Okay, maybe better isn’t the best word. Let’s go with an alternate play. That’s probably better. You know what else is a good word? Testicle. It just rolls off the tongue.

Obligatory link to my previous piece on why I’m short the Canadian banks and indirectly the housing market.

Obligatory link to some chicks showing off some cleavage.

Let’s assume you’re a little like me and you think the market is getting a tad bit overvalued. You’re running stock screeners and there’s not much of anything coming up. You look at companies that are interesting, but they’re few and far between. You even take a look at some blue chips, like say McDonalds, or Pepsico, or Exxon Mobil, and conclude they’re all a little expensive. They’re not ridiculous or anything, but you’re not about to buy them. Wow, you are so much like me. It’s almost like we’re soul mates. No, that’s not creepy at all.

Even though I predicted the real estate market would implode nationally six whole months ago, it stubbornly hasn’t happened yet. I blame all of you. Bastards. Anyway, the good news for us is there’s some significant weakness in one part of the country, and that’s Quebec.

According to the Q3 update, things aren’t good in the province. Listings are up 11% over the last year, and sales are down everywhere except Montreal, and they’re only up 2%. Prices were barely up year over year, and condo prices were down in Montreal and Quebec City. Additionally, Ottawa numbers have been weak lately too, which affects another big Quebec market, Gatineau. And this is after the last few quarters were even weaker. Prices were just barely up and that was the best quarter over the past year.

Meanwhile, Quebec’s underlying economy is perhaps the worst in Canada. Employment growth is nonexistent, up a measly 0.1% so far in 2013. The manufacturing sector and weak international trade are also weighing down the provincial economy. It’s gotten so bad that the government has taken to trying to stimulate the economy, implementing stuff like a tax credit for home renovations and giving industrial customers a discount on power generated by Hydro Quebec, the provincially owned utility.

Last year, some of you might remember that Lowe’s made a bid for Rona, trying to expand their presence in Canada. The board ultimately rejected the bid, based on an inadequate price and pressure from the Quebec government. The stock promptly fell from $14 to $10 on the news. It has since recovered to $12.50, which is a fresh 52 week high.

Rona came out with third quarter results on November 12th. They weren’t pretty. Same store sales were down 2.4%, and total sales were down over 4%. Operating profit was up, but that was only on cost cutting measures. Housing starts in Quebec were down over 30% year over year, and we’ve established that Quebec is a big deal for the company.

In fact, the company gets over 50% of their revenues from Quebec. So we have a home improvement retailer, primarily focused in Quebec, which is already struggling, and will continue to show weakness as the real estate market deteriorates. That’s the crux of the argument right there.

Rona is issuing debt too, as the long term debt load has risen from $337M to $348M over the past year. Even though they still owe some significant debt, the company just announced they’re going to buy back up to 10% of the float. Of a stock that’s trading at a 52 week high, and they haven’t had a profitable quarter since last year’s Q4, in which they only made $0.05/share.

Additionally, franchisees are pissed off at the company, and a bunch of them got together to send a letter to the CEO. They were upset that they found out about the Lowe’s offer at the same time as everyone else did, and that the company isn’t doing enough to help them weather this storm of slowing sales. The letter also sheds light on another of Rona’s issues, and that’s the two different types of stores that exist under the company’s umbrella.

Some of the stores are owned by the company itself, while others are owned by franchisees. Not only does the company have to constantly make a bunch of franchisees happy, but this infighting affects big picture company decisions. There was major uncertainty when the Lowe’s offer came out, since franchisees weren’t sure what Lowe’s would do with their stores or whether Lowe’s would continue to offer them a discount on merchandise like Rona does. It’s just tougher to run a retailer when you have to deal with owner-operators.

And finally, you’ve got Home Depot and Lowe’s continuing their expansion into Canada. Both chains are doing well in the U.S. now that home prices are improving, so they’ve got plenty of capital to spend on expanding into Canada. You’ve also got Home Hardware, a nationwide chain of over 1,000 stores mostly serving smaller cities across the country. Rona is being attacked by big box retailers on the one hand and smaller, locally owned Home Hardware stores in smaller cities. This will hurt them even more once the bottom falls out of the housing market.

Rona’s numbers are struggling now, and things are still pretty okay for Canadian housing. What happens when the market actually starts going down? I think it takes Rona right down with it.

Tell everyone, yo!