Rona initiating coverage

8/7/2019 Rona initiating coverage

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Consumer Products,

Merchandising & Special

Situations

February 12, 2009

Jessy Hayem, CFA Shane Leech-Porter (Associate)

514 289 0385 514 985 4733

[email protected] shane.leech-porter@tdsecurities

YOUR ATTENTIONIS DIRECTED TOTHE IMPORTANTDISCLOSURES INAPPENDIX A.

RONA Inc.(RON-T) C$11.78

INITIATING COVERAGE

Recommendation: BUYOverall Risk Rating: Medium12-Month Target Price: $15.5012-Month Projected Return: 31.6%

Challenge Breeds Opportunity

Market Data Financial Data Estimates

Current Price (C$) $11.85 Fiscal Y/E Dec 2006A 2007A 2008E 2009E 2010E

52-Week Range (C$) $10.0317.20 Shares O/S (mm) 115.8 Sales (mm) $4,552 $4,785 $4,844 $4,757 $4,963

Market Cap. (C$mm) $1,372 Float Shares (mm) 114.7 EBITDA (mm) $384 $400 $377 $354 $387

Float Cap. (C$mm) $1,359 Net Debt (C$mm) $510 EPS (f.d.) $1.64 $1.59 $1.36 $1.22 $1.38

Avg. Daily Trading Volume1 595 Net Debt / Total Capital 25% FCF / Share (f.d.) $0.50 $0.52 $1.13 $0.27 $0.43

Net Debt / EBITDA 1.3x

ROE 11.5% Valuation

P/E 12.8x 10.8x 8.7x 9.7x 8.6x

EV/EBITDA 7.5x 6.6x 5.1x 5.3x 4.9x1 over 3 months period Note: All figures in Canadian dollars unless otherwise specified.

Investment SummaryWe are initiating coverage of RONA Inc. (RONT) with a BUY rating and $15.50

target price. We believe that management has implemented a number of positive

initiatives that should benefit the company when the economic climate improves

and for the long term. RONA also continues to prudently preserve capital by

reducing store openings and related capex. In the near term, the macro-

environment is clearly challenging, masking the benefits of aforementioned

initiatives. As such, we expect continued deterioration in sales trends over the next

few quarters, with our EBITDA margin bottoming around Q3/09 and the lack of

earnings momentum in 2009 limiting multiple expansion. Therefore, the stock

could experience further weakness in the near term, as the market awaits visibilityon the timing of a rebound, which the macro conditions render difficult to predict.

However, we believe that investors should be gradually accumulating positions in

RONA at opportunistic prices (downward revisions to estimates post Q4 may

provide this opportunity), in anticipation of a bottoming in fundamentals toward

mid-end 2009. Home improvement and housing related stocks have typically been

among the first consumer related stocks to rebound.


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2 A Division of TD Securities Inc.

Table of Contents

Executive Summary ..................................................................................................... 3

Outlook ..................................................................................................................... 4

Valuation and Recommendation............................................................................... 4

Company Profile........................................................................................................... 6

Store Network and Distribution Infrastructure ......................................................... 6

Macro Picture to Weaken Further Before Recovery ........... ........... ........... ........... .... 9

Uninspiring Outlook for Home Improvement in 2009............................................ 12

Industry Overview ..................................................................................................... 14

Growth Strategy......................................................................................................... 17

Acquisition-Driven Growth in the Past................................................................... 17

Niche Penetration by Acquisition Opportunistic Tuck-Ins Likely...................... 18

No Large Scale Acquisition Expected in the Short to Medium Term .................... 19

Economic Climate Favours Affiliate Recruitment: A Priority for RONA.............. 20

No U.S. Foray on the Horizon ................................................................................ 21

Optimizing the Existing Business ........................................................................... 22

Financial Analysis ...................................................................................................... 31

Q3/08 review .......................................................................................................... 31Expected future performance.................................................................................. 32

Our Forecast SSS in the Context of the Current Downturn.................................... 34

Strong Balance Sheet, FCF Generation and No Financing Concerns..................... 38

How Has RONA Fared versus Others in the Industry? ......................................... 39

Valuation..................................................................................................................... 46

Looking at Previous Recessions ............................................................................. 46

Justification of Target Price ........... .......... ........... .......... ........... ........... .......... ........... . 51

Key Risks to Target Price.......................................................................................... 52

Overview of Key Players............................................................................................ 53

Home Depot Inc. (HD-N, not covered)................................................................... 54Lowes Companies Inc. (LOW-N, not covered) ..................................................... 56

Canadian Tire Inc. (CTR-T, not covered)............................................................... 57

Home Hardware Stores Ltd .................................................................................... 58

Appendix I. Share Structure and Ownership ........... ........... .......... ........... ........... .... 59

Appendix II. Management Compensation Aligned With Shareholder Interests.. 60

Appendix III. Key Executives ................................................................................... 61

Appendix IV. Board of Directors.............................................................................. 62

Appendix V. Canadas Housing Foundation Lacks U.S. Architect ........... ............ 63

Appendix VI. Long-Term Fundamental Drivers .................................................... 66

APPENDIX A. IMPORTANT DISCLOSURES ..................................................... 69


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A Division of TD Securities Inc. 3

Executive Summary

RONA Inc. holds the leading market position in the Canadian home

improvement landscape with a 15% market share. Its network of 693 stores is

spread across all provinces, with a solid position in Quebec. One of its main

competitive advantages lies in a one size does not fit all approach, consisting

of multi-format and banner stores. This gives it exceptional diversification and

flexibility to access growth areas that cannot be served by big box outlets, andwhere low population density rules this option out, in addition to areas that

favour consolidation.

In our opinion, the current state of the economy represents a significant

challenge for RONAs growth prospects in the short to medium term, as it does

for any company tied closely to consumer spending. And, unfortunately, we

believe that there are few options in the companys control to counter such a

downturn. About 80% of its revenues are directly related to the renovation industry,

and the balance is tied to new housing construction. Despite the negative near-term

outlook, over the longer term, we believe that the fundamental drivers for increased

home improvement spending remain intact people spending more leisure time athome, housing stock becoming older, homeownership rates on the rise, etc.

About half of RONAs growth over the past decade is attributable to

acquisitions, particularly since 2000. Past acquisitions and affiliate recruitment

have not only fuelled RONAs growth, but have also greatly diversified its

geographic presence, enhanced its buying power, and enabled it to reach different

types of customers. Relatively speaking, same store sales (SSS) and new store

growth have been lesser contributors to growth. Yet, store renovations, product

mix and merchandising revamping, as well as innovative marketing concepts, are

key to attracting customers. In 2009, RONA remains focused on improving

internal operations. Expansion priority, in our opinion, will center arounddealer recruitment, a profitable way to grow, requiring no capital outlay, and

limited incremental costs. This is favoured by the fact that the Canadian home

improvement industry remains highly fragmented, with the four largest players

commanding approximately 55% of the market and the rest being in the hands of

small independents. Acquisitions, if any, will likely be opportunistic tuck-ins, in

new niche areas. This also reflects our belief that, given the current economic

climate, RONA is tilting toward capital preservation.

Driven by, what we view as, a well thought out acquisition and affiliate

recruitment strategy, RONAs revenues grew at a CAGR of 20% and

EBITDA margins rose on average 70 bps per year, between 2001 and 2006.Over the same period, organic growth averaged 7.5% and EPS grew at a CAGR of

25%, as the home improvement industry benefited from a booming housing

market, and RONA implemented initiatives to increase store traffic, sales and

profits. Its SSS growth peaked in 2004, and has since decelerated, affected by

significant lumber price fluctuations in 2005-2006 and, more recently, a

deteriorating macro-economic climate. When the economy recovers, SSS should

follow suit; until then, we do not expect a material improvement. Yet, RONA

is not sitting by idly. Programs for continual upgrade of stores and merchandise


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have been in place to keep up with increasingly selective and sophisticated

consumers. In addition, in February 2008, RONA unveiled a four-year strategic

plan consisting of two overlapping phases: the PEP, which addresses Productivity,

Efficiency and Profitability, and an accelerated development plan.

Critics of the RONA story would point out that the slowing economy is uncovering

the need to fix a number of issues, including IT system upgrades, and redundant

store locations, which have resulted in the company initiating its PEP program.While there is some truth to such statements, we also believe that solid operators

typically seek to bring improvements to their operations when times are

tough, tweaking the metrics that would improve efficiency and get the

company ready for the eventual economic rebound.

A concern on investors minds has been Lowes Companies, Inc.s (LOW-N,

not covered) recent entry into Canada, adding a third, potentially national

player in the country. Lowes remains committed to opening big-box format

stores, prompting speculation about saturation of the format in Canada. This may

indeed be the case or close to it, per our analysis, suggesting that aside from

possibly stealing market share from RONA and Home Depot, Lowes may need torevisit its commitment to the big-box format, a task that its U.S. rival, Home

Depot, has struggled with. It is important to acknowledge the difficulty that typical

big-box retailers have in squeezing a large number of SKUs into a smaller store

format without a corresponding strong distribution and special order system that is

integral to servicing smaller formats. This is an advantage that RONA has, owing

to its multi-format stores and associated distribution capability.

