A Takeover Bid involving Whole Foods Market Inc. (WFM:NASDAQ) & Amazon.com Inc. (AMZN:NASDAQ), A follow up on Home Capital Group Inc. (HCG:TSX), and the downfall of Sears Canada Inc. (SCC:TSX)


The big story this week hit the wire early Friday morning, as Amazon announced its take over bid for WholeFoods – we will comment on that and its impact on the market. In our Your Stock, Our Take segment we take a question from a listener about the much maligned, Home Capital Group Inc. (HCG:TSX), which has recovered somewhat over the past month after trying to reassure the market of its continued solvency – is it a BUY at present? Our star of the week is also one of this week’s top stories, Whole Foods Market Inc. (WFM:NASDAQ), which jumped 29.4% after Amazon.com Inc. (AMZN:NASDAQ)  announced it was buying the company for $42 per share in an all-cash transaction valued around $13.7 billionOur dog of the week is Sears Canada Inc. (SCC:TSX) which lost 36.4% on the week after reported on Tuesday that its first quarter revenues were down 15%.

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Now, let’s dig into the show.

I would like to welcome again, myhost, KeyStone’s Senior Equity analyst, father of 1, and a man who has been so unimpressed with the quality of the contestants on J-Lo’s newly launched “World of Dance” contest on NBC that he has assembled a KeyStone dance squad on our lunch breaks and we are now auditioning for the upcoming season, Mr. Aaron Dunn.

The big story of the week is related to our Star of the week – let’s depart from tradition and launch into our Star.


Star of the Week – Whole Foods Market Inc. (WFM:NASDAQ)


This was the big news to end the week. Early Friday, Amazon.com Inc. (AMZN:NASDAQ) +2.44% announced that it will be acquiring Whole Foods Market Inc. (WFM:NASDAQ), +29.48% for $42 per share in an all-cash transaction of about $13.7 billion, including Whole Foods’ debt. The deal implies a $13.4 billion market cap for the natural and organic grocer.

Whole Foods will continue to operate under the Whole Foods brand, and John Mackey will continue as chief executive of Whole Foods with its headquarters remaining in Austin, Tex. Both companies expect the transaction to close during the second half of 2017.

Often you will see the acquired company’s stock soar on the merger (due to the premium) and the acquirer’s stock slump near-term – due to uncertainty about the merger and the costs, etc. Not in this case. The market loves this move for Amazon as the stock is trading up smartly today, $28 or 2.4% – while part of that may be a recovery from the tech slump of late, but this deal stopped the losing streak we saw in Amazon’s stock which started a week ago with everything tech related.

While some observers see Amazon.com Inc.’s plan to acquire Whole Foods Market Inc. as an offensive move into grocery, others suggest it is a defensive move in an area where Wal-Mart Stores Inc. dominates, some experts argue.

Of course, Wal-Mart has a strong retail brick and mortar presence – but the company acquired Jet.com in August 2016 for more than $3 billion and has been making a push into e-commerce.

This could very well be Amazon retaliating and getting more into physical retail.

Of course, the best defense is often a good offence and the move here by Amazon seems to make sense not just from a defensive point of view. No one can deny that Whole Foods has a great niche and that their products and stores remains attractive.

Whole Food’s stock has not performed very well over the last 5-years. In fact, even with the premium takeout bid on Friday, the stock is down 10% over that time – it is not a surprise that activist shareholders have been calling for change for some time now.

Amazon will have the capital to scale Whole Foods if it wants and plug Whole Foods customers into the Amazon Prime network.

The huge jump in Whole Foods stock this week, make it our star.


Mixed Bag – Impact of Amazon’s Whole Foods Acquisition


The acquisition disrupted the market generally.

The Kroger Co. (KR:NYSE) 9.83%

Following news of Amazon’s acquisition of Whole Foods Market. JP Morgan downgraded Kroger from Overweight to Neutral, while Telsey Advisory Group downgraded the stock from Outperform to Market Perform.

Shares of Supervalue (SVU:NYSE) 14.36% were down 14 percent to $3.25 following news of Amazon’s acquisition of Whole Foods Market.

Even shares in Costco Wholesale Corporation (COST:NASDAQ), a company which has masterfully avoided most of the carnage in retail foods, lost 7% to close down $12.72 at $167.34.

While there are a number of analysts looking at the move by Amazon to acquire Whole Foods as a strike against WalMart – I believe it will actually impact Target Corp. and maybe even Costco Wholesale Corp. more.

