Dollar Tree Investment Thesis

The COVID-19 pandemic has been bad for many companies. Some sectors have experienced almost complete stagnation, while others have had to operate under harsh restrictions leading to diminished revenues and tighter margins.

But this isn’t true for all businesses. Many retailers have seen increased footfall over the last twelve months, especially with the panic-buying hysteria that greeted the arrival of the virus and the demand caused by the crisis in general for essential goods and products.

One such company to have benefited from these macro drivers is Dollar Tree (DLTR), the American discount grocery store chain that operates under three brand banners: Dollar Tree, Dollar Bills, and Family Dollar.

The firm has undergone a major overhaul of late, rolling out its H2 store format to address the previously failing Family Dollar stores it had purchased in 2015. And the results have been positive. But is Dollar Tree a worthwhile investment? 

Dollar Tree’s Business Model

Dollar Tree is a low-cost play in the budget retail consumer sector. The company offers competitively priced discounted merchandise at locally convenient stores all around the US and Canada.

The market size for dollar and variety stores in the US is estimated to be about $93B in 2021, and Dollar Tree accounts for around a £22.8B share of that market. It closest rival in the space is Dollar General (DG), which takes close to $26B of the same market.

The company undertook a fairly radical restructuring model during its 2019 Store Optimization Program, which was aimed addressing the challenges to the Family Dollar stores it acquired in 2015.

The company closed a total of 84 stores at this time, and rolled out an expanded merchandise offering in its remaining outlets.

Management reported increased traffic as a result of the changes, with a greater than 10% lift in stores. It intends to continue the redevelopment of over 1,000 more stores in the near future, and to continue its project of renovation further down the line.

Moreover, the integration of Dollar Tree and Family Dollar stores has resulted in an annual saving of $50M through the streamlining of its supply chain, IT, and real estate resources, and with profitability up $55M per year on the Dollar Tree stores alone.

It is hoped that the strategy of providing Combination Stores that offer both great value and a wider-range of products will allow the business to leverage expenses and generate higher margins.

In addition, more productive stores should raise sales by around 20%, and ultimately lead to the company serving more customers in a greater number of market sectors.

Is Dollar Tree Growing Revenues? 

Dollar Tree’s fourth quarter financial results seem to reflect good news all round.

Year-on-year net sales revenue increased from $6.32B to $6.77B, and gross profit topped out at $2.15B, representing a 9.8% increase from the previous equivalent quarter.

Expenses were also down as a proportion of net sales, from 27.1% to 21.7%. 

Operating income went from $249.4M to $681.6M, and operating margins also improved during the quarter, from 3.9% to 10.1%. Diluted earnings per share were also up quite significantly, from $0.52 to $2.13, a 310% change over the previous year.

The company managed to open up another 124 new stores throughout the quarter. The business did however lose a further 45 stores, but ended the year with a total retail selling space of 125M square feet.

For the full fiscal year, Dollar Tree and Family Dollar same-store sales were both up 2.2% and 10.5% respectively.

From a valuation perspective, Dollar Tree outperforms its chief competitor Dollar General on several key metrics. Dollar Tree’s price-to-book ratio of 3.35 is almost half of Dollar General’s 6.27, and it beats on price-to-cash flow as well.

But when it comes to year-on-year revenue growth, Dollar Tree falls behind with growth of 8.04% compared to Dollar General’s 19.25%.

Still, when looking at 5-year CAGR numbers, Dollar Tree just about has it at 10.48% vs Dollar General’s 10.17%.

Headwinds & Risk Factors Facing Dollar Tree

No moat or online sales?

Dollar Tree faces fierce competition from other dollar-store and low cost retail outlets, including Dollar General (DG), Walmart (WMT), and Big Lots (BIG).

Unfortunately for Dollar Tree, it has little in the way of a business moat to distinguish itself from other retailers in the sector or provide it with a competitive edge.

However, despite not having developed much in the way of any eCommerce solutions for its business operations yet, Dollar Tree has recognized the need to have a presence in the online market space, and has recently expanded its partnership with Instacart to offer same day grocery deliveries from up to 6,000 of its stores from across the US.

The company last year trialed a successful pilot scheme with Instacart, and in the most recent conference call with investors, Mike Witynski, Dollar Tree’s President and CEO, revealed that the orders executed through the Instacart platform have significantly higher ticket values.

It is expected that the partnership will aid in expanding the customer base.

A trade war heating up?

Much of Dollar Tree’s merchandise is sourced from China. It’s perhaps telling that the company warned in its most recent Q10 filing that there’s an acute risk of its supply chain with China being disrupted in the near-future.

If the flow of goods from that country dries up, or the cost of those goods increases, bottom-line profits for Dollar Tree are sure to take a hit.

And the risk of an escalating trade war between China and the US is not only theoretical; recent actions by the US Government suggest that the trade war is already here. After all, diplomatic sanctions between the two countries are already in place.

President Trump’s Executive Order remains in place over preferential status for Hong Kong trade, and the closing of consulates in both China and the US.

Dollar Tree Investment Thesis: Conclusion

The outlook for Dollar Tree in the future is good. The company expects to open-up another 600 stores in fiscal 2021, with the further redevelopment of many of its existing stores as well.

Furthermore, Dollar Tree’s Board of Directors has just increased its share repurchase authorization to $2.4B, and the company has stated in its Q4 press release that the $1.4B it has in cash or cash equivalents might be used in a share buy-back effort. This should be music to a potential investor’s ears.

Assuming that the COVID-19 recovery doesn’t force downward pressure on Dollar Tree’s sales figures, its share price movement should be favorable.

Its price has grown 33% in the last year – which for the wider market is somewhat modest – and it’s not unreasonable to expect higher returns in the coming months and years.

 

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.