Outlook

While we expect RONA to continue benefiting from the PEP initiatives, webelieve these will be more than offset by challenging business conditions in 2009

and the ensuing negative leverage. As such, we expect continued deterioration in

sales trends over the next three to four quarters, and our forecasts reflect continued

margin compression through mid-2009. We forecast EPS of $1.22 for 2009, down

approximately 10% from $1.36 in 2008. A rebound is expected in 2010, with EPS

up 13% to $1.38, aided by a return to positive SSS territory and additional benefits

from its PEP program. We caution investors that our 2009 and 2010 EPS estimates

are approximately 10% below Street estimates. We would expect some downward

revisions to those estimates following the release of RONAs Q4 results on

February 19 and this, in our opinion, may create a better entry point in the stock.

Valuation and Recommendation

RONAs stock price performance is highly correlated with Home Depot and

Lowes. As such, following their stock downturn, RONAs stock performance had

started to deteriorate well ahead of the overall Canadian market downturn, when its

SSS turned negative in Q3/07. RONA has historically traded at an average

discount of 15% to both companies. Interestingly, both comparables appear to have


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Company Profile

RONA is Canadas largest retailer and distributor of hardware, home

improvement and gardening products. The company was founded in 1939 and

went public in 2002. It now has 21,000 employees (or 27,000, inclusive of

affiliates). It offers about 90,000 products through a multi-format, multi-banner

network that includes 235 corporate, 23 franchise, and 435 affiliate stores, and 9

distribution centers. Products sold are sourced from about 3,000 suppliers (with nosingle supplier representing more than 5% of sales), of which 90% are located in

Canada. As a member of A.R.E.N.A., a buying group that accounts for annual

purchases of US$28 billion, RONA has significant purchasing power.

RONA has two distinct business segments: retail sales through corporate and

franchised stores (Retail segment) and distribution to affiliated stores (Distribution

segment).

Exhibit 1. RONA Inc.: Retail Segment Represents Bulk of Revenues and Profits

Net Sales Breakdown by DivisionFY07

Retail

77%

Distribution

23%

RONA's EBITDA Breakdown by DivisionFY07

Retail

82%

Distribution

18%

Source: Company reports.

Store Network and Distribution Infrastructure

RONAs network of 693 stores across Canada with 15 million square feet (mmsf)

of retail space is composed of different store formats and banners located in both

metropolitan and small rural areas. The store network is supported by a strong

distribution infrastructure, inclusive of nine distribution centers (DCs)

across Canada.

Exhibit 2. RONA Inc.: Store and Distribution Centre Network

British Columbia Alberta Saskatchewan Manitoba Ontario Quebec Atlantic Total

Store Types

Big-box 4 7 1 3 20 41 1 77

Proximity 28 27 3 4 25 241 8 336

SpecializedConsumers 15 12 5 8 113 71 16 240

SpecializedICI 6 0 0 0 23 11 0 40

Total 53 46 9 15 181 364 25 693

Distribution Centres 1 4 1 3 9


RONA is Canadas largest

retailer and distributor of

hardware, home

improvement and

gardening products.


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RONAs 235 corporate stores include those for which the companys ownership

is above 50%. The 435 affiliate stores are 100% dealer-owned but must adhere to

RONAs guidelines on marketing, advertising, presentation, and product

purchasing. The 23 franchise stores are majority-owned by dealers. These stores

follow the same guidelines as affiliates; however, RONA also manages their

product selection, supply and assortment, in addition to overseeing leasing and

subleasing agreements for the properties.

Exhibit 3. RONA Inc.: Ownership Structure

# of RONAs

Type Stores Ownership RONAs Interest

Corporate 235 >50% - Distribution and retail sales

Franchised 23 050% - Royalties of 3.55% on sales

Affiliated 435 0% - Distribution sales

Total 693


RONAs network includes four primary store formats, each of which caters to

a targeted market. Big Box Stores offer over 40,000 hardware, renovation, and

gardening products. These stores range from 60,000 to 165,000 sf in size and cater

to all customer types. Proximity Stores, a new generation of stores launched in

2004, are much smaller and offer a reduced assortment of products meant to cater

to the basic hardware and seasonal needs of local communities. These stores also

typically offer an extended selection of interior decorating products. Specialized

Consumers Stores are similar in size to Proximity Stores, but are specialized to

meet the needs of specific targeted groups, including contractors, tradesmen andgardeners. Lastly, SpecializedICI Stores target Institutional, Commercial and

Industrial customers by focusing on specific product categories such as building

materials and plumbing.


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Exhibit 4. One Size Does Not Fit All

RONA STORES Banner Size (Sq ft) Products/Other

RONABig-Box Stores RONA Le Rgional

RONA Home & GardenRONA LentreptRno-Dpt

Proximity Stores RONA Le Quincaillier

RONA HardwareRONA Lexpress

RONA Le RnovateurRONA Home Centre

Totem 30,000 - Specialized in home renovation products / services- Exclusively in Alberta

Specialized Consumers RONA CashwayRONA LansingRONA Building CentreRONA Lexpress Matriaux

BOTANIX 2,00020,000 - Plants / gardening products / related services

Chester Dawe 30,000 - Building materials / hardware products- Large presence in Newfoundland and Labrador

Specialized ICI Matriaux Coupal - Market leader in sales of building materials in Montreal

Curtis Lumber - Market leader in sales of home improvement / hardware products in BC2,50060,000

Noble Trade - One of the largest plumbing / heating supply wholesalers in Ontario

Dicks Lumber - Leading lumber / building materials / hardware specialist in BC

- Wide variety with higher proportion in lumber / building materials

5,00060,000 - Specialized in lumber / building materials

5,00060,000

60,000165,000 - Extensive: 40,000 products

5,00025,000 - Complete range of hardware / painting / seasonal products


RONAs distribution infrastructure consists of nine DCs utilizing a sophisticated

management information system for product processing, distribution, and

inventory management. Depending on the size and type of orders, agreements with

suppliers, and the geographical location of stores, RONA also utilizes direct

delivery services from suppliers. RONAs three primary DCs are located in

Boucherville and Terrebonne, Quebec and Calgary, Alberta.

Exhibit 5. RONA Inc.: Distribution Centres

Indoor Lumberyard

Distribution Centre 000 sq. ft 000 sq. ft Activity

Boucherville, QC 926 DC for hardware products

Terrebonne, QC 380 Flow-through for hardware products

Saint-Hyacinthe, QC 100 125 Hub for forest products / building materialsHalton Hills, ON 45 77 Hub for forest products / building materials

Calgary, AB 320 DC for hardware products

Calgary, AB 104 375 Hub for forest products / building materials

Hopewell, AB 171 DC for hardware products

Edmonton, AB - 185 Hub for forest products / building materials

Surrey, BC 85 378 DC for hardware products; Hub for forest

products / building materials

Total 2,131 1,140



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Macro Picture to Weaken Further Before Recovery

In our opinion, the current state of the Canadian economy represents a significant

challenge for RONAs growth prospects in the short to medium term, as for any

company tied closely to consumer spending. And, unfortunately, we believe that

there are few options in the companys control, to counter such a downturn.

With the Canadian economy now in a recession, the outlook for homeimprovement spending remains challenging. Historically, home improvement

spending, which is positively correlated with GDP, has benefited from low interest

rates, rising employment and disposable income. While interest rates are at historic

lows, typically making it more affordable to renovate or purchase a house,

unemployment is on the rise and disposable income has been negatively affected

by reduced home equity values and household net worth. While we are certainly

seeing significant deceleration in the Canadian housing market, we believe it is

highly unlikely that it would experience a correction as significant as the one

witnessed in the U.S. We believe this is the result of many factors that shape our

housing sector environment, including: 1) a conservative banking sector culture

and government regulations, 2) a far less exotic and much smaller sub-primemortgage share (peak of 5% of the Canadian market in 2006 versus 2025% of the

U.S. market), 3) a mandatory insurance by the CMHC for mortgages with down

payments of less than 20%. These are just a few takeaways, and for a detailed

write-up on the subject by TD Economics, please refer to Appendix I.

Exhibit 6. Relevant Statistics

Canada

Home improvement spending vs GDP

-15%

-10%

-5%

0%

5%

10%

15%

20%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008E

2009E

2010E

YoYChange(%)

-2.0%

0.0%

2.0%

4.0%

6.0%

YoYChange(%)

YoY GDP Growth (RHS)

YoY Change in Home Improvement SpendingLagged 1 Yr (LHS)

R2= 90%

Canada

Home improvement spending vs Existing home sales

-20%

-10%

0%

10%

20%

30%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008E

2009E

2010E

YoYChange(%)

YoY Change in Existing Home SalesYoY Change in Home Improvement SpendingLagged 1 Yr

R2 = 89%

Canada vs. US

YoY Change in Existing Home Sales

-40.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

2010E

YoYChange(%)

Canada US

l-----------l

Mar'01Nov'01

l----------l

Jul'90Mar'01l----------l

Jul'81Nov'02

Canada

Existing home sales vs Unemployment rate

15

20

25

3035

40

45

50

Jan-90

Jan-91

Jan-92

Jan-93

Jan-94

Jan-95

Jan-96

Jan-97

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Q1-09E

Q1-10E

Existinghome

sales

(000)

5%6%7%8%9%10%

11%12%13%14%

Unemploym

ent(%)

Unemployment rate (RHS) Existing Home Sales (LHS)

Source: CREA, CMHC, Statistics Canada, NAR, TD Economics.