By going upmarket in acquiring Whole Foods, the impact will likely be felt by Target and Costco more than if they had gone after Kroger, for instance, which would have more directly affected Wal-Mart.

Amazon’s more affluent customer overlap with Target and Target’s struggles with its grocery business makes this bad news for them.


Your Stock Our Take – Home Capital Group (HCG)


Joan in Naniamo wants to know about Home Capital Group (HCG). She says the stock has recovered partially from its lows. Do you think this recovery will continue?

For those not familiar with the background of Home Capital, it was our weakly Dog about a month ago on the podcast. For many years this company was a steady performer with consistent earnings and dividend growth for well over a decade. But this ended in when the share price peaked in the 2014 after some serious allegations of improper reporting came to the surface. This led to depositors withdrawing their money from Home Capital which is the life blood of a bank or mortgage company and forced the company to do a very expensive financing in order to survive.  It’s been the classic story of a value trap for anyone who has bought this company over the last 18 months.

The stock closed today at $14.25 almost tripling from its low of just over $5 in early May.

But the stock is still down 55% year to date and almost 75% from its peak in 2014.

What has happened recently are a couple of pieces of good news for the company. One is a potential settlement with regulators and the other actually isn’t news but rather speculation the company is close to setting up less expensive financing to fund the company longer-term.

So will the recovery continue? It’s impossible to say but I think that at its very best Home Capital is just a speculation right now. It’s not something that we would invest. In the banking industry, public perception really does become reality. People aren’t going to want to deposit their money into an institution that they don’t trust and without those deposits it’s difficult to see how the company can fund their business economically.

Ryan: Aaron, you referred to Home Capital as “the classic story of a value trap” for investors. Can you explain to listeners what this means.

A value trap is a situation where a company looks like it offers a lot of value on a price to earnings or price to book value basis, but in reality it is a broken business with a high risk of losing more investor capital. One thing that investors will do is look at the earnings and cash flow that a company has reported over the previous year and value the stock on that basis. Historical performance is definitely a good place to start but it is only meaningful if you have good reason to believe that the earnings levels and growth rates are sustainable into the future. If there is a strong likelihood that earnings levels will decline in the future then the historical data really becomes meaningless. In the case of Home Capital, I believe that they have reported about $3.7 in earnings per share over the previous 12 months which is a price-to-earnings ratio of less than 4 times. That would be a very attractive multiple if this were a healthy, growing business. But it isn’t and you can’t put any faith in that earnings number.


THE DOG – Sears Canada Inc. (SCC:TSX)


The stock lost 36.4% on the week after reported on Tuesday that its first quarter sales were down $90 million or 15%, to $505.5 million, more importantly the company stated there is now “significant doubt as to the company’s ability to continue as a going concern.” Sears is now looking at strategic alternative including further asset sales or a sale of the business itself.

That is not a confidence inspiring statement.

This is not a surprise to KeyStone –  we actually selected Sears Holdings Corporation (SHLD:NASDAQ) in the US as a dog this past fall. For its part, that stock which was down significantly already has been cut in half again.

Sears Canada is in a bad place – The company has posted recurring operating losses and negative cash flows from operating activities in the last five fiscal years, with net losses beginning in 2014. The retailer’s net loss more than doubled year over year in the first quarter and it abruptly pulled the plug on its annual meeting, scheduled for Wednesday, postponing it to an undetermined future date.

Department stores, many of which have not recovered from the incursion of big-box specialty stores into their core categories in the 1990s, have been particularly hard hit by online retail, even as they try to grow e-commerce operations.

We think the company is now in a death spiral – it has gotten so bad that people are likely to now think twice about purchasing items under Sears Canada’s brands as they will have warranty concerns. This will likely lead to further sales declines in a very tough retail environment.


What is next for Sears?


Retailers in deep financial distress can seek protection from creditors under the Companies’ Creditors Arrangement Act (CCAA) while they restructure. Filing allows them to continue operating as they take actions to try to return to profitability, which can include selling assets, closing or selling unprofitable stores, laying off staff, typically paying suppliers and other creditors a percentage of what they are owed.

Sometimes the result is a complete closure – as in the case of Target, which liquidated its inventory and shuttered 133 stores less than two years after expanding into Canada. In other cases, it can leave the company leaner and more competitive, albeit with a smaller number of stores.

As for investors that hold shares in the company? The news is not good.

Despite the losses and the venerable old name Sears possesses, we would not touch the stock.

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