Canadian Tire Corporation Ltd

TSX:CTC.A

Earnings Call Transcript 2022-Q4

[Operator]

Thank you for standing by. My name is Paul, and I will be your conference operator today. Welcome to the Canadian Tire Corporation Earnings Call. All lines have been placed on mute to prevent any background noise. [Operator Instructions].

Now I will pass along to Karen Keyes. Head of Investor Relations for Canadian Tire Corporation. Karen?

[Karen Keyes, Head, IR]

Thank you, Paul. And good morning, everyone. Welcome to Canadian Tire Corporation's fourth quarter and 2022 full year results conference call. With me today are Greg Hicks, President and CEO; Gregory Craig, Executive Vice President and CFO, and TJ Flood. President of Canadian Tire Retail.

Before we begin, I wanted to draw your attention to the earnings disclosure, which is available on the website. It includes cautionary language about forward-looking statements, risks and uncertainties, which also applied to the discussion during today's conference call. After remarks today, the team will be happy to take your questions. We'll try to get in as many questions as possible. But we do ask that you limit your time to one question plus a follow up before cycling back into the queue. And we welcome you to contact investor relations if we don't get through all the questions today.

I'll now turn the call over to Greg.

[Greg Hicks, President and CEO]

Thank you, Karen. Good morning and welcome everyone. I will start by saying that overall, I'm pleased with our results, which demonstrate we continue to manage well through a dynamic economic environment.

I'm going to spend some time this morning discussing what we're seeing in terms of consumer demand. But before I do, I'll give you some color on our q4 and 2022 results. In Q4, we achieved a record normalized EPS of $9.34, which brought full year EPS to $18.75, a great finish to a remarkable centennial year and barely shy of last year's record. This was despite the fact that in 2022, we experienced elevated supply chain and product costs and higher foreign exchange while investing heavily in the initiatives within our better connected strategy.

Comparable sales in the quarter were consistent with last year's exceptional growth, representing a 21% increase on a three year stacked basis. Revenue was up and stronger retail gross margin led to growth in our Retail Segment IBT. Strong earnings at CTFS driven by higher revenue and lower OpEx also contributed to our record EPS.

We continue to grow and strengthen our connection to Canadians through our Triangle Rewards loyalty program and credit card with loyalty sales up 8% and loyalty penetration approaching 60% for the year. Additionally, in 2022, we successfully delivered our stated goal of more than $300 million of operating efficiencies.

So as I said, I'm pleased with what we achieved. But I'm equally pleased with how we achieved it. Through our team's diligent management of our business and our unwavering focus on our strategy. As I imagine we're all reading many of the same headlines. I know I don't need to tell you that we continue to operate against a backdrop of uncertainty. What I will tell you is what we're seeing in terms of consumer demand through our Triangle credit card data, and our loyalty program. Our credit card data tells us that we are in a different economy. Credit card spending remains elevated but growth materially softened on a year-over-year basis starting in late September. Growth in q4 was 4%, compared to 16% on a full year basis.

Within our Triangle Rewards Loyalty membership, specifically, we are seeing different spend patterns emerge based on household income levels. Triangle members in every household income segment grew their spend with us in the quarter and every quarter of 2022. However, higher income Triangle members spend growth softened in the quarter relative to previous quarters.

There were two Triangle member segments that accelerated their spend and delivered outsized growth for the quarter. The first segment is lower income members, who traditionally have had lower levels of engagement with CTC. The second segment is middle income members who have traditionally had higher engagement with us. We think these are bullish indicators of our increased relevance in a tougher economic backdrop.

Specifically at CTR, we are seeing evidence of trade down in our best level assortments, especially in essential categories. We are not seeing a meaningful shift in our discount mix, but we grew categories we would deem as essentials, offset by a decline in non-essentials. Given the macro backdrop combined with what we are seeing in the performance of our business, we are expecting a more constrained demand environment as we look forward, especially in the first six months of this year. We believe it's fair to say that our customers are in a position where they're looking for more value. And that's where you can expect us to be laser focused in 2023

It was just about a year ago, that we announced our ball Brand Purpose, we're here to make life in Canada better. And this commitment includes providing value to Canadians in this dynamic environment. This isn't a new idea for us. It's something we've been doing for more than 100 years, and we've seen in overcome our share of challenging times.

What is new, however, is that we are better prepared and a more resilient company than we've ever been. Through our unique capabilities, learnings from the pandemic and by remaining confident and committed to our better connected strategy, we will continue to deliver value to customers, because we know that's what they need.

We are responding not reacting by reorienting our tactics while remaining anchored in our strategy. We're doubling down on our unique enterprise capabilities, including our Triangle Rewards loyalty program, broad and owned brand multi-category assortment, improved omnichannel experience, and financial services business to deliver more paths to value for our customers in 2023.

I'll start with what I believe is our most important path driving value for our customers, our Triangle Rewards Loyalty Program. We welcomed a plethora of new customers during the pandemic and our determined focus ever since has been to convert these customers into Triangle Rewards Loyalty Members. This is about more than getting our loyalty cards into the hands of our customers, it's about encouraging them to register their cards redeem ECTM, shop across multiple banners engage and connect with our brand on a deeper more personal level.