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Not surprisingly, existing home sales have tapered off and recent data released

indicates that the Canadian housing market is squarely on the path of correction. This

too does not bode well for home improvements, as new owners will typically

renovate within three years of purchasing a home. Since February 2008, home sales

have continued to exhibit large year over year declines. Existing homes sold in

Canada declined 1.8% in December month over month to 27,400, on the heels of two

consecutive monthly double-digit declines in November and October. Sales activity

is now at its lowest level since 2000, and on a year-ago basis, sales volume is down36%. For the year, sales dropped 17%, representing the worst drop since 1990, when

sales fell 22.4%. Looking ahead, TD Economics forecasts that existing home sales

will drop 12.6% in 2009, before rebounding with a 6.5% increase in 2010.

Housing starts have been on a downtrend since April 2008. As of December 2008,

housing starts were down 4% year over year, off of an easier comparable as

December 2007 starts were down 16% year over year suggesting the worst in

home improvement spending is not behind us yet. To date, the decline has been

concentrated in single-unit properties, RONAs primary business segment.

However, according to CMHC, multi-unit housing, to which RONA will be

increasingly exposed to (10% of sales) through its Commercial and ProfessionalDivision, is forecast to drop significantly in 2009.

Exhibit 7. A Look at Canadian Housing Stats

Canada Housing Starts

110

130

150

170

190

210

230

250

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

2008E

2009E

2010E

Units(000)

-30%

-20%

-10%

0%

10%

20%

30%

Starts (LHS) YoY Change (RHS)

Canada Existing Home Sales

100150200250300350400450500550

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008E

2009E

2010E

Units(000)

-30%

-20%

-10%

0%

10%

20%

30%

Existing Home Sales (LHS) YoY Change (RHS)

Source: CMHC, CREA, TD Economics.

Historically, homeowners could usually recoup part of their investment later

through the resale market. Housing prices have a large impact on discretionary

income, particularly for home improvements. Until recently, with increasing

home prices, consumers could borrow against the rising value of their homes to

finance projects.


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Exhibit 8. Home Prices Declining in the U.S. and Canada

YoY Change in Home Prices

2010E

Canada

US

-15%

-10%

-5%

0%

5%

10%

15%

Jan-90

Jan-91

Jan-92

Jan-93

Jan-94

Jan-95

Jan-96

Jan-97

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

2009E

Y

oYChange

Canada US

Source: CREA, NAR, TD Economics.

Over the past 10-years, home prices in Canada grew at a CAGR of 7%, fuelling

increased home improvement spending. However, in 2008, home prices dropped

by 1%, with December prices down approximately 13%, representing the worst

drop on record. The drop was particularly pronounced in British Columbia, Alberta

and Ontario, where prices were down 14%, 7% and 12%, respectively; however,

Quebec, which accounts for about half of RONAs business, was down only 1%.

TD Economics expects this drop to be more pronounced in 2009, with Quebec

existing home sales dropping over 13%.

Exhibit 9. Existing Home Sales in Canada Weakening in All Regions

RONA's Sales Breakdown by Region

FY07

Western Canada29%

Ontario24%

AtlanticProvinces

2%

Quebec45%

Canada

Existing Home Sales by Region

-30%

-20%

-10%

0%

10%

20%30%

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008E

2009E

2010E

YoYChange

Western Canada Ontario Quebec Atlantic Provinces

Source: Company reports, CREA, TD Economics.


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Uninspiring Outlook for Home Improvement in 2009

About 80% of RONAs revenues are directly related to the renovation

industry, with the balance tied to new housing construction.

Exhibit 10. Home Improvement Retailers SSS Move in Tandem with Housing Stats

RONA SSS

vs. YoY Chg in Canada Existing Home Sales

-14%-11%-8%-5%-2%1%4%7%

10%13%

1Q-03

3Q-03

1Q-04

3Q-04

1Q-05

3Q-05

1Q-06

3Q-06

1Q-07

3Q-07

1Q-08

3Q-08

YoYChg(%)

RONA SSS Growth YoY Chg in Existing Home Sales

Home Depot & Lowe's SSS

vs. YoY Chg in US Existing Home Sales

-14%

-10%

-6%

-2%

2%

6%10%

14%

18%

1Q-01

3Q-01

1Q-02

3Q-02

1Q-03

3Q-03

1Q-04

3Q-04

1Q-05

3Q-05

1Q-06

3Q-06

1Q-07

3Q-07

1Q-08

3Q-08

YoYChg(%)

HD SSS Growth LOW SSS Growth YoY Chg in Exis ting Home Sales

Source: Company reports, Bloomberg, CREA, NAR.

Current industry conditions do not bode well for the home improvement industry

over the near term, explaining our cautious outlook for 2009. In the U.S., the

market has seen steady declines since mid-2007, although the rate of decline

has recently flattened. The Canadian renovation market has held up well,

especially when compared to the U.S. However, it appears that like housing, the

renovation market is starting to cool in Canada. Renovation spending growth

slowed to 6% in 2Q/08, the slowest pace since mid-2002, before improving slightly

to 7.7% in Q3/08, which still represented the third lowest growth rate since the

beginning of 2003.

Exhibit 11. Remodelling Activity Slowing in Canada and Declining in the U.S.

Canada Remodelling Expenditures

$0$5

$10$15$20$25$30$35$40$45

1Q-00

3Q-00

1Q-01

3Q-01

1Q-02

3Q-02

1Q-03

3Q-03

1Q-04

3Q-04

1Q-05

3Q-05

1Q-06

3Q-06

1Q-07

3Q-07

1Q-08

3Q-08

C$bln

0%

5%

10%

15%

20%

YoYChange(%)

Four Quarter-Moving Expenditures YoY Change

U.S. Home Improvement Activity Indicator

$70$80$90

$100$110$120$130$140$150

1Q-00

4Q-00

3Q-01

2Q-02

1Q-03

4Q-03

3Q-04

2Q-05

1Q-06

4Q-06

3Q-07

2Q-08

1Q-09E

US$bln

-20%-15%-10%-5%0%5%10%15%20%

YoYChange(%)

4-Quarter-Moving-Total Expenditures YoY Change

Source: Statistics Canada, Harvard Universitys JCHS.


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Typically, remodelling cycles lag homebuilding activity by several quarters

and are less volatile. First-time homebuyers will generally spend less than trade-

up buyers, given their lower incomes and the fact that a substantial part of their

wealth is usually tied up in their new homes. Home improvement spending is

driven in part by housing turnover, given that new owners will typically renovate

within three years of purchasing a home. Despite the negative near term outlook,

over the longer term, we believe that the fundamental drivers for increased

home improvement spending remain intact. Homeowners take on remodelling projects to improve their living environment, especially given that people are

spending more leisure time in their homes. Among other factors, the housing

stock is becoming older and homeownership rates are on the rise (for details

see Appendix IV).

Despite the negative near-

term outlook, over the

longer term, fundamental

drivers for increased home

improvement spending

remain intact .


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Industry Overview

The Canadian Home Improvement Industry has grown at a 10-year CAGR of

approximately 8.5% to reach $41 billion in 2007. It remains highly fragmented,

with the four largest players (three of which are publicly traded),

commanding approximately 55% of the market. Remaining players are much

smaller, with most generating less than $100 million in annual sales.

Exhibit 12. Canadian Home Improvement Industry

Canadian Retail Home Improvement Industry

$15

$20

$25

$30

$35

$40

$45

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008E

2009E

C$b

0%

5%

10%

15%

20%

Market Size YoY Change

CAGR ('9707): 8.4%

Canadian Home Improvement Industry

C$41b (2007)

Other45.2%

Home DepotCanada

14.7%

HomeHardware

11.7%

RONA

15.3%

Canadian TireRetail

13.1%

Source: Company reports, Hardlines.

RONA has achieved impressive market penetration, increasing its market share

from approximately 6% in 2000 to 15% in 2007 perHardlines, an industry

publication, although the company claims to have a 17% share (based on its own

computed market size of C$36 billion). It has been the prominent consolidator in

Canada and we believe that RONA remains well positioned to continue leading

the consolidation of the Canadian home improvement market. Its goal of

reaching a 20% share of the market by 2011 seems realizable, seeing that a largeportion of the market remains in the hands of independents.

