You might have read about short-sellers recently targeting Canadian Tire (TSX:CTC.A) as a stock that is ripe for a big crash. Canadian Tire is one of the biggest retailers in the country. From automotive to kitchen accessories, this company deals in a wide range of products.
Right now, it looks like all is well with Canadian Tire’s stocks. Investors are funneling their money into the company’s stock with the same eagerness and expectations as before. The company’s dividend yield currently stands at 3.23%, the highest in its entire history.
But some investment gurus are reading between the lines. They think that the retail giant is overvalued at the moment and could face a sharp drop in its stock price in the coming days. Some are even suggesting that Canadian Tire can be stripped of half its stock valuation.
Even if we do not get into the number game, it seems very likely that Canadian Tire will see losses in its stock value in 2020. There are three primary reasons why I think this could happen in the next year.
1) The wrong prioritization of investment
While its local and foreign competitors are directing money into expanding operations and acquiring market edge, Canadian Tire keeps putting the profits into dividend payouts and buybacks. This strategy is undoubtedly maintaining the stock value and demand for the company, but just for the time being. As competitors close in, Canadian Tire will lose this selling point too.
2) Overhead costs are bogging down the company
A massive physical footprint, which was once considered the strength of a retailer, is turning into Canadian Tire’s Achilles heel. The digitization of the retail landscape has made brick-and-mortar operations more of a burden than an edge. The company is overseeing over 1,500 outlets all over Canada. The recurring cost of running this vast outlet network is increasing every day.
Many nationwide retailers are getting rid of those excessive overheads by increasing its online footprint. However, we are not seeing such a strategy being deployed by Canadian Tire. Overhead costs, along with indiscreet use of profits, could severely dent the company’s TSX standing.
3) A gross difference between debt and equity
The stocks of Canadian Tire are still investment grade, thanks to its track record of maintaining a good credit rating. But here too, there is a cause for concern for investors. Canadian Tire currently has a BBB+ rating from S&P.
This rating means its stocks are just one rank away from being relegated to the speculative-grade or junk category. S&P’s “Outlook” evaluation puts Canadian Tire in the “Stable” zone. But we also need to consider the fact that this evaluation was conducted in the first quarter of 2019.
If Canadian Tire undergoes credit rating degradation in the coming days, it might not be able to reverse that any time soon. The reason is pretty simple: a massive gulf between its outstanding debt and equity.
For Canadian Tire, things haven’t drifted into the uncontrolled downward spiral yet. The company has substantial goodwill with an established retail network. With the right policies, this machinery can help the retailer to get back its groove.
But right now, we are not seeing even a discussion about any corrective measure. This inaction validates the speculation to an extent. You might want to avoid Canadian Tire stock as it could slump in 2020.
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Fool contributor Jason Hoang has no position in any of the stocks mentioned.