279,706 Accumulated other comprehensive income (loss) (4,993) 40,557 (7,748) (7,748) (7,748)
62,037 102,237 428,527 517,675 619,197 Total liabilities and shareholdersʹ equity 1,200,539 1,363,038 1,397,638 1,443,461 1,496,277
RJ Equity Research │ Page 35 of 36
Exhibit 27: DOL – Key Operating Metrics Source: Company reports, Raymond James Ltd. Exhibit 28: DOL ‐ Peer Group Comparison Source: Capital IQ, Bloomberg, Raymond James Ltd.
Shrs Market 1000 1001 1002 1003 Enterprise Value /Price O/S Cap. EBITDA Ratios
Company Name TK 20/11/2009 (mln) (mln) LFY FY1E FY2E FY3E LFY FY1E FY2E FY3E LFY FY1E FY2E FY3E LFY FY1E FY2E FY3E
U.S. Value Retailers LAST 1000 1001 1002 100399 Cents Only Stores NYSE:NDN $12.56 69.6 $874 0.12 0.65 0.78 0.80 103.7 19.3 16.1 15.7 $60 $101 $115 ‐ 12.4 7.4 6.5 n.a.Big Lots Inc. NYSE:BIG $24.15 82.3 $1,988 1.89 2.03 2.17 2.31 12.8 11.9 11.1 10.5 $329 $346 $368 ‐ 5.7 5.5 5.1 n.a.Family Dollar Stores Inc. NYSE: FDO $30.38 140.5 $4,269 2.07 2.29 2.54 2.71 14.7 13.3 12.0 11.2 $617 $663 $690 $731 6.6 6.1 5.9 5.6Dollar General Corp. NYSE: DG $23.21 318.0 $7,381 0.34 1.23 1.52 1.80 68.1 18.9 15.3 12.9 $868 n.a. n.a. n.a. 12.7 n.a. n.a. n.a.Dollar Tree Inc. NASDAQGS:DLTR $48.93 90.9 $4,448 2.53 3.33 3.71 4.07 19.4 14.7 13.2 12.0 $529 $639 $690 $736 8.2 6.8 6.3 5.9
Group Average 43.7 14.8 13.1 12.5 8.2 6.3 5.8 5.6
U.S. Discount LAST 1000 1001 1002 1003Target Corp. TGT $47.46 754.3 $35,797 2.86 3.18 3.55 4.15 16.6 14.9 13.4 11.4 $6,228 $6,585 $7,077 $7,676 8.4 8.0 7.4 n.a.Wal‐Mart Stores Inc. WMT $54.28 3,906.8 $212,058 3.35 3.61 3.95 4.36 16.2 15.0 13.7 12.4 $29,889 $30,980 $33,055 $35,251 8.5 8.2 7.7 7.2
Group Average 16.4 15.0 13.6 11.9 8.5 8.1 7.5 7.2
U.S. Group Average 35.9 15.4 13.5 12.3 8.9 7.0 6.5 6.2
Canadian RetailAlimentation Couche‐Tard Inc TSX:ATD.B $20.00 194.8 $3,896 1.29 1.44 1.51 1.76 15.6 13.9 13.3 11.4 $588 $608 $648 $698 7.7 7.4 6.9 6.5Canadian Tire Corp. Ltd. TSX:CTC.A $55.12 81.6 $4,500 4.59 4.38 4.69 5.32 12.0 12.6 11.8 10.4 $895 $902 $950 $1,071 5.6 6 5.3 4.7Empire Co. Ltd. TSX:EMP.A $45.29 66.5 $3,012 4.04 4.04 4.41 ‐ 11.2 11.2 10.3 n.a. $768 $799 $836 n.a. 5.2 5.0 4.8 n.a.Loblaw Companies Limited TSX:L $32.52 280.8 $9,130 1.99 2.27 2.46 2.70 16.3 14.3 13.2 12.1 $1,630 $1,773 $1,855 $2,004 7.6 7.0 6.7 6.2Metro Inc. TSX:MRU.A $36.40 111.1 $4,044 3.19 3.17 3.44 3.70 11.4 11.5 10.6 9.8 $715 $724 $750 $785 6.7 7 6.4 6.1Sears Canada Inc. TSX:SCC $24.07 107.6 $2,590 2.68 1.69 1.90 ‐ 9.0 14.2 12.7 n.a. $517 $417 $438 n.a. 4.2 5.2 4.9 n.aShoppers Drug Mart Corp. TSX:SC $43.29 217.5 $9,413 2.60 2.71 3.01 3.39 16.7 16.0 14.4 12.8 $1,084 $1,154 $1,273 $1,441 10.0 9.4 8.5 7.5
Group Average 13.2 13.4 12.3 11.3 6.7 6.6 6.2 6.2
Dollarama Inc. TSX:DOL $20.20 72.7 $1,468 ($0.36) $1.02 $1.22 $1.39 n.a. 19.8 16.6 14.6 $154 $169 $199 $217 12.1 10.9 9.3 8.6
Earnings/DistributionPer Share Price/Earnings Ratios EBITDA
F2005 F2006 F2007 F2008 F2009 F2010E F2011E F2012E
SSS % Growth 2.4% 6.1% 2.8% ‐1.5% 3.4% 7.2% 4.2% 4.1%Number of Stores 349 398 463 521 564 608 649 696Y‐o‐Y % Growth 14% 16% 13% 8% 8% 7% 7%
Square Footage (ʹ000) 3,163.7 3,657.6 4,349.9 4,941.7 5,437.0 5,949.3 6,350.5 6,810.4 Y‐o‐Y % Growth 16% 19% 14% 10% 9% 7% 7%
Sales/Avg Sq.Ft. 235.2 255.9 260.4 245.8 246.5 258.3 264.0 270.7Y‐o‐Y % Growth 9% 2% ‐6% 0% 5% 2% 3%
Gross Profit/Avg Sq.Ft. 63.3 81.4 87.8 83.8 84.2 88.1 90.8 93.6Y‐o‐Y % Growth 29% 8% ‐5% 0% 5% 3% 3%