Most participants in the Canadian home improvement industry are members of

buying groups. As of 2007, 10 buying groups represented approximately $13.6

billion in purchases, or approximately 33% of the Canadian industry. However,

faced with increased competition and defections to RONA and Home Depot, as

well as the impact of softening commodity lumber prices, the buying groups

collectively reported a 3% drop in purchases in 2007, the first drop since 2001.

Buying groups continue to face significant challenges, including limited

succession planning underscored by the aging owner demographic, continuedintense competition from the likes of RONA and Home Depot, not to mention

the impact of the weakening economy. In an attempt to remain competitive they

are becoming more proactive. As confirmed by Hardlines, current trends among

buying groups include:


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Exhibit 13. Top 50 Dealers and Retail Chains in Canada

Retail # of Y/Y Chg

% Market Sales (C$M) Y/Y Stores in # of

Company Location Share 2007 Change 2007 Stores % DIY % Pro Affiliation

1 RONA QC 15.3% 6,300 10% 679 37 85% 15% A.R.E.N.A.

2 Home Depot Canada1

ON 14.7% 6,040 1% 165 10 85% 15%

3 Canadian Tire Retail2

ON 13.1% 5,382 4% 473 5 85% 15%

4 Home Hardware ON 11.7% 4,800 4% 1,031 6 55% 45%

5 Pro Retail Services ON 2.9% 1,200 0% 800 0 70% 30%

6 TruServ Canada SK 1.6% 670 2% 766 0 80% 20% Mutual7 Alpa Lumber Group

1ON 1.6% 650 2% 19 0 10% 90%

8 Kent Building Supplies1

NB 1.0% 417 6% 32 2 50% 50% ILDC

9 United Farmers of Alberta1

AB 0.9% 360 13% 35 0 na na Sexton

10 Canac-Marquis Grenier Lte1

QC 0.7% 296 8% 16 2 72% 28% Mutual (May/07)

11 Windsor Plywood BC 0.6% 235 6% 61 2 50% 50% Delroc

12 Nelson Lumber AB 0.4% 160 3% 5 0 20% 80% Tim-BR-Marts

13 Pacific West Systems1

BC 0.4% 155 5% 8 0 5% 95% Tim-BR-Marts

14 McDiarmid Lumber Ltd. MB 0.4% 151 13% 14 1 40% 60% Tim-BR-Marts

15 Dicks Lumber1,3

BC 0.4% 147 7% 3 0 15% 85% Sexton

16 The Rockett Group1

ON 0.3% 140 4% 5 0 5% 95%

17 Peavey Industries AB 0.3% 133 8% 29 1 95% 5% Mutual/Mid-States

18 Patrick Morin1

QC 0.3% 127 3% 13 0 50% 50% ILDC

19 TSC Stores1

ON 0.3% 124 10% 39 8 92% 8% Mutual

20 Igloo Building Supplies1

AB 0.3% 119 13% 4 1 0% 100% ILDC

21 Patene Bldg. Supp. Ltd.1

ON 0.3% 115 8% 12 0 3% 97% Tim-BR-Marts/TSG

22 Central Home Improv. Warehouse1

NS 0.2% 92 3% 8 0 60% 40% ILDC

23 Franois LEsprance Inc.1,4

QC 0.2% 81 4% 5 0 50% 50% RONA

24 Pierceys Building Supplies1

NS 0.2% 80 4% 5 0 25% 75% PAL

25 Turkstra Lumber ON 0.2% 79 1% 12 2 20% 80% ILDC

26 Star Building Materials1

MB 0.2% 75 4% 5 2 95% 5% ILDC

27 Jaques Lafert Lte. QC 0.2% 68 5% 4 0 65% 35% ILDC

28 Copp Building Materials Ltd. ON 0.2% 62 5% 4 0 60% 40% ILDC

29 Potvin & Bouchard Inc.1

QC 0.1% 57 4% 5 0 70% 30% ILDC

30 Builders Warehouse1

ON 0.1% 55 4% 1 0 33% 67% BMR

31 Millwork Home Centres ON 0.1% 55 4% 3 0 50% 50% ILDC

32 Davidson Enman Lumber1

AB 0.1% 54 8% 3 0 5% 95% Tim-BR-Marts

33 Groupe Dynaco1

QC 0.1% 54 4% 12 0 n/a n/a BMR

34 Gibson Bldg. Supplies1

ON 0.1% 53 4% 2 0 20% 80%

35 McMunn & Yates MB 0.1% 52 6% 11 0 40% 60% ILDC

36 Notre Dame Agencies NFLD 0.1% 51 9% 9 0 70% 30% Castle

37 House of Tools AB 0.1% 51 6% 13 0 20% 80% Western Tool38 J&H Builders Warehouse SK 0.1% 47 7% 2 0 35% 65% ILDC

39 United Lumber ON 0.1% 46 0% 4 0 45% 55% Home Hardware

40 Moffat & Powell ON 0.1% 43 8% 5 0 35% 65% ILDC

41 Groupe Gaston Ct1

QC 0.1% 43 5% 7 0 35% 65% ILDC

42 Logic Lumber AB 0.1% 41 21% 2 0 10% 90%

43 Bolt Supply House AB 0.1% 38 9% 14 0 0% 100%

44 J.O. Lvsque1

QC 0.1% 36 6% 5 0 100% 0%

45 Executive Home Bldg. AB 0.1% 35 9% 1 0 10% 90% Home Hardware

46 Ferlac Inc.4

QC 0.1% 34 6% 4 0 70% 30% RONA

47 Payzant Building Products1

NS 0.1% 34 3% 3 0 45% 55% Home Hardware

48 Quincaillerie R. Durand1,4

QC 0.1% 33 3% 1 0 70% 30% RONA

49 Harrons RONA Building Centre4

ON 0.1% 30 11% 2 1 3% 97% RONA

50 Lake Scugog Lumber ON 0.1% 27 4% 1 0 30% 70% Castle

Total market Size5

71.2% 41,062 4,362 80

1Hardware Merchandising sales estimates

2Home and Leisure sales only

3Acquired by RONA in December 2007

4Included in RONA's sales figures

5Hardlines estimate of market size

Source: Hardware Merchandising, TD Newcrest.


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Growth Strategy

RONAs stated four areas of growth can essentially be grouped into two:

1. Acquisitions: Acquiring complementary businesses and recruitment of

independent dealers

2. Organic growth: New store openings and initiatives to drive SSS growth such

as renovations/upgrades as well as a number of programs grouped under itsrecently launched strategic plan, including optimizing the supply chain, IT

upgrades, loyalty programs, new store concepts, product rationalization and

increased sales of private label brands.

Acquisition-Driven Growth in the Past

About half of RONAs growth over the past decade is attributable to acquisitions,

particularly since 2000. Over the past eight years, RONA has successfully

completed 11 acquisitions, adding over 200 stores and approximately $2.8 billion

to sales. Past acquisitions have not only fuelled RONAs growth, but have alsogreatly diversified its geographic presence, enhanced its buying power, and

enabled it to reach different types of customers. The company has recorded

about $80 million in synergies from past acquisitions, and has yet to fully reap the

benefits from its latest acquisitions.

Exhibit 14. About Half of RONAs Growth Stems from Acquisitions

Approximate Sources of Growth

20022007

Acquisitions50%

Organic growth

30%

Affiliate

recruitment20%

Source: Company reports, TD Newcrest.

RONA has a strong track record of sticking to its acquisition criteria, which

include: 1) profitable target that is immediately accretive to earnings; 2) operations

in a segment with good growth potential; 2) operations in a complementary

business for recurring synergies to be attainable; and 3) strong management. The

company typically pays 57x EBITDA and looks for a minimum ROI of 15%.

About half of RONAs

growth over the past

decade is attributable to

acquisitions, particularly

since 2000.


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RONA has typically achieved synergies of 34% of sales, once acquisitions are

essentially fully integrated, usually by the end of the second year. The average

EBITDA multiple paid, post-synergies, was therefore closer to 3.54.0x.

Primary synergistic drivers include improved purchasing terms, the elimination of

overlapping corporate functions, as well as improvements in distribution and

merchandising. The integration of different information technology systems is

usually lengthier and can take up to a couple of years. Wherever possible, RONA

applies best-practices from acquired companies across the rest of its network. Thisis especially true for those with experience in ICI, a relatively new area for RONA.

Niche Penetration by Acquisition Opportunistic Tuck-Ins Likely

In the first several years after its IPO, RONA focused on expanding its geographic

footprint coast-to-coast. However, in 2005, the company established a Pro Services

division to address the ICI market (Institutional, Commercial and Industrial market).

Since then, four of the seven acquisitions undertaken have been in this segment.

At the end of 2007, RONA grouped the operations of Materiaux Coupal, CurtisLumber, Noble Trade, and Dick's Lumber under a newly created Commercial and

Professional Division. The new division includes 40 of the companys corporate

stores and accounts for 10% of consolidated revenues. Below, we detail the two

most significant acquisitions in the segment.

