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  Sodisco lives in the shadow of an 800-pound gorilla

BENJ GALLANDER and BEN STADELMANN

Saturday, February 23, 2002

Retail has always been a competitive jungle, but the entire landscape has been transformed drastically over the past decade or so. Big-box stores like Costco Wholesale Corp. have rewritten the rules of economies of scale, changing the nature of buying, distribution, and inventory management. This has shaved prices, and margins, sending many rivals to the corporate graveyard.

Some communities have tried to protect local businesses by keeping the monster retailers at bay, but it's not just the family-owned stores that have to contend with this threat to their livelihood.

Older, less adept, large competitors have also been pummelled, as the bankruptcy of Kmart Corp. attests. Kmart is a giant in its own right, operating 2,100 stores with annual sales of $37 billion (U.S.).

Still, that doesn't hold a candle to Wal-Mart Stores Inc.'s $191 billion in sales, a company that Jerry Storch, vice-chairman of Target Corp. stores, recently called "vicious predators" in a speech to the University of Minnesota's school of management.

Another 800-pound gorilla is Atlanta-based Home Depot Inc., the do-it-yourself home improvement titan with more than 1,100 stores and annual sales of $50 billion. But there are signs that the company's growth is slowing as new second-tier locations start cannibalizing sales from older operations. Volume is the lifeblood of these huge stores; you need a lot of throughput to justify stocking 50,000 items on the shelves. That automatically limits the number of population centres that can support them.

The Contra Guys waded into this Darwinian saga by grabbing a position in Sodisco-Howden Group Inc. (SOD-TSE) in December at $1.19 a share with a target price of $4.74. The stock closed on March 1, 2002, at $1.61 on the Toronto Stock Exchange.

We've had our eye on this company for years, but its history dates back a whole lot further -- to 1878, when David Howden opened his general store in Watford, Ontario. Today, Sodisco bills itself as the largest distributor to independent hardware and building centres in Canada.

Last November, the firm announced the acquisition of Quebec-based Marchands Unis, which should vault revenue to more than $500 million (CDN) this year from 1998's $363 million.

Sodisco's dealer network is extensive, numbering about 1,500 in all after the recent expansion. Obviously these outlets are tiny by comparison with Home Depot, but they are part of the backbone of small-town Canada. The local hardware store is also part of neighbourhoods in our large cities, where convenience and friendly, knowledgeable service can be a welcome relief from the massive scale and bustle of those mega-emporiums.

The key is to co-exist with "Agent Orange," rather than mount a direct confrontation based on Home Depot's strong suits, variety and price.

Also prompting our "buy" decision was a clear improvement in the company's capital structure. Previously there had been a motley collection of bond issues a share count in the hundreds of millions -- ridiculous for a company this size.

Over the past few years, the outstanding debentures were converted into capital stock and a 20-for-1 stock consolidation brought the share count down to about 20 million. Interest expense has been reduced and, after a couple of bad quarters, the company managed to post a slim profit of $279,000 for the third quarter. But that does include a restructuring charge of just over $1 million, so there is no pro-forma hocus-pocus in that black ink.

Our main concern regarding this stock is that this has so far been a very atypical recession. Real estate and housing starts normally take a big hit as the economic vise begins to bite, but so far the building boom has not been dented and prices are firm.

The lowest interest rates in 40 years can take most of the credit for this amazing performance, but can it last? History indicates that such prosperity usually ends with a thud, as resale values decline, banks tighten up on mortgages and people put off their quest for the ultimate dream home. Hopefully a deflating real estate market won't make a monkey out of us, but we are willing to take a swing.

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