By converting shoppers into members, we can provide them with more value through ECTM and offers for the products they want and need. In an environment where relevance will be critical, frequency matters and offering the right products to the right customers at the right time is critical. When our customers become registered members, we can do this for them. Triangle is already one of our strongest capabilities for providing value. So we're working off a very powerful platform.

When you consider where we were five years ago, we knew very little about our members, and they were earning and redeeming their ECTM at mostly one banner, Canadian Tire Retail. In a relatively short amount of time, we built an incredibly strong capability for our business. And this year, we're reinforcing this strength in two main areas.

The first is continuing to drive registration, as that enables customers to see and fully realize the value of Triangle Rewards through redemption. In 2022, growth from our registered members outpaced growth from other loyalty members, and drove the $800 million increase in loyalty sales. And registered members have consistently increased spend in both essential and discretionary items at CTR. Although growth rates have declined since earlier in the year, their behavior is significantly different than non-registered and non-members. This further supports our belief and engagement and Triangle and ECTM is enabling members to retain their spending.

Additionally, every time a registered member shop or redeem, we learn more about them, which helps us determine how best to deliver value to them in the future. This continuous cycle creates a flywheel effect in which value begets more value. I'll also add that we issued $350 million of ECTM to our membership in 2022, an increase of 16% compared to 2021. So the flywheel is primed for value delivery and 2023.

Our second focus area within triangle is helping customers earn CCTM faster through the use of strategic promo offers and driving cross shop across our banners. During this call last year, I went fairly deep on Party City performance to demonstrate the power of the Triangle Rewards program. As a reminder, last year, we disclosed the fact that the standalone Party City Business was up 26% for the full year, and that we had almost 400,000 Triangle members shop the banner, and that these members over indexed on our key 30 to 49 year old families customer segment.

In 2022 we continued to drive customers to Party City through cross banner engagement. Another 400,000 members shopped the banner for the first time in 2022. And full year comp sales in our standalone stores were up 18%. On last year's call I also mentioned we had recently activated Triangle rewards of Pro Hockey Life. The power of the triangle has manifested in this business as well, with 127,000 triangle members shopping the banner and our full year sales of 19%.

In addition to making our banners stronger through cross shop initiatives, next month, we will launch the mass marketing of Triangle Select our subscription model that includes a number of perks including ECTM access operators on products with our own brands portfolio. You'll recall that throughout last year, we ran a beta test of Triangle Select, what we learned is that Select really accentuates our differentiators our own brands, our physical stores and Canadian Tire Money. Subscribers earn ECTM faster in large part, thanks to the program's ECTM accelerator offers. For example, in our beta test the average member's annual incremental earnings through Select specific bonuses were more than three times this subscription fee.

We also saw that the program drives significantly more spend and cross shop across our banners and members that cross shop spend an average of three times more than those who shop at only one banner. We've been working on this program for quite some time and believe this timing is perfect for adding even more value to our membership.

Another critical path for delivering value to customers is their unique multi category product assortment. We've long been known for the breadth of our assortment, and by continuing to expand our range of good better and best products over the last many years, we are in a better position now than ever. The breadth of our assortment, especially in our own brands portfolio enables us to continue meeting customers wants and needs while providing much needed value if and when they are looking to trade down.

At CTR, we've designed entire categories, such as barbecues, kitchen appliances, bikes and tents to have good, better and best product representation. This strategy has enabled the engineering of profit at each quality tier. For example, within kitchen appliances, we offer MASTER Chef which is our good tier product, Vida PADERNO as our better and PADERNO is our best.

At SportChek, we are very pleased with our own brand performance, including ford with design and woods, both of which are positioned within the better tier relative to strong best level national brands. And at marks you've heard us talk about going the other way. And rounding out our assortment architecture with best level national brands, such as Carhartt, Sketchers, and Levi's to provide upsell alternatives to our own brands and attract new customers.

Additionally, as a high low retailer, across our banners, we have always been able to offer value to customers through our pricing and promo strategies. Now we have more tools to surface value across all our banners, namely Triangle Rewards and our use of first party data through which we can optimize promos and send offers directly to a member as opposed to relying only on mass marketing. As I mentioned earlier, we are starting to see some bifurcation between essential and non-essential products. And this shift is aligned to what we previously planned through our strategic focus on pet, automotive and fixing as we roll out a refresh concept connect at CTR stores, where we can we are accelerating shifting more of our resources into essential categories.

For example, we are well on our way with rolling out our enhanced Petco shop and shopping experience across our CTR network. Most of our stores have been extremely busy this month implementing the new concept. We have over 80% of the store network setup. And we'll have 90% complete by the summer. We're also looking at how we focus our inventory purchases and marketing spend into these types of categories.

For example, at Mark’s, we're looking to expand our industrial workwear assortment, including testing a new Mark’s Pro store concept later in the year. Overall, all of these product examples illustrate the resiliency of our offering, and our ability to pivot as different consumption patterns emerge.

Finally, before I turn it over to Gregory, I want to spend some time talking about our determined focus on providing a seamless omnichannel customer experience. The experience we offer, both in store and online is all part of the larger value equation for the customer. We remain confident and committed to these important investments as they will further our competitive posture and drive operational efficiency over the long time -- long term.

