ALBERTA LIQUOR RETAILER FORCED TO DEFEND STRATEGY
Activist offensive on Liquor Stores N.A. draws on notions that don’t hold water
Locally grown Liquor Stores N.A., the largest publicly traded booze retailer in North America, is under siege from a Torontobased activist investor.
PointNorth Capital, the fund backed by John Bitove, Barry Goldberg and Phil Evershed, is seeking to restructure Liquor Stores’ business operations and replace six of the company’s eight directors with its own nominees.
The proxy fight began to unfold last November, when PointNorth announced it had accumulated a 9.9 per cent stake in Liquor Stores. Subsequent meetings made clear the dissident shareholder’s intent was to replace four or five directors.
The objective, as with all activist undertakings, is to take control, with the aim of adding shareholder value. The argument is that existing management has failed to do so.
The retail world in Alberta these days is no picnic, and that includes the recession-proof world of liquor sales.
PointNorth believes Edmonton-based Liquor Stores, which has 252 stores in Canada and the United States, is moving too slowly on its building renewal plan, with 140 outlets awaiting a facelift. It has also questioned the need for a U.S. office, contends the business has too many products and needs to improve efficiency. It also doesn’t like Liquor Stores’ strategy of warehousing the products it buys at low wholesale prices, which the company contends increases the profit margin on several mainstream brands.
Call it a physical hedging program.
It costs money to warehouse product and PointNorth would rather see a just-in-time inventory system in place. That, too, has its challenges and could lead to a lack of product on store shelves. Liquor Stores sees its breadth of product offerings as a key strength.
It’s worth remembering Liquor Stores went public, as an income trust, in 2004 — during the heyday of income trusts — and when access to capital was easy. It converted to a corporation at the end of 2010.
Since 2004, its average annual total return to shareholders has been 8.4 per cent and its performance in 2016, despite its assets being concentrated in Alberta, translated into total returns to shareholders of 33 per cent — outperforming other Canadian and U.S. grocery retailers.
Being a trust meant it was a cash-generating machine and focused on maintaining distributions to shareholders. What the income trust model actively discouraged was re-investment in the business.
In the retail world, not reinvesting in your storefronts or inventory management systems can come back to haunt you. And these days, it’s more complex than ever — requiring an understanding of real estate, information and inventory systems and consumer spending patterns. The list of ingredients driving profitability is long.
The board slate proposed by PointNorth includes two members with no experience as directors of publicly traded companies. Two other nominees have experience in the retail liquor business, but it in the regulated environment of the Maritimes.
Alberta became the first province to privatize the liquor business, in 1993. Liquor Stores’ chairman, Jim Dinning, was the province’s treasurer at the time.
Privatization has resulted in a significant amount of expertise operating in what has become a very competitive market for liquor sales. Outside Alberta, there is a fair bit of envy when it comes to both price and choice. And while B.C. has eased government control of liquor sales, it’s still behind Alberta.
PointNorth, being based in Ontario, doesn’t necessarily see that on a daily basis.
Its plan to woo shareholders would decrease store selection, decrease staffing and eliminate the ability to buy bulk at discount prices and warehouse the products, Liquor Stores asserts. PointNorth would also decrease the private label aspect of Liquor Stores, a retail element known to boost profit margins.
Another factor is that 70 per cent of the company’s stores are in Alberta, where it’s been a tough economy since 2014 — even for liquor sales. The company’s share price history has mirrored the downturn fairly closely, yet its return to shareholders — since the bottom fell out of the oil market — is almost 8 per cent.
Has the current board and management done everything right? Unlikely.
That’s why, in response to PointNorth’s overtures, Liquor Stores said in April that it would be willing to accept two board nominees and avoid a nasty proxy battle. PointNorth declined.
And, as investment firm Cormark Securities cited in a recent report, elements of PointNorth’s proposal make sense, such as reducing inventory, continuing to renovate the stores and decreasing staffing costs.
What doesn’t make sense is PointNorth’s recommendation to eliminate the revenue generating potential of growing the private label offering — which Cormark estimates could boost gross margins between 60 and 70 per cent — and the ability to warehouse product, which costs 1.5 per cent but reduces the cost of goods sold by 10 per cent. That’s an 8.5 per cent differential to the upside.
The shareholder vote is scheduled for June 20.
The right answer in all of this likely lies in looking for key leverage points within the existing business plan, rather than blowing it up entirely.
The bottom line is this: There isn’t a company that can point to their success being directly tied to aggressively cutting costs. You can’t cut your way to prosperity. At some point you can no longer deliver what your customers expect and they go elsewhere.
For that reason, the full PointNorth plan doesn’t add up.