SG&A/Avg Sq.Ft. 39.8 43.2 45.9 47.6 50.2 53.2 52.7 54.9Y‐o‐Y % Growth 9% 6% 4% 5% 6% ‐1% 4%
Inventory/Store (ʹ000) ‐ 387.1 358.6 381.0 442.6 481.4 501.1 511.3Y‐o‐Y % Growth ‐7% 6% 16% 9% 4% 2%
Inventory/Avg Sq.Ft. ‐ 53.0 48.7 50.2 56.5 60.4 62.1 63.5Y‐o‐Y % Growth ‐8% 3% 13% 7% 3% 2%
Inventory Velocity 5.55 5.34 4.86 4.62 4.47 4.45Inventory Yield 1.87 1.82 1.66 1.57 1.54 1.54ROIC % 9.8% 10.7% 9.0% 10.7% 9.4% 10.1% 10.2%
RJ Equity Research │ Page 36 of 36
Risks
Some of the risk factors that pertain to the projected 6‐12 month stock price target for Dollarama are as follows:
Competitive Threats: Dollarama’s lack of flexibility in engineering profit margins through consistent price increases may limit its ability to compete effectively with mass merchants, discount stores and variety of other retailers with prime retail site locations.
Inflation In Cost of Goods Sold: Given the sensitivity of profit margins to merchandise prices, increases in inflation rate would result in higher COGS and reduced earnings and profit margins. Frequent increases in the prices of various raw materials could lower the company’s profit margins and affect its financial results.
Currency Fluctuations: Dollarama sources majority of its merchandise (~50%) from overseas (mainly from China ‐ with 50% of purchases made in US$). While the company hedges against the fluctuations of the C$ against the US$, the earnings remain susceptible to Renminbi/US$ fluctuations.
Disruption of Distribution Network: Disruptions or delays in inventory replenishment could adversely impact operation and earnings. Factors resulting in disruption of service include, but not limited to: (1) international shipping slowdown or disruption, (2) increased import duties and taxes, (3) extreme weather conditions, and (4) sudden hikes in energy costs.
General Economic Factors: Unstable global economy, rising consumer debt levels and changes in consumer preferences and buying patterns, as well as changes in unemployment rate, labour costs, and fuel price may have negative impacts on Dollarama’s financial results.
Debt Covenants & Interest rate risks: The capital structure of Dollarama could hinder the company’s ability to secure additional financing, in light of the existing covenants.
Insufficient Capacity & Lower‐than‐Expected Store Expansion Growth: Dollarama’s underlying growth strategy will potentially require further warehouse/distribution centre expansion through F2012. Expanding its store network outside of its core market (Ontario and Quebec) could result in lower profitability, while expanding within the core market could potentially cannibalize the existing stores’ sales, both of which could translate into lower sales per store/square footage.
Increases in Rent and Occupancy Costs in Targeted Locations: Dollarama’s stores are mainly leased from third parties. Changes to the conditions of these agreements, most of which are not generally cancellable, upon their expiry could result in higher rent expense, hence negatively impacting cash flows and earnings.
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Analyst Certification
The views expressed in this report (which include the actual rating assigned to the company as well as the analytical substance and tone of the report) accurately reflect the personal views of the analyst(s) covering the subject securities. No part of said personʹs compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in this research report.