You'll recall from our investor day, that experience is one of the top five pillars within our better connected strategy. In 2022, we made good progress against these initiatives. And I'll give you a few of the highlights. To help our CTR stores operate more efficiently and improve their in--stock position, we've implemented a new assortment management platform we call Tetris, which empowers stores to build customized assortments and inventory depth at the item level. We've been building this platform for two years. With the help of a committee of associate dealers and a partnership with Montreal based IVADO Labs, who are world class leaders in AI, machine learning and optimization. The AI technology has been rolled out to over a third of the network with the remainder scheduled to be completed this quarter.

On the customer facing side, we continue to roll out in store automations that CTR. 80% of stores now have pickup lockers and more than half have electronic shelf labels. Since we launched our new online automotive service appointment system in late September, over 80,000 customers have booked using the system in more than 80% of our stores. This year, we expect the number of stores offering online booking to reach 90% and represent over 10% of our total service visits.

In terms of our e-commerce experience, we've moved closer to having a single integrated website through the launch of our one digital platform at CTR in 2022. Party City migrated to the new platform a couple of weeks ago, and our mark since SportChek banners will migrate this spring. Additionally, we continue to enhance the ways in which customers can shop with us by expanding our ship to home options, including through our partnership with DoorDash. As discussed in our Q2 call last year, through this partnership, we rolled out to our same day delivery across our SportChek network. We've been very pleased with the results and the customer experience scores have been extremely positive.

Earlier this week, we launched an express same day delivery pilot with DoorDash at 10 CTR stores in Ottawa. If the program scales positive experiences the same way it has for SportChek, our intention will be to roll out this program nationally.

In terms of our supply chain, we continue to use 3PLs as needed, while expanding our capacity through our new distribution center in the Greater Toronto area, which will improve e-commerce fulfillment rates for Mark's and SportChek. Overall, our ongoing investments and focus areas demonstrate how we're providing more value to our customer and enhancing their shopping experience.

And with that, I'll pass it over to Gregory.

[Gregory Craig, EVP and CFO]

Thanks, Greg. Good morning, everyone. Overall, our strong operational performance through the year and the strong finish to the fourth quarter against exceptional comps helped us achieve an outstanding result in a dynamic economic environment. We were very pleased to report full year normalized EPS of $18.75, within 1% of last year's record EPS despite the headwinds we continue to face throughout the year, which included higher freight and supply chain costs, and a stronger U.S. dollar to name a few.

For the quarter, normalized diluted EPS was up 11% to $9.34, after $20 million of normalization costs related to the operational efficiency program, which represented around $0.25 on a per share basis. Q4 revenue was up in both retail and financial services and that along with an improvement in the retail gross margin rate, translated into higher gross margin dollars. We manage operating expenses carefully as we continue to invest in the business and operate with elevated supply chain costs.

IT came in at 6% higher for the quarter, which when combined with the impact of share repurchases in 2022 drove the 11% increase in EPS.

Let me now take you through the performance of the business on a segment basis starting with retail. Retail sales were up just over 1% to $5.7 billion in the quarter. In our petroleum business, higher prices at the pumps once again offset flat volumes, driving a 10% increase in sales and contributing positively to retail sales growth.

Now turning to retails comparable sales, which exclude petroleum. Comparable sales were in line with an exceptional Q4 last year, when they were up 11.3%. And on a three-year stack basis comparable sales were up 21%. Mark's and Helly Hansen were the standouts from a growth perspective. Mark's comp sales were up 4% against a 15% comp last year, and Helly Hansen revenue was up 21% on top of strong growth in 2021.

Let's now look at the highlights for each of the banners starting with Canadian Tire. At Canadian Tire Retail, we continue to meet the changing needs of Canadians through the breadth of our assortment, allowing us to hold comparable sales flat against a 9.8% comp. The automotive division once again posted strong growth, as it has done for 10 consecutive quarters now.

Automotive was up 5% and auto maintenance and light auto parts did particularly well both at Canadian Tire and Part source. Diesel and gardening was in line with last year. A great result considering the decline we saw in Christmas categories against the significant growth over the last three years with categories like Christmas lights and decor up 15% on a compound annual growth rate basis since 2019.

The Living division was also up slightly on last year, with solid performance and kitchen and growth and essential pet and home categories. Party City also saw strong growth both within Canadian Tire and at the standalone stores, with sales up 30% and 10% respectively. Our fixing and playing divisions were down in the quarter compared to last year, with playing seeing decline in exercise categories, which grew well during the pandemic and as we started to cycle the return to hockey and winter sports last year.

Investment on our Canadian Tire store network remains a key component of our strategy grow the top line. 36 Canadian Tire stores were refresh, expanded, or replaced in 2022 and we were pleased with the results, which continue to track ahead of our expectations. Another 23 projects are expected to come on stream in the first half of 2023.

