How Leon’s profited off government handouts
Firm hiked regular dividend twice and announced one-time special dividend payment
While most Canadian companies have been hurt by the pandemic, Leon’s, Canada’s largest furniture and mattresses retailer, reported stellar results in the midst of an unprecedented lockdown.
It was surprising, to say the least. Despite seeing its revenue decline by a whopping 38 per cent in April and then by 46 per cent in May, mainly due to the temporary closure of more than half of its stores, the company’s net income suddenly shot up by 88.8 per cent in the second quarter of 2020 (which ended on June 30), to $47.2 million, compared to
5 million the year before.
In fact, the furniture retailer’s income for the second quarter was the second largest quarterly profit it has reported in 101 years of operation.
How can that be?
Leon’s didn’t discover a gold mine under its North York head office, but it did identify another treasure, courtesy of the federal government: The Canada Emergency Wage Subsidy (CEWS) — which generated a $29.8-million windfall for the furniture company.
The CEWS program provides eligible companies with a 75 per cent subsidy for salaries for both active employees and those laid off and rehired. While firms were encouraged by the government to immediately rehire employees let go when the pandemic hit, this was not a binding condition for receiving funds.
This allowed companies like Leon’s to book record profits by receiving large subsidies for active employees while keeping the company lean for a few months.
To be clear, Leon’s participation in the CEWS program is completely legitimate. The company met the eligibility requirements set by the government (initially a revenue drop of 30 per cent or more). One could even argue that it had a fiduciary responsibility to its stakeholders to accept the subsidy that the government offered.
Nonetheless, while receiving CEWS money, Leon’s was able to report record profits, hike its dividend and launch an aggressive share repurchase program, which helped to funnel money into the pockets of shareholders and executives who hold stock.
Now you may be wondering: To what extent did CEWS funds contribute to the company’s record profit in the second quarter?
The answer to this question is provided right there in the company’s second quarter earnings release: “Excluding the impact of the CEWS … adjusted net income in the current quarter totalled $25.3 million or flat to the prior year’s quarter.”
So, if profit including CEWS was $47.2 million and excluding CEWS was $25.3 million, the net contribution of government aid to Leon’s profit in the second quarter totalled $21.9 million.
But in order to fully understand how the CEWS program helped the company to book such a large profit, one needs to look closer at the timeline of the events.
On March 25, Leon’s announced the immediate layoff of approximately 3,900 employees, and the temporary closure of 72 stores. It later disclosed that 1,900 additional employees were laid off in subsequent weeks, for a total of 5,800, or 70 per cent of its workers. But when the CEWS program (which Torstar benefits from) was announced in April, the company didn’t rush to hire back all of the employees who were laid off. Receiving a 75 per cent subsidy for employees who were not fired and keeping the company slim were the keys to its record profit in the second quarter, since overall, revenue was down 25 per cent.
Leon’s wasn’t transparent in disclosing exactly when it hired back the employee was
y hint provided in its Q2 earning release, where it announced that “during the month of June 2020” it rehired “the majority” of employees.
Leon’s would not provide specific figures for how many employees were rehired each month, but company spokesperson Jonathon Ross did say that as of November 11, the company had “returned 95% of its workforce to pre-pandemic levels.”
Ross added that “millions of dollars were spent to support our temporarily laid off workforce with company-paid benefits throughout the entire period, and (Leon’s) recognized the efforts of our associates with a ‘one time’ payout during (the third quarter, which ended
pt. 30) 2020.”
With respect to the big profit in its second quarter, Ross said that Leon’s “generated record cash flow through stringent cost-cutting and prudent cash management.” But in its Q2 report, Leon’s disclosed that the net impact of the government subsidy on its net income was $21.9 million.
At least some of that large second quarter profit went directly to investors and executives who hold company stock.
In its first quarter earnings report, the company initially announced a cut to its shareholder dividend, from 16 cents a share to 12 cents a share. But after the second quarter profit hit the books, the company felt comfortable enough to boost the dividend back up in third quarter to 14 cents a share.
And while Leon’s continued to receive government funds in the third quarter, albeit a much lower amount ($2 million), it announced yet another increase of its regular dividend to the pre-pandemic level of 16 cents a share.
In addition, on November 10, it boldly announced that “due to our cash position, the directors are pleased to declare a special dividend of $0.30 per common share” — a $24 million cash transfer to the company’s shareholders.
The special dividend won’t be paid until January — at a time when Leon’s may no longer be receiving CEWS funds. But the proximity of the government support to Leon’s $24-million transfer to shareholders is concerning.
When asked how this dividend policy can be justified, Ross said, “Only when we saw the results of our efforts did we return the dividend payout to the prepandemic level.”
When asked about the special dividend, Ross replied, “We rewarded shareholders with a special dividend as we historically had done (prior to the Brick purchase in 2012) when our cash position got to a level of comfort.”
The third business action that raises questions was the decision by Leon’s to embark on a massive share repurchase program while receiving subsidies.
Share buyback plans help generate higher stock valuations by reducing the number of shares outstanding and increasing earnings per share. They are viewed as a tax-friendly way to generate for shareholders and as an alternavalue tive to dividend payments.
On Aug. 12, in its second quarter results, Leon’s reported that it had applied to the TSX to start a share repurchase program to buy up to 4.99 per cent of outstanding shares — a $74-million financial commitment.
On Sept. 30, the last day of the third quarter, while Leon’s was still actively receiving CEWS funds, it started buying back shares. This is inconceivable.
Leon’s behaviour is disappointing and should not be allowed under the CEWS program. One would expect a company with such a strong reputation in the Canadian retail space to show better leadership.
The CEWS program was designed to help companies on the brink of collapse survive the pandemic and to help employees keep their jobs. But it allows companies like Leon’s to take advantage of taxpayers’ money to make its shareholders richer.
This is a direct result of the government’s failure to put limitations on companies receiving financial aid.
In the future, when governments give any form of federal aid to companies it must come with clear restrictions on dividend payments and share buybacks. Executive compensation should be limited as well.
With a bailout package for the airline industry currently being negotiated, this lesson is as important as ever.