Scotia research note on ZZZ - Outperform, $44 TargetA Revisit on a Good Name: ZZZ
OUR TAKE: We believe ZZZ shares are likely to do well in 2018 as the growth strategy continues to be deployed and as the omni-channel platform will be executed over an entire year. ZZZ operates a network of 247 stores across the country, with approximately 42% of these executing to the new prototype. The company will continue to renovate the fleet and some 20-30 stores will be brought to the new prototype over the course of next year. ZZZ easily sees room for 325 stores across the country, which suggests several years of good returns, with a two-year payback for new store openings at a minimum pace of 10 per year. The exit of Sears from the market could provide further opportunity, particularly in satellite markets. ZZZ is on a path to drive its current 25% market share higher. The shares are up 19.8% YTD, but we anticipate further share price appreciation over the coming year. We introduce our 2019 EPS forecast of $2.05 and roll our valuation forward.
KEY POINTS
Sears Canada has historically been the second-largest mattress retailer in Canada behind ZZZ and, as of the end of January 2018, will have exited the market. The demise of Sears provides ZZZ with an opportunity to pick up incremental share, and we anticipate ZZZ is in a position to garner more than its fair share of the Sears volume.
In addition, the company will benefit from a more rational pricing environment with Sears gone from the market. Given the nature of the mattress industry, which operates primarily on just-in-time inventory, the ongoing liquidation at Sears is not likely to impact ZZZ's mattress sales. The company believes accessory sales may see an impact but expects it to be limited.
ZZZ online platform Bloom "bed-in-a-box" launched in May; performing ahead of expectations. ZZZ can now lay claim to a true omni-channel platform. Bloom has moved quickly to become one of the company's top 10 selling SKUs for ZZZ. In addition, the vast majority of Bloom mattresses are being purchased in stores as the company's online offer is driving consumers to the stores for trial. This latter point validates the belief that customers want to test before purchase.
Last week, ZZZ announced an NCIB to purchase 1.6M shares (~4% of float) over the next 12 months. ZZZ has a sound balance sheet with leverage <1x and generates significant free cash flow. We applaud the company's decision to return cash to shareholders in the form of a buyback to augment its dividend growth. The company has already been active on the buyback – a good sign.