As I've done previously, I want to sum up where we ended the year in terms of the relationship between sales and revenue growth. Sales growth slowed at CTR in the second half of the year, as we started to comp quarters without any of the impacts of pandemic restrictions, and with a softening consumer demand environment towards the end of the year. Turning to revenue for CTR, we saw a similar pattern. Revenue is very strong in the first half of the year, up 7% on 2021, but decelerated for the last six months with Q4 up 1%. However, on a full year basis, revenue growth outpaced sales growth by close to 300 basis points.

As we have mentioned previously, given our dealer model, revenue and sales growth can be out of sync in any given quarter. Therefore, we would expect the growth patterns for revenue and sales to converge over the course of the coming quarters as they typically do. I will speak more about this in a moment when we get to inventory.

Moving over to SportChek, comparable sales grew in 2022, up almost 2% driven by 4% growth in the first half of the year. Q4 comparable sales were down 2% against the 16% comp last year, when we had the benefit from the post-COVID resumption of team sports. A highlight in Q4 was Fanwear, our new name for licensed apparel, with growth driven by World Cup related demand. We also had better national brand product availability as supply chain started to normalize. However, the softening consumer demand environment and milder weather resulted in lower sales in category like outerwear, skiing and snowboarding.

From a triangle rewards perspective, SportChek continues to attract new to CTC members and personalized tribal member offers continue to drive engagement for the banner, with more than a million customers activating one to one offers.

Moving out of Mark's, we recorded our 10th consecutive quarter of positive performance with comp sales up 4% and close the year up a significant 10%. In the quarter, sales of casual and industrial footwear were key performers with casual footwear sales up 10% driven by the innovative IceFX technology, which is embedded in many of our own brand boot products. We sold over 150,000 pairs of IceFX boots in Q4 up an impressive 50% over Q4 of last year. We continue to drive towards a healthy mix of national and own brand sales of Mark's and are very happy with the outcomes the strategy is delivering.

Impressively sales of own brands at Mark's hit $1 billion for the first time in 2022, partially driven by the strength of casual and industrial brands, Denver Hayes, and Dakota Pro. Mark's also continues to focus on growing national brand sales as a customer acquisition vehicle, and brands like Carhartt were up 27% for the year. Our strategic initiatives have also helped Mark's continue to attract new customers to our Triangle program. And in 2022, we continue to see an increase in active Triangle members and the under 30 segment at Mark's.

Now on Helly Hansen, revenue was up 21% with strong sell through a both sportswear and workwear across wholesale and e-commerce channels. We had double digit revenue growth across most markets, including North America and Europe. In the U.S., a continued focus on e-commerce, direct-to-consumer and retail channels drove exceptional growth. We also continue to build our sales through CTC banners in Canada, and on a full year basis, sales for CTC banners were up 8%.

Moving to margin now, you will recall the Q4 has historically been the strongest margin quarter for the retail segment, but this year was our highest yet. Retail gross margin rate excluding petroleum and increased 40 basis points in the quarter to 39.9%, with the full year retail gross margin rate slightly behind last year at 35.6%. At Investor Day last March, we said we were aiming to retain the gross margin expansion we had achieved for the pandemic. And we were really pleased with the great job the team did managing through product cost and freight headwinds to get us within range of last year's margin rate.

As expected, and as discussed in the previous calls, although still elevated, we started to see some easing this quarter on both freight and product cost inflation. And we were able to set these costs with higher product margins at CTR. Better mix also helped with contribution from Mark's and Helly Hansen, which was partially offset by higher promotional intensity at SportChek.

Looking forward, we feel good about our negotiated freight contracts for the year and expect to see commodity deflation work its way through our negotiations as we move throughout the year. Our goal continues to be to hold and protect our retail margin rates over the longer term, while striking the right balance between demand creation and being price competitive as needed to ensure we're driving value for our customers.

Let's now move on to how Financial Services performed in 2022. The Financial Services business had its strongest year on record generated $442 million of IBT. Receivables also exceeded $7 billion for the first time. Q4 IBT was up 38% to $87 million, as higher receivables and higher spend, contributed to higher revenue and improved markets and reduced acquisitions drove lower marketing expense.

Cardholder engagement remained strong, active accounts and average account balances were both up by around 6%. Gross average accounts receivable was up by 12.4% in Q4, but lagged the full year growth of 13.2% as we slowed acquisition, and saw slowing card sales. While card sales grew 4% for the quarter spend growth has slowed considerably from the 21% growth in card sales we're seeing on a Q3 year-to-date basis.

Risk metrics are continuing to trend up as we expected. The PD2 plus [ph] rate was back to historical levels at 2.9%, and while write-off rates are still well below historic norms at 4.9%, did increase in the quarter. Looking ahead, we expect write-offs to continue returning to more historic levels, as the increased investment in new accounts, a key strategic initiative that we outlined at Investor day works its way through the portfolio and mature account performance stabilizes.

Despite ongoing economic uncertainty, key indicators like employment remain robust. Our portfolio remains healthy and continues to perform well. We continue to keep a close watch on macroeconomic data and are ready to enact our playbook for additional measures to manage risk as needed.

Finally, the allowance rate at 12.6% continues to be within our targeted range of 11.5% to 13.5%.