Noble Trade Acquisition

In April 2007, RONA acquired Noble Trade, a leader in the Ontario plumbing and

heating, ventilating and air conditioning (HVAC) markets, with 19 stores and 1

DC. At the time of the acquisition, the company had annual revenues of over $150million, had been growing at an average annual rate of 27% since 1998, and had

EBITDA margins above RONAs legacy operations. We estimate that RONA paid

about 7x EBITDA and that the acquisition was immediately accretive to earnings.

With this acquisition, RONA significantly improved its purchasing power for

plumbing products and is also benefiting from Noble Trades management

experience in addressing the plumbing industry and more specifically commercial

and professional customers. In fact, at the end of 2007, it appointed Michael

Storfer, Noble Trades president, to head up its new ICI division.

In January 2008, RONA increased its penetration of the Ontario plumbing market

through the acquisition of Best-MAR Plumbing and Heating Supplies. RONAsubsequently rolled this company into Noble Trade.

The Noble Trade acquisition

represents a full push into

the Ontario plumbing and

HVAC markets


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Dicks Lumber = Where the Builders Buy!

In December 2007, RONA acquired Dicks Lumber, a lumber, building materials

and hardware specialist with three specialized stores in the Vancouver, British

Columbia area. At the time of the acquisition, the companys annual revenues were

about $100 million. Given its focus on lumber and building materials, which

typically carry lower margins, its profit margins were slightly below RONAs

legacy operations. However, RONA argues that owing to the limited investmentrequired by these businesses, returns on invested capital are equivalent to or higher

than retail operations. We estimate that RONA paid about 6x EBITDA and that the

acquisition was immediately accretive to earnings. This acquisition is RONAs

third in this segment in British Columbia, giving it the leading position in

western Canadas contractor building supply market.

Exhibit 15. RONA Inc.: Acquisition History

Transaction Est. Annual Sales /

Total Price Sales Price / Price / Store

Date Company Acquired Location Stores (C$m) (C$m) Sales(1)

EBITDA(1) Acquired

Mar-00 Cashway ON 66 $85 $342 0.25x 5.0x $5

Jun-01 Revy Home Centres Inc. ON, MB, SK, AB, BC 51 $220 $805 0.27x 5.2x $16

Sep-03 Rno-Dpt 2 QC 20 $250 $847 0.30x 5.1x $42

Apr-05 Totem AB 16 $96 $260 0.37x 5.8x $16

Mar-06 Chester Dawe 3 NL 8 $37 $80 0.46x 5.8x $10

Apr-06 51% interest in operating businesses of Matriaux Coupal Inc. 3,4 QC 9 $22 $64 0.35x 5.8x $7

Jul-06 Curtis Lumber3 BC 6 $28 $80 0.35x 5.8x $13

Aug-06 Mountain Building Centres Ltd. 3 BC 3 $7 $20 0.35x 5.8x $7

Apr-07 Noble Trade Inc. 3 ON 19 $152 $150 1.02x 7.0x $8

Dec-07 Dicks Lumber3 BC 3 $48 $100 0.48x 6.0x $33

Dec-07 Centre de Rnovation Andr Lessard 3,5 QC 1 $5 $15 0.36x 6.0x $15

Jan-08 Best-MAR Plumbing and Heating Supplies 3 ON 3 $7 $20 0.36x 6.0x $7

Total 205 $958 $2,782

Average - 0.41x 5.8x $15

1

Shown pre-synergies2 C$350m purchase price included ~C$100m in real estate; subsequent to the transaction, RONA entered a sale-and-leaseback transaction; PF EV/EBITDA adjusted

for sale-and-lease-back and assumed rent expense3

TD Newcrest Estimated Transaction Price4

Matriaux Coupal Inc.recorded 2005 annual sales of $125m5

TD Newcrest Estimated Sales Figure


No Large Scale Acquisition Expected in the Short to Medium Term;

Focus on the Pro

We expect RONA to continue targeting acquisitions that further increase its

presence primarily in western Canada and Ontario. Significant opportunities

remain in traditional retail, but we believe the company remains more focused on

the ICI industry, a market estimated at $70 billion and largely in the hands of

independents. In particular, in the near term, we expect RONA to target

companies focused on plumbing and HVAC, similar to the recent Best-MAR

acquisition. These two industries alone are estimated at $13 billion nationally, with

plumbing accounting for $1 billion in Ontario alone.

Dicks Lumber doubled

RONAs presence in ICI

segment and significantly

increased its presence in

western Canada.


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In addition to the primary synergistic drivers previously discussed, acquisitions in

the ICI industry would offer some cross-selling opportunities with RONAs retail

operations and also reduce the overall seasonality of RONAs business, given that

it is typically less cyclical than retail. Management has indicated it would like to

have a national presence for its ICI operations by the end of 2010. We

estimate that a $50 million acquisition (or about $100 million in annual sales)

would add $0.020.03 to EPS on an annualized basis. RONA is not alone in

recognizing the potential for increased sales in the underdeveloped ICI market. Asdiscussed in the section entitled Overview of Key Players, both Home Depot and

Lowes have programs in place catering to the Pro.

In 2009, as RONA remains focused on integrating recent acquisitions and

improving internal operations (i.e., the PEP, or Productivity, Efficiency and

Profitability program), we expect the company to target opportunistic tuck-ins,

but will prioritize dealer recruitment. This also reflects our belief that, given

the current economic climate, RONA is tilting toward a capital preservation

mode. Once economic conditions begin to improve, and as the PEP program nears

completion, we believe that the company could look to make a larger acquisition.

We suspect that both Kent and Home Hardware are on its radar, although RONAhas also successfully been using dealer recruitment as a means to grow its market

share and buying power, while avoiding any potential competition bureau issues,

particularly in the case of Home Hardware.

Economic Climate Favours Affiliate Recruitment: A Priority for RONA

We believe that dealer recruitment represents a priority for RONA and a

profitable way to grow, requiring no capital outlay and limited incremental

costs. In fact, in mid-November, RONA announced that these activities would be

spearheaded by a separate department and would fall under the directresponsibility of President and CEO, Robert Dutton, attesting to the importance of

this growth vector for the company.

Exhibit 16. RONA Inc.: Affiliate Recruitment 2003-2008 (year to date)

Home Tim-BR Pro Retail Sexton

Year Hardware MARTS Castle Services Group Other Total

2003 0 1 2 5 0 3 11

2004 1 6 2 4 2 10 25

2005 7 4 2 8 1 9 31

2006 1 6 6 12 2 10 37

2007 2 5 6 6 3 5 27

2008 YTD 7 2 0 8 3 6 26

Total 18 24 18 43 11 43 157

Represents (C$m) 128 118 116 191 28 162 743


In 2009, while RONA

remains focused on

improving internal

operations

its priority for expansion

will be through dealer

recruitment, a profitable

way to grow, requiring no

capital outlay and limited

incremental costs.


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Since 2003, RONA has recruited nearly 160 affiliates, representing over $700

million in annual retail sales. A new affiliate recruited by RONA typically signs

a 10-year agreement and agrees to purchase a minimum of 90% of its merchandise

through RONA although the company boasts that on average, this percentage is

often closer to 95%. In addition to lower price guarantees, the RONA banner and

private label programs, as well as marketing assistance, affiliates have the

opportunity to share the success through RONA share ownership (typically held as

collateral for the affiliates obligations). This is an advantage that buying groupssuch as Home Hardware cannot offer. Historically, new affiliates recruited have

recorded on average, a 1015% increase in sales within the first two to three

years of joining RONAs network. The company seeks to enlist affiliates with

entrepreneurial owners looking to grow their business; it will also assist them in

drafting their business and growth plans, the success of which ultimately benefits

RONA as well. In fact, as shown in Exhibit 17, RONA affiliates have initiated a

number of projects, ranging from new concepts to store expansions, and, in some

cases, even acquisitions.

Exhibit 17. RONA Inc.: Projects Initiated by Affiliates

2003 2004 2005 2006 2007 2008E Total

# of Projects 90 105 144 166 180 164 849

Value (C$m) 21.0 23.1 48.0 68.8 53.1 33.5 247.5


In the tough economic context, independent dealers may increasingly look to

align themselves with a larger network, such as RONAs, in search of lower costs

obtained when joining a larger buying group, among other benefits such as improved

merchandising approaches and tested store concepts, wider product assortment, a

national distribution network, and exposure to a recognized banner. This also holds

true when taking into account Lowes entry into Canada, and the fear of dealers

being further squeezed out. It is also worth noting that a number of these

independents do not have formal succession plans in place. In fact, even

uncertainty over succession plans at Home Hardware, with its founder (said to be 87

years old) set to step down in April, are leading a number of its members to consider

alternative options. Note that RONA has recruited the most affiliates from Home

Hardware and Pro Retail Services (which consists of Pro and Ace dealers and has

had a large turnover of executives trying to run the brand in Canada).

No U.S. Foray on the Horizon

In our conversations with management, it was clear that RONA has no intention to

enter the U.S. market, at least over the next three years. Mr. Dutton firmly believes

that the company has enough growth opportunities in Canada, as evidenced by the

fact that the market remains highly fragmented even after several years of

consolidation, in addition to numerous niche opportunities described above; and

we tend to agree.