Stock Ratings
STRONG BUY 1: the stock is expected to appreciate and produce a total return of at least 15% and outperform the S&P/TSX Composite Index over the next six months. OUTPERFORM 2: the stock is expected to appreciate and outperform the S&P/TSX Composite Index over the next twelve months. MARKET PERFORM 3: the stock is expected to perform generally in line with the S&P/TSX Composite Index over the next twelve months and is potentially a source of funds for more highly rated securities. UNDERPERFORM 4: the stock is expected to underperform the S&P/TSX Composite Index or its sector over the next six to twelve months and should be sold.
Distribution of Ratings
Out of 212 stocks in the Raymond James Ltd. (Canada) coverage universe, the ratings distribution is as follows: Strong Buy and Outperform (Buy, 58%); Market Perform (Hold, 38%); Underperform (Sell, 4%). Within those rating categories, the percentage of rated companies that currently are or have been investment‐banking clients of Raymond James Ltd. or its affiliates over the past 12 months is as follows: Strong Buy and Outperform (Buy, 41%); Market Perform (Hold, 33%); Underperform, (Sell, 0%). Note: Data updated monthly.
Risk Factors
Some of the general risk factors that pertain to the projected 6‐12 month stock price targets included with our research are as follows: i) changes in industry fundamentals with respect to customer demand or product/service pricing could adversely impact expected revenues and earnings, ii) issues relating to major competitors, customers, suppliers and new product expectations could change investor attitudes toward the sector or this stock, iii) unforeseen developments with respect to the management, financial condition or accounting policies or practices could alter the prospective valuation, or iv) external factors that affect global and/or regional economies, interest rates, exchange rates or major segments of the economy could alter investor confidence and investment prospects.
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Equity research analysts and associates at Raymond James Ltd. are compensated on a salary and bonus system. Several factors enter into the compensation determination for an analyst, including i) research quality and overall productivity, including success in rating stocks on an absolute basis and relative to the S&P/TSX Composite Index and/or a sector index, ii) recognition from institutional investors, iii) support effectiveness to the institutional and retail sales forces and traders, iv) commissions generated in stocks under coverage that are attributable to the analyst’s efforts, v) net revenues of the overall Equity Capital Markets Group, and vi) compensation levels for analysts at competing investment dealers.
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subject company. 1f RJL has received compensation for services other than investment banking within the last 12 months with
respect to the subject company. 2 Analyst and/or Associate or a member of his/their household has a long position in the securities of this stock. 3 RJL makes a market in the securities of the subject company. 4 RJL and/or affiliated companies own 1% or more of the equity securities of the subject company. 5 <Name> who is an officer and director of RJL or its affiliates serves as a director of the subject company. 6 Within the last 12 months, the subject company has paid for all or a material portion of the travel costs
associated with a site visit by the Analyst and/or Associate. 7 None of the above disclosures apply to this company.
Date Price Rating TargetNov-25-09 $20.20 2 $23.00
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COMPANY SYMBOL EXCHANGE DISCLOSURES
Dollarama DOL TSX 1a, 1b, 1e
R A Y M O N D J A M E S LT D . CA N A D I A N IN S T I T U T I O N A L E Q U I T Y T E A M W W W . R A Y M O N D J A M E S . C A
EQUITY RESEARCH HE A D O F EQ U I T Y RE S E A R C H
Daryl Swetlishoff, CFA 604.659.8246 SE N I O R SU P E R V I S O R Y AN A L Y S T
Patricia Hernandez, PhD, CFA 604.659.8236 Heather Fennell (Supervisory Analyst) 403.509.0509
C O N S U M E R P R O D U C T S & R E T A I L