Now I'll move on to operating expense. This quarter marked the culmination of our three year operational efficiency program. And I want to take a minute to thank the teams internally that have worked so hard to implement around 250 initiatives across the business that have delivered more than $300 million in annualized run-rate savings, ranging from the heavy lifts of our workday implementation to the smaller day to day process optimization projects across the business that mean we are operating far more efficiently. While, at this time we don't expect to put a new program in place, we will continue to bring up the operational discipline we have developed to how we run our business. Improving efficiency continues to be an important focus for us as we move forward.

The OE savings we achieved combined with lower variable compensation expense contributed to full year normalized consolidated OpEx as a percentage of revenue of 25%, up only slightly versus last year. The increase was mainly driven by normalized retail OpEx, which continue to run slightly above revenue growth driven by higher IT investments as we transition to a cloud based infrastructure and higher supply chain costs.

Now, moving on to inventory. Corporate inventory levels were 30% higher this time last year. And that's that compares to a 20% increase at Q3. Our year-end inventory build was primarily due to three factors. First, as we discussed last quarter, lower than expected planned sales in Q2, and Q3, are responsible for some of the bills particularly in the spring summer inventory at CTR.

The second factor was early receipts of merchandise, primarily at Helly Hansen, where inventory levels were lower last year, as we built inventory in support of direct consumer and strong wholesale demand. And unit cost inflation remained an important contributor to the increase in corporate inventory. A key focus for us remains managing through the higher level of corporate inventory.

Overall, we're managing our seeds and expect corporate inventory levels to normalize over the course of the year. And we believe a strong and stock position across all of our banners remains important to drive sales in a competitive environment.

Dealer ending inventory is up a more modest 10% relative to last year. A mild December means dealers are now sitting on some carryover winter inventories, but we still have some selling window left for these businesses. And we'll give you some perspective on where we land in our Q1 call. We also talked last quarter about the dealers ending heavier in spring summer inventory. We are expecting this to impact spring summer sell through to dealers by around $150 million, which will drive software revenue at CTR in the first half of the year. We expect the largest impact of this to be in the first quarter.

Turning out operating capital. In 2022, operating capital expenditures for the year were in line with our Q3 expectations at just under $750 million as we continue to invest in the store network, our supply chain and the capital elements of our IT transformation. And total capital expenditures at $850 million. We expect next year's operating capital expenditures to fall in a similar range of between $750 million to $800 million as we continue to invest in our better connected strategy.

Finally, turning to capital allocation, we continue to manage our cash and after capital expenditures, we have generated significant available retail cash flow over the last two years. This has allowed us to fund strong returns to our shareholders with $750 million paid out to shareholders in 2022, of which $325 million was paid out in dividends. We also continue to be active and buying back our shares, targeting a total of between $500 million and $700 million in share repurchases by the end of 2023.

In summary, the operating environment has changed around us as we've come through 2022 and it remains a little uncertain as we enter 2023. But we delivered a strong set of results with the hard work of many teams across the business. Strong comps in early 2022 and the spring summer inventory carryover that we have discussed will provide some headwinds on both sales and revenue, which will impact quarterly phasing in 2023.

However, we continue to believe we are better positioned than we've ever been to operate with agility. And as Greg discussed, deliver value to our customers. We remain convinced that our strategic direction is the right one, and will continue to deliver strong returns to shareholders over the longer term as we build an even better business.

With that, I'll hand it over to Greg for his closing remarks.

[Greg Hicks, President and CEO]

Thanks, Gregory. I'll end my prepared remarks today by reiterating that we are fully equipped to navigate this dynamic economic environment. Our business model is resilient, our management team is strong and we are a much better retailer today than we've ever been, because of our unique capabilities that we continue to strengthen through our better connected strategy.

We are of course watching listening and learning from what's happening right now and keeping a keen eye on where our customer is going. But we're running this business for the long term. Our collective ambition to execute the initiatives within our better connected strategy has not changed. And this is where my leadership team and I will remain focused.

One year ago, we made a commitment to our customers, employees, communities and shareholders that we are here to make life better, and that is what we intend to do from providing customers with value through our products, services and shopping experiences, to stepping up with support for our communities. I mentioned this on last quarter's call, but I believe it bears repeating. As Canadian families find themselves increasingly stretched, Canadian Tire jumpstart charities can and will be there to ensure that no matter what happens, kids can continue to participate in sport and recreation.

I'll end my prepared remarks this morning by thanking our frontline team, our associate dealers, our corporate team members and our board of directors for their commitment and dedication and making 2022 our centennial year so memorable. Although 2023 looks to be a little more uncertain, we're moving forward with clarity and confidence in our strategy, and with a clear focus on providing value to our customers.

And with that, I'll pass it over to the operator for questions.

[Operator]

Thank you. We will now take questions from the telephone lines. [Operator Instructions] The first question is from Brian Morrison from TD Securities. Please go ahead. Your line is now open.

[Brian Morrison, TD Securities]

All right. Good morning. Thanks very much. Gregory, maybe two questions here. Maybe we can dive into the gross margin and retail. I think last quarter, you thought that ex petroleum, you're going to see some reprieve from freight and surcharges relative to Q3, but rather than having, a margin decline of 100 to 200 basis points, you're up kind of 50 basis points year-over-year. So can you just go through maybe breakdown surcharge and freight I think it was a headwind, the contribution from mix at CTR and Mark's maybe pricing and leverage. Just give us some idea relative to last year that 50 basis point breakdown, please.

