AVENTOS Equity Research Report No. 2

For many years, Leon’s has delivered strong results with growing earnings (see figure A in the appendix). Even during the years of the global financial crisis around 2008 and beyond, the company remained profitable and continued to report increasing earnings. Nevertheless, the company is currently trading at an earnings multiple of just around 13x, while in October 2024, Canadian investor Fairfax Financial Holdings acquired Leon’s competitor, ‘Sleep Country,’ at a multiple of 17x earnings. Based on our sum of the part analysis, we estimate the net value of the operating business at >C$1.5 billion, applying their current EBITDA- multiple of 11.5x.

The company holds around 15% market share in the Canadian furniture market, where it generates over C$2.5 billion in annual revenue, operating over 201 corporate-owned stores and 97 franchise locations. The group expanded its offerings after acquiring competitor ‚The Brick‘ in 2013. Across various regions in Canada, it now provides a wide range of merch- andise, including furniture, major appliances, and home electronics, via multiple banners and service companies such as furniture insurance offerings. The retail footprint spans across Canada, with a focus on core markets including Vancouver, Toronto and Montréal.

When “big box” warehouse retail was gaining market share, Leon’s early adoption of that layout and retail space growth strategy put them well ahead of the curve. Over subsequent market cycles, competition was gradually pushed out of the furniture business (e.g., Eaton’s, Sears, or Bad Boy Furniture) and moats magnified through natural selection. Meanwhile, across retail categories, mom-and-pop stores were struggling to keep up with larger store formats, especially today, as today’s “zero” customers are hard to catch since they hardly show any brand loyalty, and consumer tastes change in increasingly short cycles. The group knows how to capitalize on that market dynamic by simultaneously doubling down on their mar keting spend. In various markets, Leon’s ranks first among top advertisers. Being a leader on the Canadian furniture market allows Leon’s to benefit from economies of scale and demon strates its efficiency in deploying retained earnings dollars. The company yields a return on incremental invested capital levels (as defined in the appendix) of around 25% for the trailing twelve months, signaling good custody of fiduciary duty.
 

In addition to their core business, Leon’s owns a portfolio of 202 properties, currently recorded at cost at with net book value of below C$300 million. The company owns around 490,000 square meters of well-located lettable area of which many properties also bring light industrial real estate attributes, given their warehouse retail acquisition history. Reported asset and land values reflect simple retail property business plans, resulting in several owned land plots with significant unbuilt capacity. This creates sizeable potential for large-scale densification in core locations.

Vending their real estate assets into a REIT would unlock substantial hidden reserves. Leon’s uncovered plans of an IPO in the second quarter of 2023, with its execution contingent on the right market conditions. Assuming conservative market rent estimates and an average cap rate of ~7%, we estimate that operating real estate values would exceed C$1 billion. As many assets show light industrial characteristics, in terms of physical structure, i.e., single-story warehouses with high-rack components, and locational qualities, there is justifiable market-backed upside tweaking our model towards the more highly priced light industrial sphere. Since early 2020, sustained by onshoring trends, light industrial facilities become integral to domestic infrastructure and the security of supply chains, and enjoy more competitive pricing parameters.

Floating their real estate portfolio, Leon’s can capitalize on dynamics stemming from REIT advantages including liquidity premiums and generally better investor visibility of property values; scaling benefits from an easier access to debt financing and equity capital; diversification with a country-wide store network; regulatory transparency with more suitable reporting standards; and tax appeal, i.e., 20% deduction on income derived by REIT dividends.
 

There is more. Within Leon’s land portfolio, there are two specific land plots actively under review for rezoning. The company’s headquarters in North York, Toronto, sits on a treasury of unused land capacities. Clutched by highway 400 and 401, the property is right at the intersection of two of the country’s busiest arterial roads. Leon’s envisages a two-phased mixed-use development, with the first phase focusing on various commercial uses for which they already obtained rezoning approval allowing for a broader range of uses and higher density developments such as residential property. The second phase includes a joint venture to build 4,000 residential homes, with submission of secondary plans expected by mid-2025. Based on recent comparable pricing, that project could add up to another C$400 million to capitalizable value, beyond the value of the standing portfolio.

And there is a second project in Burlington, Ontario, with less than half of the premises covered by rentable space. West end of Lake Ontario and close to Hamilton, Burlington sits in the middle of Toronto and Niagara Falls, a border town on the Canada-United States border. Dual zoning on that 32 acre-sized land offers substantial development upside for various uses. Leon’s property portfolio glimmers with more of these kinds of hidden values. This could add another mid eight-figure amount to the valuation. The two projects are pictured in figure B in the appendix.