In the tough economic

context, independents mayincreasingly look to align

themselves with a larger

network, such as RONAs,

in search of lower costs.


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RONAs growth target is realizable, especially given the trend among baby

boomers for more DIFM (do-it-for-me) projects (Appendix IV).

Increase Customer Awareness and Loyalty: RONA claims to have achieved

significant brand awareness in Canada, and that approximately 78% of Canadians

across the country are now familiar with the company. This should continue to be

achieved through several advertising and marketing campaigns, including the

companys sponsorship of the 2010 Winter Olympics in Whistler, BritishColumbia. The exclusive association (relative to competitors) with the Air Miles

rewards program in Canada has also proved fruitful, with 54% of RONA revenues

being derived from Air Miles collectors, who, according to management, spend

35% more on average than other customers. RONAs goal is to raise the level of

revenues from collectors to 60%.

Profit Enhancement Initiatives Prioritized under the PEP

The first phase of RONAs 2008-2011 plan aims to focus on lowering costs and

improving efficiencies.

Product Management: Since 2005, RONA has reduced its product offerings from

over 200,000 SKUs to 90,000, reducing store clutter, removing obsolete items, and

focusing on best selling, profitable product categories. A similar process now aims at

reducing the SKU count to 65,000 by 2011. The company will focus on in-stock

guarantees for its best performing SKUs. With improvements in demand planning

and the POS system, RONA should be able to pull products as needed direct-to-

store. This should result in lower inventory levels and a reduced need to use satellite

DCs.

Aiming for 100 Bps Improvement in Gross Margins: RONAs goal is toincrease its direct global sourcing to 810% of revenues sourced from Asia, 5%

currently. Increasing its private label offering from 15% of sales to 20% by 2011

should improve gross margins; these products are typically priced 510% below

national branded products, but carry 10 percentage points more in margins. In

Q3/08, these already represented 17% of total.

Expand Information Technology Systems: RONA will be investing $40 million

to standardize its IT infrastructure, which involves upgrading human resources,

financial and demand planning platforms. As for the POS system, an IT provider

has been selected and tests are to be conducted in 2009 in several stores. It aims to

eventually upgrade it to allow for greater data-mining flexibility for promotionsand price increase implementation across the network.

Improve Inventory Management and Optimize use of existing DCs: Enhanced

supply logistics, better demand planning and the harmonization of product offers

should reduce overall inventory levels. 2008 to date, the company has realized

significant inventory reductions, with same-store and DC inventory levels down

nearly $80 million or 10% year over year. RONA is also analyzing delivery

methods used by 200 of its major suppliers to fine tune its direct-to-store, DC

RONA aims to improve

gross margins by

increasing global sourcing

and private label offer,

among other initiatives.

Year to date, significant

inventory reductions were

achieved through improved

inventory management and

optimized use of DCs.


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or cross-dock deliveries. By having suppliers deliver high-volume products to

RONAs cross-dock DC rather than direct to store, on-hand inventory levels should

drop. We believe that the companys existing distribution centers are sufficient to

support organic growth over the forecast period and, in maximizing its cross-dock

use, the Terrebone DCs volume should double (now operating at 50% capacity).

Calgary DC expansion plans (set to cost about $25 million), as well as the eventual

consolidation of three DCs in Alberta, were recently put on hold until market

conditions improve. RONA also recently appointed Paul Jovian as the new SeniorVice-President, Supply Chain Management to oversee the optimization if its entire

supply chain, an initiative that stems from its strategic plan. Mr. Jovian has 25

years experience, having previously been employed at Canadian Tire, most

recently in the role of Vice-President, Supply Chain, major projects.

Disposal of non-core assets: To improve profitability, RONA closed four non-

profitable stores in 2008 (none were closed in 2007). We do not expect further

closures in the near term.

Modest New Store Construction Plans. But, Will They Be CurtailedFurther?

In 2007 RONA opened 10 new stores (compared to 15 originally targeted, and

versus 8 in 2006) in Alberta, Ontario and Quebec, for a total investment of $186

million. Six are located in Ontario, where RONA is focused on growing its market

share and strengthening its competitive position, particularly against Lowes; in

2007, Lowes opened its first six stores in Canada, all of which were located in

Ontario (see the section entitled Overview of Key Players for additional details).

Exhibit 19. RONA Inc.: New Store Openings

F09E

F04 F05 F06 F07 F08E TD Mgmt Target1

F10E

Big Box 1 2 5 7 2 1 2 2

Proximity 3 4 3 3 4 3 5 5

Total 4 6 8 10 6 4 7 7

11 big box and 2 proximity stores are relocations


One of RONAs main competitive advantages lies in its one size does not fit all

approach. It allows the company flexibility to penetrate smaller markets quicklyin communities of all sizes. RONA has been scaling back the size of its typical big-

box store, which now averages 80,000100,000 sf, down from 120,000 sf a few

years ago. This is a result of scarcity of large development areas and escalating

land costs in some parts of the country and mainly the belief that the younger

more-informed generation is in search of convenience and expertise. This has also

led to the development of RONAs Proximity and Specialized stores, in addition to

its goal of providing consumers personalized service typical of small regional

hardware stores. It costs RONA $2430 million for a new big-box store and $14-

One of RONAs main

competitive advantages liesin its one size does not fit

all approach.


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18 million for a Proximity (land, building, inventory and pre-opening expenses

included). Once fully ramped up over 2436 months, we understand that these

stores typically add sales of $2040 million and $1220 million, respectively.

Fiscal 2008 to date, RONA has opened six stores two big-box and four

Proximity. Another Proximity store originally scheduled to open this year, is now

expected to open in early 2009. Management had indicated that it expects to

open two big-box (one relocation) and five Proximity stores (two relocations)in 2009. However, we question whether the company will maintain its new

store opening goals for next year given the deteriorating economic climate, and

suspect that RONA will likely postpone some of these projects to early 2010 (we

address this further in the Financial Section of the report).

Proximity Store expansion in Western Canada and Ontario is the focus. RONA

currently has land bank and site commitments for over 30 new stores, with the

majority located in Ontario and western Canada. We expect the majority of new

store openings to be Proximity stores averaging 52,000 sf, given 1) the limited sites

available for big-box formats, as we discuss below, and 2) RONAs ability to

leverage its distribution structure in addressing local customer needs with smallerstore formats.

Big Box Format Is Near Saturation, Especially In Ontario. So, Where IsLowes Going Next?

The big-box is a large format retail footprint of 85,000140,000 sf. Since their

appearance in 1992, big-boxes enjoyed significant growth and through the mid-

1990s, sales grew as much as 30%, perHardlines. The rate of sales growth peaked

in 2005, when market share topped 21.8%, and dropped slightly to 21.5% in 2007.

Canada counted 255 big-box stores, and will likely end 2008 with 264. Home

Depot is the largest in this category, with 172 stores; RONA comes in second with

77. Kent, the third player with seven stores, operates only in Atlantic Canada. The

announcement of Lowes entry into Canada, and the subsequent opening of eight

stores, adding yet a third (potentially) national player in the country, have

prompted queries over the ultimate penetration level of this store format.

RONA management believes that the Canadian market for big-box stores is

close to saturation, and our analysis below seems to concur. As described in the

section above, this is part of the reason why RONA has been scaling back the

opening of this store format (having pioneered the mini big-box as far back as

1997, with its RONA Regional banner in Quebec). Home Depot, which had 165

big-box stores in Canada (65% of total) at the end of 2007, is also testing smaller

store formats with a 45,000 sf prototype opened in Ontario in October 2008.

A recent article in Hardlines pointed out that unless Lowes can increase the big-

box market share without taking it solely from competitors, the total size of

Canadas big-box market is not likely to increase dramatically. We agree with this

and believe that over the next couple of years, if Lowe is successful in pursuing its

aggressive market penetration (with a target of 100 stores), both Home Depot and

The majority of new store

openings will likely focus

on Ontario and Western

Canada.


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Exhibit 21. Big Box Saturation Analysis in Canada

Canada Big Box Penetration by Company 2007 Canada Big Box Penetration by Company 2008E

Square # of people Square # of people

Population Population # of Footage/ / big-box Population Population # of Footage/ / big-box

(mm) Density big-box Population (000) (mm) Density big-box Population (000)

Home Depot 165 0.55 200 Home Depot 172 0.57 194

RONA 77 0.26 428 RONA 77 0.25 433

Kent 7 0.02 4,704 Kent2

7 0.02 4,759

Lowe's 6 0.02 5,488 Lowe's2

8 0.03 4,164

Total 32.9 3.5 255 0.85 129 Total 33.3 3.5 264 0.87 126

New Additions Possible 3,4 44 New Additions Possible 3,4 39

U.S. 301.1 31 3,917 1.43

1Store count as of Q3/08

2Store count as of Q4/08

3Assumes saturation point of 1 sf per person

4Assumes average big-box = 110,000 sf in size.

