Square Footage Growth and Online Channel Will Drive Sales for This Retailer

Ash is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Dollar Tree (NASDAQ: DLTR) is looking for a growth opportunity with increased selling space this year. The company will achieve this with continuous square footage growth and with the expansion of its online channel Dollar Tree Direct. It is increasing its square footage with new store openings in the US and Canada. Dollar Tree Direct will be a growth driver with its chain-wide MasterCard roll-out in FY 2013. It is also taking some initiatives in merchandising and assortment to fuel growth. With the addition of new SKUs and its Deal$ concept, its merchandising initiative is expected to bring incremental impulsive purchases. Now, let’s discuss these initiatives in detail.

Square footage growth in the US and Canada will help to generate incremental sales

Dollar Tree is increasing square footage and selling space to boost its sales growth. In 2012, it grew rapidly with 320 new stores and 80 stores remodeled. In FY 2013, it is expected to open 340 new stores with relocation of 75 stores in the US and Canada. It has already opened 94 new stores and relocated and expanded 16 stores in the first quarter of this year. The company is on track for its yearly store growth plans. Over the long term they will look to increase locations up to 7,000 in the US and 1,000 in Canada.

Dollar Tree Direct with MasterCard roll-out will uplift sales

Debit and credit card purchases represent around 39% of total sales. Acceptance of MasterCard at 75% of stores boosted credit penetration by 180 bps YOY in Q4 last year. MasterCard roll-out will be chain-wide in FY 2013. This will boost Dollar Tree Direct sales because credit the card customer spends double compared to the cash customer. This online channel offers around 2,600 items and will continue to uplift sales with 5 million unique visitors to deals-stores.com site.

New front end fixtures and Deal$ format will increase impulsive purchase

The company is taking new merchandising initiatives where it has introduced new front end fixtures with 40% more impulsive items. It has also expanded 75 new SKUs of stationery and 90 new SKUs of candy. Its small format stores concept Deal$ continued to grow with 25 new units in 2012 and a similar growth rate in 2013. In the first quarter of 2013, it lifted $1 restrictions in this value segment offering. This will help it to offer more products to a larger customer base, which is expected to bring incremental sales.

Downside Risk

Some of the downside risks are also associated with the above mentioned initiatives. If the company continues to increase its store footage, then its comp sales growth will take a hit. Major Discount stores like Dollar General (NYSE: DG) and Family Dollar Stores (NYSE: FDO) are expanding their store base and offering low priced products. This will create pressure on the margins of the company. Deal$ format stores are good for high density locations, but they are not as profitable as Dollar Tree. These risks are there, but the moves will pay off in the long term with fundamental growth plans in place.

Peer Analysis

Among dollar stores, the two other major players are Dollar General and Family Dollar Stores. Dollar General is a strong competitor with expansion plans for 635 new stores, including 50 stores in California in FY 2013. Its new stores in DG Market and DG Plus format stores will have more coolers/freezers this year. This will help them to offer more fresh produce and meat. Its tobacco rollout will drive top-line growth for them. Tobacco sales were 33% more than expected in the test markets and are expected to increase comparable store sales. The Phase 5 initiative of merchandise assortment and its expansion to 4,200 stores will help it to increase right selling space and place most productive SKUs to offer.

Family Dollar Stores has reported 146 bps lower gross margins than the consensus estimate in last quarter's results. This decline was accredited to poor performance in the discretionary category, where the Home and Apparels segment faced weak demand. In the second half of this year, the company is expecting margins to go up with more direct sourcing and more private label expansions. Its new “Fee Development Program” will be helpful in generating high margins. Fee Development Program is a part of store growth strategy, where the company will open new stores and relocate old stores with more cost effective financing. In this program, stores will be developed and sold or leased back on margins to be run by others.

 

P/S ratio

Op. Margin

1Yr. Fwd. P/E

Dollar Tree

1.44

11.61%

14.74

Dollar General

1.02

12.41%

13.89

Family Dollar Store

0.65

7.50%

14.46

Source: Google Finance and Yahoo Finance Date: June 1, 2013

Dollar Tree reported an operating margin of 11.61% and 1-year forward P/E of 14.74, which is the highest among the peers mentioned above. Dollar General has the highest operating margin of 12.41% and the lowest forward P/E of 13.89. Family Dollar Store has the lowest P/S ratio of 0.65 but also the lowest operating margin of 7.5% and relatively higher forward P/E of 14.46.

Conclusion

Dollar Tree has taken some strong initiatives for growth in the future. It will increase selling space with square footage growth in the US and Canada. Its online channel, with chain-wide MasterCard rollout, is expected to drive traffic in the future. Its new merchandising initiatives will increase impulsive purchases. Dollar General is also expanding its stores with tobacco rollout across all stores, so I recommend a “buy” for both these stocks for long term investment. Family Dollar Stores is suffering from low gross margins, and its store growth initiatives will take time to impact margins. Hence, I recommend a “Sell.”

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Ash Sharma has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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