Chapters Inc. – 8 October 1998
4
n Chapters Offer Some Defensive Characteristics
Better Balance Sheet: Chapters has made substantial
improvements in its balance sheet over the past few years.
The company reduced its leverage (LTD:LTD+Equity)
considerably in the past few years from 89.2% in fiscal
1996 to 9.6% at the end of fiscal 1998. This permits
greater flexibility and provides a more defensive posture in
the current market environment.
Books Are Not “Big-Ticket”: In the context of an
economic slowdown it is worth noting that book retailing,
although not immune to the effects of declining
consumption is somewhat defensive. The average book
purchase is not deemed a “big ticket item”.
Rolling Out Tried Formula Lowers Risk: Chapters is in
an advantageous position of adapting a tried formula to the
Canadian marketplace and being able to learn from the
activities of its American counterparts.
Valuation
In our view, Chapters is well positioned in a growth
segment of the retail market. It is interesting to note that
CHP's one-year forecast P/E multiple of 21.5 is lower than
comparable US book superstores which trade at 22.8
times. Further, CHP's two-year forecast P/E of 13.7 is
lower than comparable US book stores which trade at a
P/E of 18.0 times. At the same time its two-year growth
rate exceeds that of the comparables. Our twelve to
eighteen month price objective of $24 is based upon
applying a 16 times multiple to forward earnings which is
a 11% discount to the multiple afforded Barnes & Noble
(BKS; US$24 7/8, C-1-1-9) and Borders Group (BGP;
US$22 13/16, B-1-1-9). This is an extremely well managed
company, in our view, with a very clear focused strategy that
should deliver solid earnings growth over the next several
years and hence we should see a rising share price.
Table 3: Valuation Table
Earnings Earnings Price to
Price LY P/E FY1E Growth P/E FY2E Growth P/E Book
Category Killers
Home Depot HD $36.75 $0.82 44.8 $1.05 28.0% 35.0 $1.30 23.8% 28.3 7.2
Toys R US TOY $16.81 $1.60 10.5 $1.60 0.0% 10.5 $1.80 12.5% 9.3 1.1
Average 27.7 14.0% 22.8 18.2% 18.8 4.1
US Book Companies
Barnes & Noble BKS $23.56 $0.93 25.3 $0.93 0.0% 25.3 $1.20 29.0% 19.6 3.1
Borders Group BGP $24.63 $0.98 25.1 $1.22 24.5% 20.2 $1.50 23.0% 16.4 3.2
Average 25.2 12.2% 22.8 26.0% 18.0 3.1
Chapters CHP $20.00 $0.90 22.2 $0.93 3.3% 21.5 $1.46 57.0% 13.7 2.2
Updated as of October 6, 1998, Source: Merrill Lynch.
[YCHP] The securities of the company are not listed but trade over-the-counter in the United States. In the US, retail sales and/or distribution of this report may be made only in states where these securities are exempt from
registration or have been qualified for sale. MLPF&S or its affiliates usually make a market in the securities of this company.
[BKS, BGP] An officer, director or employee of MLPF&S or one of its affiliates is an officer or director of this company.
Opinion Key [X-a-b-c]: Investment Risk Rating(X): A - Low, B - Average, C - Above Average, D - High. Appreciation Potential Rating (a: Int. Term - 0-12 mo.; b: Long Term - >1 yr.): 1 - Buy, 2 - Accumulate, 3 - Neutral, 4 -Reduce,
5 - Sell, 6 - No Rating. Income Rating(c): 7 - Same/Higher, 8 - Same/Lower, 9 - No Cash Dividend.
Copyright 1998 Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S). This report has been issued and approved for publication in the United Kingdom by Merrill Lynch, Pierce, Fenner & Smith Limited, which is
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