Source: Company reports, Hardlines, TD Newcrest.

Since Lowes first foray into Canada was in Ontario, we have taken a closer look

at the saturation of the Ontario market. Using the same assumptions as above, the

Ontario market seems to have little room for new big-box stores, or four net newadditions possible. Ontarios denser population, relative to other regions, would

justify a higher saturation level (as is the case in the U.S.). A slight tweak to the

saturation level to 1.05 sf of space per person and a store size of 100,000-110,000

sf, raises the number of possible additions to 1021 stores.

Exhibit 22. Big Box Saturation Analysis in Ontario

Ontario Big Box Penetration by Company 2008E

Square # of people Saturation Point (# of Sq. Ft. per Person)

Population Population # of Footage/ / big-box 1.00 1.05 1.10 1.15

(mm) Density big-box Population (000) 100 15 21 26 32

Home Depot 1 85 0.73 151

RONA 19 0.16 673 105 9 15 21 27Kent 0 - -

Lowe's 8 0.07 1,599 110 4 10 16 22

Total 12.9 13.4 112 0.96 114 115 -1 5 11 17

New Additions Possible2,3

4 120 -6 0 6 12Avg.

SquareFoo

tageof

New

Stores(000)

Sensitivity Analysis # of Big Box Additions Possible in Ontario

1Opened four stores in Ontario year to date as of Q3/08

2Assumes saturation point of 1 sf per person

3Assumes average big-box = 110,000 sf in size.

Source: Company reports, Hardlines, TD Newcrest.

Why We Do Not Believe Lowes is Interested in RONA, at Least For Now

Lowes announced entry into the Canadian market in June 2005 prompted

speculation surrounding its potential interest in acquiring RONA. This appears to

have subsided of late, but remains in the back of investors minds as a possibility;

we chose to address it as we believe that there are a number of reasons why an

acquisition of RONA might not make sense, for now.


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Lowes has not grown by acquisition in the past. Almost all its growth has

been organic, with the exception of one acquisition, of a 32-store hardware

chain in nine western U.S. states in 1998. At that time, it had 465 stores.

Both RONA and Home Depot are scaling their store sizes back as discussed in

the previous section. The exception to the rule remains Lowes Canada, which

has maintained its intention to build full sized big-box stores and a disciplined

approach to its store format. Industry observers seem to attribute this to Lowesdesire to provide Canadian consumers the full product assortment in order to

make biggest impact on the market, which it seems to have achieved.

So what is to stop Lowes from developing smaller store formats in Canada?

Nothing, in our view. But, it has yet to do so in its own backyard, where

independents make up over 45% of the market. The latest developments in the

U.S. indicate that Lowes is reconsidering its super-size strategy, with about

30% of its store openings in 2009 expected to use a 103,000 sf format rather

than the 117,000 sf format; No indications of going smaller have been

provided. It is also important to acknowledge the difficulty that typical big-

box retailers like Lowes and Home Depot have in squeezing a largenumber of SKUs into a smaller store format without a corresponding

strong distribution and special order system that is integral to servicing

smaller formats. RONAs system is constantly fine-tuned and still involves

over 20,000 items being hand-picked per day.

A few corporate differences arise when looking at the two companies as well:

Lowes entire store network is corporately owned, whereas RONAs includes

23 franchised stores (or 3.3% of its network). Admittedly, this is not a big

factor as these franchised stores could be converted or sold if need be. Also,

Lowes typically owns 90% of its real estate, versus RONAs 25%. And, most

importantly, particularly given that Lowes has such a disciplinedapproach to its store formats, we would be hard-pressed to see the

company become interested in RONAs affiliated dealer network of 435

stores (or 63% of its store network, which tends to be small in size).

Also, RONAs distribution network fully integrates both its corporate stores and

affiliates and would be nearly impossible to separate. About 25% of RONAs

workforce is unionized, whereas Lowes (and Home Depots) is not. And

finally, theres the Quebec factor. Owing to cultural differences and additional

costs involved in following laws governing the use of two official languages in

the province, it is typically developed last (or not at all). A few examples that

come to mind include retailers such as Pottery Barn, Williams Sonoma, andRestoration Hardware that have yet to open stores in the province.

It is also worth mentioning that RONA has a flip-in poison pill to

discourage unsolicited takeover bids (adopted in early 2005). Under the plan,

in the event of an unwelcome bid, existing shareholders (except the would-be

acquirer) may acquire additional shares at a 50% discount to the market price

and, in so doing, would significantly dilute the acquirers existing position.

Lowes maintains its

intention to open full sized

big-box stores in Canada.


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We acknowledge that Lowes growth could, to large extent, be achieved by

stealing market share away from Home Depot and RONA; but it seems

unlikely to expect the totality of its growth to stem from that, especially given

the scarcity of prime real estate locations. It is important to recall that when

Lowes began to encroach on Home Depots big-box market share in the U.S. by

offering a new fresher big-box look, the latters existing store network was more

mature and in need of revamping. This does not hold true in the Canadian market,

where the big-box store network is relatively younger. As shown in our big-boxsaturation analysis, Lowes would likely need to change its approach to new store

development and consider smaller store formats, in which case, the RONA

proposition becomes appealing. The one main issue remains RONAs extensive

dealer network, which is fully integrated within its retail distribution structure and

is tough to separate.

Lowes may steal some big-

box market share away

from Home Depot and

RONA. But then what?


31/72


Financial Analysis

Driven by a well thought out acquisition and affiliate recruitment strategy and

mid-single digit SSS growth, RONAs net sales grew at a CAGR of 20%, and

EBITDA margins rose on average 70 bps per year, between 2001 and 2006.

Over the same period, organic growth averaged 7.5% and EPS (f.d.) grew at a

CAGR of 25%, as the home improvement industry benefitted from a booming

housing market and RONA implemented initiatives to increase store traffic, salesand profits. In fiscal 2007, RONA faced significant headwinds, with worsening

economic conditions and unfavourable weather conditions. For the year, the

company recorded a meager 0.9% organic growth, saw SSS drop for the first time

in its history as a public company and EBITDA margins retreat 10 bps.

Exhibit 23. RONA Inc.: Select Historical and Forecast Income Statement Statistics

Consolidated sales vs. EBITDA margins

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2002 2003 2004 2005 2006 2007 2008E 2009E 2010E

C

$b

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

Net Sales EBITDA Margin

Net Income

020406080

100120140160180

2002 2003 2004 2005 2006 2007 2008E 2009E 2010E

C$

mm

Retail Sales & EBITDA margins

0.0

0.51.01.52.02.53.03.54.04.55.0

2002 2003 2004 2005 2006 2007 2008E 2009E 2010E

C$b

6.0%

6.5%

7.0%

7.5%

8.0%

8.5%

9.0%

9.5%

Sales EBITDA Margin

Distribution Sales & EBITDA margins

0.5

0.7

0.9

1.1

1.3

1.5

2002 2003 2004 2005 2006 2007 2008E 2009E 2010E

C$b

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

Sales EBITDA Margin

Source: Company reports, TD Newcrest estimates.

Q3/08 review

In Q3, RONAs results were weighed down by the deteriorating economic

conditions, despite the progress made on its PEP initiatives. At $0.46, Q3/08

EPS (f.d.) was down 10% from $0.51. Retail segment revenues were essentiallyflat, as the positive impact from recent acquisitions and new store openings was

offset by a 3% drop in SSS. Sales declined in most product categories, but average

basket size was up in the quarter. Distribution segment sales were up 9%, owing to

the recruitment of new affiliates, an accelerated conversion process and increased

purchases by existing affiliates due to the introduction of new sales programs.


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Consolidated adjusted gross margins improved 40 bps year over year in Q3/08

driven by 1) a 6% year-over-year increase in private label product sales, which

now account for approximately 17% of overall sales; 2) product management

improvements logistics costs were reduced by approximately $1 million due to

the continued optimization of RONAs distribution channels; and 3) improved

product purchasing terms. Retail segment EBITDA margins dropped 90 bps

year over year to 8.9%. However, excluding one-time charges related to store-

closures, margins would have been down only 10 bps as benefits from RONAsPEP initiatives partially offset the impact of lower SSS. Management indicated that

the integration of its two most recent acquisitions, Dicks Lumber and Best-MAR

were going well and that both posted improved EBITDA margins in the quarter. As

for the Distribution segment, EBITDA margins improved 41 bps, driven by

higher sales and supply chain improvements.

Expected future performance

In Q4/08,we foresee organic growth and margin momentum continuing to slide, as

economic conditions worsen. Retail segment revenues are forecast to drop 2.5%,driven by a decline of 5.5% in SSS, partially offset by the contribution of the past

couple of acquisitions (Best-MAR and Dicks Lumber). Distribution segment

revenues should fare better, aided by the addition of 25 dealers recruited to date. In

Q3/08, management noted that its affiliate dealers, which typically operate smaller

stores, have been less affected by the economic slowdown than the corporate store

network. We expectconsolidatedEBITDA margins to drop by 40 bps, which takes

into account previously announced store closure costs of about $3.7 million.