[Gregory Craig, EVP and CFO]

Sure, Brian. It's Gregory. I'll start and I think what I'll do is I'll pass it over to TJ to talk a bit more specifics around some of the product margin work within CTR. Here's what I'd like to anchor everybody in. And we've said this Brian for I got to feel like a broken record. We've said it so often. But I want to bring everybody back to what we said an investor day, which was we grew our retail gross margin rate, excluding petroleum by around I think, was 140 basis points between the 2019 to the end of 2021.

And what we said at that point was our long-term target, our Northstar is we want to keep those gains that we achieved over that window, and recognize that any quarter is going to have noise in it and some bumpiness around a kind of what can happen, given our banners and our mix of businesses et cetera.

And I think what we saw last year just reinforces that point that we want to get everybody to so to me, the most important thing I hope you can take from this call, in my mind is we are committed that is still our target, to basically maintain that gross margin rate that we talked about at investor day that full year achievement, and any quarter, there's going to be some bumpiness.

So let me just say a little bit about Q4, and then I will get TJ to unpack it a little bit more. You're right to acknowledge. And we said in the third quarter, there was some, some headwinds that we saw are starting to dissipate into the fourth quarter. And fuel surcharge is the one that I would draw your attention to. I know we had this exact discussion on it was a more meaningful impact in Q3, and we felt it was going to be less meaningful in Q4. So that would be a piece of the equation.

Product margins at CTR a big part of the equation, I'll get TJ to speak to in a second. And then even just business mix. Like Mark's warehouse continue to kind of punch above its weight around results. So that actually helped drive our overall margin rates as well. So maybe I'll let TJ give it a little bit more flavor on the great work his team did in delivering what I think are just across all of our businesses, but I specifically want to give TJ whether he'll talk about CTR.

[TJ Flood, President, Canadian Tire Retail]

Hey, Brian. Maybe I'll just add a little bit of color here, just building on some of the things Gregory talked about. Obviously when you're dealing with the inputs and the variables associated with margin rate. There's a lot of complexity to it, right. We're dealing with FX, we're dealing with product costs, and we're dealing with freight. And all of those headwinds hit us at varying intervals throughout the year, and particularly when you think about copying those variables, year-over-year. And when we set pricing strategy, we do so over a little bit of a longer term time horizon.

So you may see some variability and how we comp our margins, quarter to quarter to quarter. But the team has done an amazing job in managing some significant headwinds on product costs on freight, and even FX as we went through the year. When you think about our promotional elasticity models, how we look at reg pricing, how we look at our own brands portfolio and how utilize our triangle ecosystem to be much more targeted in our promotional activity. I'm very proud about how the team has performed in managing margins. And you saw that come to life in in Q4.

As we go forward, everything gets -- it continues to be volatile. And there's a lot of different headwinds and tailwind in front of us. You mentioned freight earlier, we do expect some freight release next year, but we also expect competitive intensity to dial up a little bit particular in the discretionary category. So we are committed, as Gregory said to our long term goal of maintaining our margin rates that we built over the last couple of years in the pandemic. So that's how we see it as we go forward here.

[Brian Morrison, TD Securities]

Okay, thank you. Maybe I can follow up with one more question with respect to you're seeing this easing supply chain. When do you expect inventory to start to see some a decline year-over-year or moderate year-over-year? And I guess on that front, when should the 3PL and IT costs start to dissipate within SG&A drive some leverage? Should IT be in the second half of the year? And where the 3PL?

[Greg Hicks, President and CEO]

Yeah, Brian, it's Greg. Maybe I'll take that. I think Gregory spent a fair bit of time going through our inventory position and his prepared remarks. And I think it provided a pretty good unpack.

I think the key is managing the lead time down in our average purchase orders. I talked about this coming out of Q3, and it's still about 25 to 30 days higher, which even when we're running really efficiently impacts turns pretty significantly. And it is in the domestic supply chain here in Canada. So we're definitely focused on bringing our inventory down, which will help with our cost efficiency, and it'll roll through gradually. It'll roll through gradually through the year. And to the extent that we can deliver that drawdown as we move forward, tighten up the lead times, we hope to see the variable cost and the supply chain start to decrease as well.

I think the key as I think about it, and how we're talking about our teams is in any inventory rebalancing, I think the key is ensuring that we're being surgical and not overreacting with global policies and shock and approaches. We need to feed essential businesses and work to wind down non-essential where the demand signals are weaker.

But the teams have been focused on inventory since day one of the pandemic. So I have confidence that we can use our capabilities and strong vendor relationships to manage the situation effectively.

[Brian Morrison, TD Securities]

Okay, thanks very much. Congratulations.

[Greg Hicks, President and CEO]

Thanks. Thanks, Brian.

[Operator]

Thank you. The next question is from George Doumet from Scotiabank. Please go ahead. Your line is open.

[George Doumet, Scotiabank]

Yeah, thanks. Good morning. Congrats on the quarter. Thank you for the margin breakdown. Maybe talk a little bit about the outlook and the sustainability on the gains that we made on the retail gross margin ex fuel. And maybe how early can we see the benefits of commodity deflation, how should we think of that?

