Dollar Tree’s Loss is a Clear Indication of Value

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On Thursday shares of Dollar Tree (NASDAQ: DLTR) fell 8% after the company said its third quarter sales would be near the low end of its prior guidance, and then on Friday the stock fell another 5% as the market continued to react. The consensus was for sales to be near the top of its $1.71 - $1.75 billion range. The company attributed its guidance to higher gas prices, cautious consumer spending, and a shift in the calendar year including two days of pre-Halloween sales occurring in the fourth quarter. This news had an effect on “dollar stores” across the board, and although the market is selling the news, I believe that Dollar Tree is a buy at these levels.

If the company announced Q3 sales of $1.71 billion, then it would still post a 7% gain year-over-year in revenue. There’s no doubt that the sales growth of the Dollar Tree are beginning to decline, and are leading some to question whether or not the company was a ‘fad” with its everything’s a dollar business model. Perhaps the company was “cool” when it first entered new cities, but now people prefer the more expensive and trendier Wal-Marts or Krogers. Maybe people have such a large increase in disposable income that they don’t mind paying $10 for a broom or $4 for cooking utensils when they could obtain them for a dollar at the Dollar Tree. However, considering the service and products offered at the Dollar Tree, does any of this make sense?

The Dollar Tree is not a fad nor is it a dying brand. The company saves consumers money, and has managed to fill its store with useful products at a price of just $1, which continues to amaze me. Just last night my wife and I were at a Dollar Tree and she was amazed at the number of pieces she found for her Christmas village, pieces that cost anywhere from $10-$50 apiece at Michaels and other holiday specific stores. Therefore, the fact that this company can maintain margins above 5% completely blows my mind. It’s a fast-growing company that continues to add stores and stock useful products, but is going through a challenging period, and is now priced very cheap.

The fact that the Dollar Tree lost over $1.3 billion from its market cap during the final two days of last week, by meeting its own guidance, and missing the expectations of Wall Street by $20-$40 million, is insane. Think about it, Wall Street was expecting $1.75 billion and the Dollar Tree is “probably” going to announce $1.71 billion, and if it had the additional two days of pre-Halloween sales it might have met the expectations, because there's no arguing that holiday sales are the major contributor to sales for Dollar Tree.

If we average $6.97 billion, which is its revenue during the last 12 months, by the number of days in the year we can estimate that on average Dollar Tree records $19 million per day in sales. Like I said, the catch is that larger sales occur during the holiday seasons, such as Halloween. As a result, if Dollar Tree would have had the additional two days of pre-Halloween sales it might have been closer to meeting expectations. Therefore, its loss of $1.3 billion in market capitalization doesn’t make sense and is a clear sign that the market overreacted to the news and didn’t process the information. It’s a classic example of a domino effect market, where investors sell without fully understanding why they are selling. At the end of the day, it comes down to selling to avoid future loss, but neglecting to determine whether or not it made sense.

In my opinion, the market overreacted in a drastic manner in regards to Dollar Tree’s loss of valuation. The stock is now trading at just 14.27x next year’s earnings, and is valued similar to competitors Family Dollar Stores (NYSE: FDO) and Dollar General (NYSE: DG). And although the three companies are often compared, I don’t think there are many similarities. Both the Dollar General and Family Dollar sell a variety of products but are more along the lines of a bad Wal-Mart. Neither the Dollar General nor the Family Dollar have an identify, or a service that separates them from the competition. Dollar Tree, with its “everything’s a dollar” gives it an identify, and in some cases it’s the first choice of consumers in an unstable economy.

The performance on Thursday was very surprising, because it’s not like the stock was trading at 52-week highs and was correcting, but rather a 22% loss over the last three months. Therefore, I think DLTR was priced accordingly to miss analyst expectations and that it will continue to thrive throughout the remainder of this year. The company always does well during the holidays and I suspect this year will be no different, and with more stores the sales will be even greater. As a result, I conclude that its losses were over-exaggerated, the miss was already priced in, and that its weakness was due to timing and potentially higher costs. This means that investors should expect an even better Q4 and movement in the months that follow.  However, keep in mind that when stocks fall to this degree the recovery is sometimes slow. Therefore, watch the stock over the next few weeks, and if it fits into your portfolio, then it might be wise to seek a good entry point and ride the stock higher in the years that lies ahead.

 


BrianNichols has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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