CO N S U M E R PR O D U C T S & RE T A I L Kenric Tyghe, MBA 416.777.7188 Sara Kohbodi (Associate) 416.777.4916
E N E R G Y
OI L & GA S SE R V I C E S , HE A D O F EN E R G Y RE S E A R C H Andrew Bradford, CFA 403.509.0503 Nick Heffernan (Associate) 403.509.0511
I N T E R N A T I O N A L O I L & GA S Rafi Khouri, B.Sc, MBA 403.509.0560 Braden Purkis (Associate) 403.509.0534
O I L & GA S RO Y A L T Y TR U S T S / O I L & GA S PR O D U C E R S Kristopher Zack, CA, CFA 403.221.0414 Gordon Steppan (Associate) 403.221.0411
O I L SA N D S / O I L & GA S PR O D U C E R S Justin Bouchard, P.Eng. 403.509.0523 Christopher Cox (Associate) 403.509.0562
O I L & GA S PR O D U C E R S Luc Mageau, CFA 403.509.0505
I N D U S T R I A L S P E C I A L S I T U A T I O N S
AE R O S P A C E & AV I A T I O N / IN D U S T R I A L PR O D U C T S & SE R V I C E S HE A D O F I N D U S T R I A L RE S E A R C H
Ben Cherniavsky 604.659.8244 Theoni Pilarinos, CFA (Associate) 604.659.8234 Greg Jackson (Associate) 604.659.8262
I N D U S T R I A L PR O D U C T S & SE R V I C E S Frederic Bastien, CFA 604.659.8232 Jamil Murji, CFA (Associate) 604.659.8261
I N D U S T R I A L PR O D U C T S & SE R V I C E S Steve Hansen, CMA, CFA 604.659.8208 Alexandra Syrnyk (Associate) 604.659.8280
M I N I N G
BA S E ME T A L S & MI N E R A L S , HE A D O F MI N I N G RE S E A R C H Tom Meyer, P.Eng., CFA 416.777.4912 Adam Low, CFA (Associate) 416.777.4943 Miroslav Vukomanovic (Associate) 416.777.7144
GO L D S Brad Humphrey 416.777.4917 Forbes Gemmell, CFA 416.777.4948 Afjal Mohammad (Associate) 416.777.7084
UR A N I U M / JU N I O R EX P L O R A T I O N Bart Jaworski, P.Geo. 604.659.8282 David Sadowski (Associate) 604.659.8255
P A P E R & F O R E S T P R O D U C T S
PA P E R & FO R E S T PR O D U C T S Daryl Swetlishoff, CFA 604.659.8246 David Quezada (Associate) 604.659.8257
R E A L E S T A T E
RE A L ES T A T E & REITS Mandy Samols, CA, CFA 416.777.7175
T E C H N O L O G Y
TE C H N O L O G Y, AL T E R N A T I V E EN E R G Y & CL E A N TE C H Steven Li, CFA 416.777.4918 Anthony Jin (Associate) 416.777.6414
EQUITY RESEARCH PUBLISHING AC T I N G HE A D O F PU B L I S H I N G
Cynthia Lui 604.659.8210 Ashley Ramsay (Research Editor) 604.659.8226 Deborah Cheetham (Publishing Assistant) 604.659.8200 Inder Gill (Publishing Assistant) 604.659.8200
INST ITUT IONAL EQUITY SALES HE A D O F SA L E S
Mike Westcott 416.777.4935 Michelle Baldry (Marketing Coordinator) 416.777.4951
T O R O N T O (CAN 1.888.601.6105 | USA 1.800.290.4847)
Laura Arrell (U.S. Equities) 416.777.4920 Sean Boyle 416.777.4927 Jeff Carruthers, CFA 416.777.4929 Jon De Vos (London) 0.207.426.5632 Richard Eakins 416.777.4926 Jonathan Greer 416.777.4930 Michael Horowitz 416.777.4946 Aman Jain 416.777.4949 Dave MacLennan 416.777.4934 Robert Mills 416.777.4945 Doug Owen 416.777.4925 Nicole Svec-Griffis, CFA (U.S. Equities) 416.777.4942 Lakshmi Thurai (London) 0.207.426.5626 Neil Weber 416.777.4931 Carmela Avella (Assistant) 416.777.4915 Ornella Burns (Assistant) 416.777.4928
V A N C O U V E R (1.800.667.2899)
Scot Atkinson, CFA 604.659.8225 Doug Bell 604.659.8220 Terri McEwan (Assistant) 604.659.8228
M O N T R E A L (514.350.4450 | 1.866.350.4455)
John Hart 514.350.4462 David Maislin, CFA 514.350.4460 Tanya Hatcher (Assistant) 514.350.4458
INST ITUT IONAL EQUITY TRADING CO-HE A D O F TR A D I N G
Bob McDonald, CFA 604.659.8222 Andrew Foote, CFA 416.777.4924
T O R O N T O (CANADA 1.888.601.6105 | USA 1.800.290.4847)
Pam Banks 416.777.4923 Anthony Cox 416.777.4922 Ross Davidson 416.777.4981 Oliver Herbst 416.777.4947 Andy Herrmann 416.777.4937 Rebecca Joseph 416.777.4938 Eric Munro 416.777.4983 James Shields 416.777.4941 Bob Standing 416.777.4921 Peter Mason (Assistant) 416.777.7195
V A N C O U V E R (1.800.667.2899)
Nav Cheema 604.659.8224 Fraser Jefferson 604.659.8218 Derek Oram 604.659.8223
M O N T R E A L (514.350.4450 | 1.866.350.4455)
Sebastien Benoit 514.350.4466
RETA IL RESEARCH & D ISTR IBUT ION Don Ogden, CFA 604.659.8227 Samantha Barrett, CFA 604.659.8235 Arno Richter (Associate) 604.659.8243 Casey Beierle (Assistant) 604.659.8233
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