[Gregory Craig, EVP and CFO]

Yeah, maybe I'll start with that. It's Gregory here. And if Greg, TJ would want to pile on as well, I'm sure they will. Look, I want to take you back to what I just said to Brian's question, which is -- and I think TJ said it well around how difficult it is to manage this on a quarter by quarter basis. There's -- so we are remain committed towards that target outlook range of having our retail gross margin rate be flat to what the gains we achieved up to 2021. And at any given quarter, there could be some variation within there.

Now you pointed out something specific around commodity, which is a great question. And what happens is that's going to come to us differently, depending on the business line negotiates their purchases for the year. So I think that's going to flow throughout 2023 to be frank, but as TJ mentioned, for every debit, there's a credit. So there's some FX pressure on a year-over-year basis, but again, so what I want you to take from this is that we are targeting over a long-term basis to maintain those games we had pre-pandemic and be in that kind of range we were at in 2021.

[George Doumet, Scotiabank]

Great, thanks. And just my follow up on, if you can just talk a little bit about the strengthen auto has it held throughout the quarter? Are you seeing maybe a deferral of perhaps some discretionary products? And can you talk a little bit about how the segment usually behaves and past economic slowdowns?

[TJ Flood, President, Canadian Tire Retail]

Hey, George, it's TJ. Maybe I'll take that one. And just wanted to kind of provide a bit of context, our automotive business has been very resilient over the last few years despite the headwinds the industry has been facing during the pandemic. We've demonstrated consistent growth in this division with Q4 representing our 10th consecutive quarter of growth. And we're seeing higher engagement and performance across many of our repair and maintenance categories like oil and fluids as well as an auto service. So we're really liking the trajectory of the business.

And as we talked a lot about at Investor day back in March, we're continuing to invest in our automotive division in a myriad of ways across our assortment, our capabilities and our customer experience. And we're on a journey to modernize the auto service experience for our customers through a suite of things that we call Auto Care which is updated technology and capabilities be like the ability for our store staff to engage with customers directly with SMS, new auto service tablets, which drive efficiency for our techs and our communication with our customers, and new online appointments.

So when you think about what this business and the industry has experienced, we believe that there's a lot of runway here for us for growth. When you think about the average age of the fleet in Canada, it's getting older because of the shortage of new cars. And that really provides a lot of tailwind for us. So that in the combination with the market share opportunities in front of us, we're very bullish about automotive as we go forward here.

[George Doumet, Scotiabank]

Thanks for answers.

[Operator]

Thank you. The next question is from Luke Hannan from Canaccord Genuity. Please go ahead. Your line is open.

[Luke Hannan, Canaccord Genuity]

Thanks. Good morning, everyone. Greg, I wanted to go back to something that you mentioned at the beginning of your prepared remarks the dynamics that you're seeing across the difference, household income cohorts. But that was interesting, because it sort of differs to what intuitively we would think were the higher income household would be a little bit more resilient than those middle and lower income cohorts. So you mentioned that the you're seeing strengthen those non-essential rather strength in essential categories, less so in non-essential categories, can you give us a little bit more color as to what you're seeing in those higher income households baskets beyond just those essential non-essential mix? And how does that compare for some the cardholder data that you see for spend beyond just what's at CTC banners?

[Greg Hicks, President and CEO]

Yeah, I mean, in general, Luke, if you think about income, the representation of sales or the mix of sales at various income levels. If you take under $75,000 households, and then over $125,000 households, historically, those groups represent about 30% of our sales tax on a consolidated basis across all of our banners. And what we saw, and I just think this just speaks to the power of the data kind of analytics that we have here.

And it and it did surprise us was a real shift, especially in the fourth quarter, where around the year, higher up income went from 30% to 20%. And in the fourth quarter was even lower than that. And the opposite was true for under $75,000 households were the percentage of mix for those income segments went up to 45% in Q4.

So, we think these are some bullish indicators of the resiliency of our model, and that we can add value, provide value to lower income segments of the market.

Generally, when you get to your question with respect to discretionary and non-discretionary, through the pandemic, higher income households have participated more in discretionary categories. So it would stand to reason that as that starts to pull back across all Canadian families that we would see that in our higher income households, we're just extremely fortunate here with our Triangle Rewards program that we can rifle in to other segments to compensate for the softening we're seeing in higher income households. So that's probably the way you should think about it, Luke.

[Luke Hannan, Canaccord Genuity]

Got it. Very helpful. And then as my follow up, it was it was mentioned in the MD&A, that there was a higher than -- well, higher than last year level of promotional intensity at SportChek. I'm curious, and where does that rank sort of relative to pre-pandemic levels if you think about the average sort of level of promotional intensity that you usually get through the holiday period?

[Greg Hicks, President and CEO]

Yeah, maybe I'll take that. It's Greg again. I think the promotional intensity that we saw in SportChek really magnified in the fourth quarter. And the magnification stemmed from activity from big brands and the DTC channel. So we saw a more aggressive movement in terms of the depth of the discount, and the timing was much earlier than we would have expected. I think the teams did a really good job, you know, managing in the in the environment. But again, it just it just speaks to how the competitive environment in can change on a dime, and you just have to be able to read react and pivot.

