2 Ways to Profit from Canada’s Changing Retail Sector

If you’re like most U.S. investors, your view of the Canadian retail sector has been tainted by Target Corp. (NYSE: TGT) and its disastrous northern foray.

Today, we’re going to look past that blunder at a market that’s quietly growing, particularly in certain key areas. Further on, we’ll look at two ways to play these trends.

First, back to Target, which announced its Canadian move in January 2011 and opened the first of its 133 stores north of the border on March 5, 2013. But fast-forward just over two years, to April 12, 2015, and the last 13 locations were shutting down; the other 120 had already gone dark in the preceding weeks.

In all, Target sank C$7 billion into its Canadian misadventure. And it’s not the only recent retail casualty. In the past few years, once-popular chains have either closed (Mexx, Danier Leather) or slashed their store counts (Jacob, Le Chateau).

Leaving Target Behind

With a list like that, you can be forgiven for thinking the Canadian retail space is a dead zone for investors and operators alike.

But the numbers say something different.

While just-released figures show overall July retail sales contracting 0.1% from June and missing expectations, the decline was mainly the result of lower sales at gas stations. Stripping out gas stations, they edged up 0.2%.

On a year-over-year basis, retail sales grew 1.8% in July (excluding motor vehicles and parts).

Over the past five years, Canadian retail sales have grown 8.5% (excluding motor vehicles and parts) from C$356.6 billion in 2011 to C$387.0 billion in 2015, according to StatCan. But some subsectors put in stronger performances, such as personal-care products (up 14%) and clothing (up 19%), ground zero for many of the recent closures.

That last figure explains why U.S. retailer Nordstrom Inc. (NYSE: JWN) sees opportunity in Canada. Unlike Target, Nordstrom is going slowly, having entered the market with a single outlet, in Calgary, Alberta, in late 2014. It opened its fourth store, at Toronto’s Eaton Centre, last week.

So far, the effects of the oil-price crash, which have been ricocheting through the Canadian economy since mid-2014, haven’t affected Nordstrom. Here’s what VP James Nordstrom told analysts in May:

“We’ve not seen a material impact from those [macroeconomic issues], particularly in Calgary, which has a big concentration around the energy industry … overall, our business there remains strong.”

Canadian brick-and-mortar retailers also have less to fear from online shopping. Last year, it accounted for 6% of total retail spending, compared to 9% in the U.S., though it is growing quickly. Why the slow uptake? You can chalk part of it up to Canada’s huge land mass and sparse population, which make shipping costs a bigger factor here.

Of course, the sector still entails risk. For one, it’s highly competitive, and Canadians are fiercely loyal to domestic chains. Years of retail therapy may also be starting to take their toll: Canadians now carry record amounts of household debt—167.6% of disposable income, on average, as of the end of the second quarter.

So investors need to tread cautiously. Nonetheless, the sector does boast opportunities for above-average dividend yields and capital gains. Here are some ways to tap them.

REITs, Niche Retailers in the Sweet Spot

When hunting for retail opportunities north of the border, it helps to focus on companies in markets that face less competition from foreign or domestic chains. North West Company (OTC: NWTUF, TSX: NWC) is one example. It operates discount stores in Canada’s north, Alaska and island communities in the Caribbean. These areas are far too small to attract the gaze of, say, Wal-Mart.

Another way to profit is through real estate investment trusts (REITs) that operate shopping malls. With the growth of e-commerce, some investors worry that retail REITs will eventually run into trouble.

To counter that, we like to see trusts with top-quality malls in busy areas and anchored by tenants that are tough for online competitors to upend, such as grocery stores and pharmacies. Other Amazon-resistant chains include those offering experiences you just can’t get online, like restaurants and cinemas.

For example, Canada’s biggest REIT, RioCan (OTC: RIOCF, TSX: REI), boasts two such chains among its major tenants: Cara/Prime Restaurants, owner of the Kelsey’s and Milestones restaurant chains, and theater operator Cineplex Inc. (OTC: CPXGF, TSX: CGX).

It’s also important to note that some REITs benefit from online shopping. Industrial REITs, for example, are gaining as Amazon, Wal-Mart and others require more warehouse space to store an ever-rising pile of online orders.

So don’t let the headlines scare you away from the Canadian retail space. If you choose your stocks carefully, you’ll enjoy gains and rising dividends for years to come. For a look at our top picks, check out the latest issue of Canadian Edge.