Excluding these costs, EBITDA margins would only drop approximately 10 bps.

Our EPS forecast stands at $0.20, down 22% year over year remember that Q4 is

seasonally the companys second weakest quarter after Q1.

In 2009, we are forecasting consolidated revenues to decline by approximately

1.8%, before turning 4% higher in 2010.Within the Retail Segment, we expect

the mid-single-digit SSS decline seen in 2008 year-to-date to continue into 2009,

with forecast SSS growth of -5%, more than offsetting the positive impact from

four new planned store openings. Management had guided for seven new stores in

2009, although we believe that a few of these projects may be postponed in view of

prudently allocating capex in the current economic backdrop.

In its 2009 Budget, the Federal Government proposed a new Home Renovation

Tax Credit (HRTC). Effective through January 31, 2010, homeowners can claim a

tax credit for 15% of renovation expenses up to $1,350, for projects between$1,000 and $10,000. The government estimated the total value of the tax credit at

approximately $3 billion, and expects about 4.6 million families to take advantage

of the benefit. The government of Quebec, the province where RONA generates

about half its business, also announced in January, that it would provide

homeowners with a refundable tax credit of up to $2,500 for home improvement

and renovation expenses in excess of $7,500.


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Piggybacking on this move, RONA offered a 10% cash-back to be redeemed in

gift cards applied to the cost of materials purchased at RONA or Rno-Dpt

anywhere in Quebec, for use in a project that is eligible for the governments tax

credit program. The company will also most likely extend this incentive outside of

Quebec. While this is a step in the right direction, in that it might stimulate some

consumer spending, we do not believe it will materially affect our expectations.

We expect 2010 retail revenues to improve modestly by 2.8%, given our

expectations for a similar new store opening pace in 2009 and 1% SSS growth.

In the Distribution Segment, revenues are expected to rise 5% and 9% in 2009

and 2010, respectively, mainly driven by the continued recruitment of new

affiliates, and despite weak organic sales growth of -1.1% and +1.3%. While we

believe that the current economic environment is supportive of recruitment, we are

conservatively forecasting $150 million in additional retail sales from affiliate

recruitment in 2009, below managements goal of $200 million.

Consolidated EBITDA margins are expected to drop about 30 bps in 2009 at

7.5% and increase by about 35 bps in 2010. This year, the negative leverage

from weak top line growth should largely offset benefits from profit improvementinitiatives launched, including improved product purchasing terms, increased

private label product sales and inventory management improvements. We expect

new store opening costs to remain a drag on profitability longer than is typical as

revenue growth will also take longer to materialize. Also recall that about 50% of

RONAs cost base is fixed, in addition to the fact that it is attempting to strike

a balance between reducing its payroll costs, which represent approximately

60% of SG&A, and continuing to provide good customer service a key

element in the battle with other home improvement retailers, and, along with

price, one of the two top reasons for shopping at a given retailer, after

proximity.Retail Segment 2009 EBITDA margins should drop approximately

40 bps, off of an easy comp in 2008, when RONA recorded close to $15 million instore closure charges (excluding these charges, margins actually drop 70 bps).

Distribution Segment margins are expected to remain essentially flat.

Exhibit 24. RONA Inc.: LTM EBITDA Margins and EPS to Trough in Mid-2009

LTM EBITDA Margins

6.0%

6.5%

7.0%

7.5%

8.0%

8.5%

9.0%

4Q03

1Q04

2Q04

3Q04

4Q04

1Q05

2Q05

3Q05

4Q05

1Q06

2Q06

3Q06

4Q06

1Q07

2Q07

3Q07

4Q07

1Q08

2Q08

3Q08

4Q08E

1Q09E

2Q09E

3Q09E

4Q09E

1Q10E

2Q10E

3Q10E

4Q10E

LTME

BITDAMargin(%)

LTM EPS (f.d.)

$0.70$0.80

$0.90$1.00$1.10$1.20$1.30$1.40$1.50$1.60$1.70$1.80

4Q03

1Q04

2Q04

3Q04

4Q04

1Q05

2Q05

3Q05

4Q05

1Q06

2Q06

3Q06

4Q06

1Q07

2Q07

3Q07

4Q07

1Q08

2Q08

3Q08

4Q08E

1Q09E

2Q09E

3Q09E

4Q09E

1Q10E

2Q10E

3Q10E

4Q10E

C$



34/72


While we expect RONA to continue to benefit from the PEP initiatives being

undertaken, we believe this will be more than offset by the challenging

business conditions in 2009 and the resulting negative leverage. Our forecasts

reflect continued margin compression through mid-2009, before rebounding. We

agree with managements recent statement that it may not achieve its original

objective of low single digit EPS growth over the first half of its 20082011 plan.

We forecast EPS of $1.22 for 2009, down approximately 10% from $1.36 in 2008.

Note that 2008 to date, RONA has incurred $15 million in pre-tax store closurecosts segments, which we do not exclude as one-time items, and therefore shave

about C$0.09 per share off our 2008 EPS estimate. We chose not to adjust our EPS

for these costs, given that this is the first year that RONA discloses them and the

fact that business was likely re-routed to other RONA stores nearby. We expect a

rebound in earnings in 2010, with EPS up 13% to $1.39, aided by a return to

positive SSS territory and additional benefits from its PEP program.

RONA is not exposed to material foreign exchange fluctuation. About 10%

purchases are denominated in U.S. dollars (the rest in Canadian dollars). These

purchases consist mostly of seasonal products acquired in Asia and some U.S.

sourcing. Its annual procurement in U.S. dollars is about US$200 million andmanagement typically hedges 80% of U.S. dollar purchases. Since RONA

conducts it business entirely in Canada, there is no other source of direct foreign

exchange risk.

Our sensitivity analysis indicates that each 1% change in SSS yields a 1520

bps change in EBITDA margin for RONA on an annual basis (or

$0.030.04/share). The sensitivity is more pronounced in Q1 and Q4, given

revenue seasonality and taking into account the lower fixed cost absorption during

these slower quarters.

Our Forecast SSS in the Context of the Current Downturn

Looking back at the past few recessions, the cyclical peak to trough decline in U.S.

existing home sales has averaged 30%. In the current cycle, the U.S. housing

bubble began to burst in 2005-2006, due to high default rates on subprime and

adjustable rate mortgages (ARMs). Since the peak of September 2005, U.S.

existing home sales are down 37%, nearing the level reached in the recession of

the 1980s (-39%). In Canada, since the peak of November 2007, existing home

sales have also dropped 37%. Although Canada is not subject to the same

difficulties tied to the U.S. subprime mortgage, existing homes sales activity

appears to have caught up rather quickly with U.S. housing declines. This isdespite the stark differences in the two housing markets, such as the lack of

aggressive lending practices in Canada and the consequent lower foreclosure rates.

Each 1% change in SSS

yields a 1520 bps change

in EBITDA margin for RONA

on an annual basis.


35/72


36/72


Exhibit 26. Components of Year-Over-Year Change in U.S. Residential

Investments

-12

63.3

-115.4

8.8

13.8

5.4

-9.9

-16.8

16.5

-150.0

-100.0

-50.0

0.0

50.0

100.0

2005 2006 2007

YoYChange(U

S$bln)

New Construction Spending Improvements Other Investments

14% YoY Chg in ResidentialInvestment

(2%) YoY Chg inResidential Investment

(17%) YoY Chg inResidential Investment

Source: BEA.

As for Canada, residential investment as a percentage of GDP has held up

relatively well compared to the U.S. The ratio currently stands at 5.6%, above its

historical average of 4.7%. While we do expect this metric to soften, here again,

we do not believe the downturn should be as pronounced as it has been in the U.S.

Still, using TD Economics forecast GDP for Canada and a trough of 4.7% for the

residential investment-to-GDP ratio would yield an expected drop of about 16.0%

for residential investments in Canada in 2009. Taking into account the fact that,

historically, renovation has accounted for approximately 45% of the growth in

residential investments in Canada, home improvement spending could drop about

7% in 2009. Remember that it took 12 quarters for this ratio in the U.S. to movefrom its peak to the current trough, whereas our trough estimate for Canada is

reached in only five quarters.


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Exhibit 27. How Far Can Residential and Home Improvement Spending Drop?

Q1/07 Q2/07 Q3/07 Q4/07 Q1/08 Q2/08 Q3/08 Q4/08 Q1/09E Q2/09E Q3/09E Q4/09E 2008 2009E

US Residential Investment (US$b; SAAR) 677 654 618 571 528 505 479 439 427 413 401 433 488 418

GDP (US$b; SAAR) 13,511 13,738 13,951 14,031 14,151 14,295 14,413 14,265 14,237 14,229 14,297 14,408 14,281 14,293

GDP y/y chg 4.2% 6.7% 6.2% 2.3% 3.4% 4.1% 3.3% -4.1% -0.8% -0.2%

Documents

Rona initiating coverage