In general, I don't think I would say it was it was any more intense than kind of pre pandemic periods, it just came from a different place. And so when Nike and Adidas or DTC store marks down the same inventory that we're carrying in our stores, it becomes pretty difficult for us not to react. So a little bit of a nuance relative to 2019, where we wouldn't have seen that type of aggressive activity. But I think with minimal snow here in the fourth quarter in the outerwear businesses, I think the trigger got pulled just a little bit quicker than previous years.

[Luke Hannan, Canaccord Genuity]

Thank you very much.

[Operator]

Thank you. The next question is from Mark Petrie from CIBC. Please go ahead. Your line is open.

[Mark Petrie, CIBC]

Yeah, thanks. Good morning. I want to ask just about this sort of shift from non-essentials to essentials is a bigger part of your business. How would you characterize the impact of that on top line? I would assume it's somewhat deflationary. But if you could just talk about that. And then also, if there is an impact on margin rate? Thanks.

[TJ Flood, President, Canadian Tire Retail]

Hey, Mark. It's TJ, thanks for the question. When we talk about essential and non-essential, it's actually amazing how our business and our assortment is set up to flex with the needs of consumers and Canadians as they evolve. If you look at some of the discretionary categories that we had big growth in during the pandemic.

So you think of that we put together a basket of like bikes, and outdoor kayaks and recreational type products with exercise and things like that big, big discretionary kind of portfolio of goods. We declined about $175 million in those businesses this year. But in two categories that are more essential based like in automotive, we had parts and auto maintenance, those two categories alone were more than able to offset a huge chunk of decline in discretionary good.

So overall, as we go forward, discretionary is a big component of our assortment, as is non-discretionary. So we have to balance that. And we do believe that we're well positioned with our good, better best architecture to compete in essential categories. And when you think about the dynamics we have and the growth opportunity we have in front of us with automotive, all of the work we're putting around pet, which we believe is more essential or non-discretionary. These are the areas that we think are going to pay dividends for us. And we're able to manage the margins relatively well. It's kind of a mixed bag within essential and non-essential. I mean, obviously, automotive is very strong margin rates. So we like the profile there.

But we do feel like we're going to have to be a little bit more, have a little bit more promotional intensity on the non-discretionary stuff in 2023. So as we said earlier, we feel very good about our ability to manage through all the margins and our capabilities. And our assortment architecture really lends itself well to the evolving needs of Canadians.

[Mark Petrie, CIBC]

Appreciate the comments. I'll pass the line. Thanks.

[TJ Flood, President, Canadian Tire Retail]

Thanks, Mark.

[Operator]

Thank you. The next question is from Peter Sklar from BMO Capital Markets. Please go ahead. Your line is open.

[Peter Sklar, BMO Capital Markets]

Hi, good morning. This issue of the carryover of the spring summer inventory. It sounds like it's at the store level. Are you also seeing that in your DCs and inventories -- do you do have carryover on the corporate side?

[Greg Hicks, President and CEO]

Yeah, Peter, it's Greg. I'll take that. I think when I talked about kind of the factors of inventory carryover at the corporate level, we decide the dealers, as you've said, there was three factors we identified. One was inflation, the second we talked about was kind of some of the preorder activity at Helly. And they had to increase their inventories, given that their models is changing towards kind of direct to consumer a little bit.

And the third was exactly what we just said that spring summer carryover predominantly, and we mentioned that in Q3 as well. So, we're both a little heavy, us and the dealers. The way we manage this, and I've already seen TJ's receipt plan for '23 is basically we manage kind of our volume purchases down. And so that's why I say I think by the end of the year, I think I see us kind of getting back to that more normalized level of inventory.

Now what I will say is we're always going to have this inflation increase. So let's be clear on that even on a year-over-year basis. And we are supporting a higher level of sales. So I think the right way to think of this is kind of on a turn spaces from an inventory perspective. But we see ourselves kind of managing that way and I would suspect by the end of the year we're going to get to where we want to get to from our -- that's our objective.

[Peter Sklar, BMO Capital Markets]

And then situation like this, like do you do markdowns and should we expect markdowns? And do dealers have the discretion to do markdown so that has to come from the direction of corporate?

[TJ Flood, President, Canadian Tire Retail]

Hey, Peter, it's TJ. We work very closely with our dealer partners on managing kind of inventory and seasonal markdowns and things like that. They do have some discretion within their stores, if they are heavy in certain pockets. So you may see in store specials from different dealers from time to time. But we manage that very closely with them. And in sync, we can manage down in the pockets of inventory that that we feel we're having.

[Peter Sklar, BMO Capital Markets]

Okay, thank you.

[Operator]

Thank you. There are no further questions registered at this time. I will turn the call back to Greg Hicks.

[Greg Hicks, President and CEO]

Well, thank you for your questions and for joining us today. We look forward to speaking with you when we announce our Q1 results on May 11. Bye for now.

[Operator]

Thank you. The conference has now ended. Please disconnect your lines at this time. And we thank you for your participation.