A Top-Notch Discount Retailer for Long-Term Value Investors

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As a value investor, I really like to search for good and sustainable businesses for a long term holding portfolio. That business should have a history of earning a high return on equity, growing free cash flow while employing little debt. However, along with a terrific operating history, its stock price has already enjoyed a corresponding rise. By most of the time I look at it, it has already been a darling of the stock market and definitely not cheap anymore.  Nevertheless, at some point, the great business might have some missteps. There could be a lawsuit, a weak quarter’s result, a dispute, etc. And following those missteps, the stock might experience a significant decline. That’s when I got excited.

What happened?

Recently, Dollar Tree’s (NASDAQ: DLTR) stock price decreased nearly 8%, from $$46.91 to $43.28 per share, due to its weak outlook for third quarter results. The company remains cautious about weak consumer spending and higher gas prices. Actually in August, it has already forecasted that quarterly sales and earnings would be below analysts’ expectation. It’s expected to earn $0.47 to $0.51 EPS on revenue of $1.71 billion and $1.75 billion, whereas average analysts’ forecasts were $0.52 EPS on revenue of $1.77 billion.  And now it said that sales might come at the lower end of the earlier forecast for the third quarter.

Historical profitability

Looking at Dollar Tree’s historical operating performance, it was a story of nice growth with good return over the years. In the last 10 years, the company has grown its revenue at an annualized rate of 16.7%.  Its EPS was $0.45 per share in 2002, and in 2011, its EPS reached $2.02, marking annualized growth of 16.2%.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>2002</strong></p> </td> <td> <p><strong>2003</strong></p> </td> <td> <p><strong>2004</strong></p> </td> <td> <p><strong>2005</strong></p> </td> <td> <p><strong>2006</strong></p> </td> <td> <p><strong>2007</strong></p> </td> <td> <p><strong>2008</strong></p> </td> <td> <p><strong>2009</strong></p> </td> <td> <p><strong>2010</strong></p> </td> <td> <p><strong>2011</strong></p> </td> </tr> <tr> <td> <p>Revenue (USD mil)</p> </td> <td> <p>2,329</p> </td> <td> <p>2,800</p> </td> <td> <p>3,126</p> </td> <td> <p>3,394</p> </td> <td> <p>3,969</p> </td> <td> <p>4,243</p> </td> <td> <p>4,645</p> </td> <td> <p>5,231</p> </td> <td> <p>5,882</p> </td> <td> <p>6,631</p> </td> </tr> <tr> <td> <p>EPS (USD)</p> </td> <td> <p>0.45</p> </td> <td> <p>0.51</p> </td> <td> <p>0.53</p> </td> <td> <p>0.53</p> </td> <td> <p>0.62</p> </td> <td> <p>0.7</p> </td> <td> <p>0.84</p> </td> <td> <p>1.19</p> </td> <td> <p>1.55</p> </td> <td> <p>2.02</p> </td> </tr> <tr> <td> <p>ROE (%)</p> </td> <td> <p>20.52</p> </td> <td> <p>17.5</p> </td> <td> <p>16.55</p> </td> <td> <p>14.89</p> </td> <td> <p>16.41</p> </td> <td> <p>18.67</p> </td> <td> <p>20.48</p> </td> <td> <p>23.9</p> </td> <td> <p>27.51</p> </td> <td> <p>34.83</p> </td> </tr> </tbody> </table>

Since 2002, it posted  double digit returns on equity consistently, in the range of 16.4%-34.8%. If it earned $0.47 per share, the lower end of the forecast, trailing twelve months EPS would be $2.28 per share.

Cash flow

Dollar Tree has been a cash cow in the last 10 years. Its free cash flow has grown from $71 million in 2002 to $436 million in 2011, marking an annualized compound rate of 19.9%.

<table> <tbody> <tr> <td> <p><em>USD million</em></p> </td> <td> <p><strong>2002</strong></p> </td> <td> <p><strong>2003</strong></p> </td> <td> <p><strong>2004</strong></p> </td> <td> <p><strong>2005</strong></p> </td> <td> <p><strong>2006</strong></p> </td> <td> <p><strong>2007</strong></p> </td> <td> <p><strong>2008</strong></p> </td> <td> <p><strong>2009</strong></p> </td> <td> <p><strong>2010</strong></p> </td> <td> <p><strong>2011</strong></p> </td> </tr> <tr> <td> <p><strong>Free Cash Flow</strong></p> </td> <td> <p>71</p> </td> <td> <p>7</p> </td> <td> <p>95</p> </td> <td> <p>226</p> </td> <td> <p>183</p> </td> <td> <p>172</p> </td> <td> <p>272</p> </td> <td> <p>416</p> </td> <td> <p>340</p> </td> <td> <p>436</p> </td> </tr> </tbody> </table>

Balance sheet

As of July 2012, Dollar Tree had a quite strong balance sheet with net cash. It had around $270 million interest-bearing debt and $380 million cash on hand. Total stockholder’s equity stood at $1.52 billion. With the current market capitalization of $9.97 billion, the enterprise value (after adjusting debts and cash on hands) is $9.86 billion.


The market values Dollar Tree at 19.3x P/E, 6.5x P/B and 14.4x P/CF. Its P/E seems to be high, however, the business grew at a high rate for the last 10 years. Its PEG ratio (5 yr expected) is around 1.05x and its forward P/E is 15x.


Dollar Tree’s industry peers are Family Dollar Stores (NYSE: FDO), Dollar General (NYSE: DG) and Wal-Mart Stores (NYSE: WMT). In the recent fiscal year, Family Dollar Store and Dollar General have been experiencing similar growth. The three companies have benefited from the discount business model since the recession. Dollar Tree’s operating margins have risen from 7.8% to 12%, and same-store sales increased from 2.5% to 6%. Similar operating margins and the same-store growth trend could be detected in Family Dollar Stores and Dollar General, and it was far higher than Wal-Mart Stores. That is why we might see the valuation of Wal-Mart to be lower than the other three.

<table> <tbody> <tr> <td> <p>%</p> </td> <td> <p><strong>Dollar Tree</strong></p> </td> <td> <p><strong>Family Dollar Stores</strong></p> </td> <td> <p><strong>Dollar General</strong></p> </td> <td> <p><strong>Wal-Mart Stores</strong></p> </td> </tr> <tr> <td> <p><strong>ROE</strong></p> </td> <td> <p>36.4</p> </td> <td> <p>35.3</p> </td> <td> <p>19.5</p> </td> <td> <p>21.8</p> </td> </tr> <tr> <td> <p><strong>Operating margin </strong></p> </td> <td> <p>12.4</p> </td> <td> <p>7.55</p> </td> <td> <p>10.18</p> </td> <td> <p>5.94</p> </td> </tr> <tr> <td> <p><strong>Net margin</strong></p> </td> <td> <p>7.57</p> </td> <td> <p>4.63</p> </td> <td> <p>5.7</p> </td> <td> <p>3.54</p> </td> </tr> <tr> <td> <p><strong>Debt to Equity</strong></p> </td> <td> <p>19</p> </td> <td> <p>49</p> </td> <td> <p>56</p> </td> <td> <p>62</p> </td> </tr> </tbody> </table>

From the table, Dollar General delivered the lowest return on equity and second-highest debt to equity level. Combined with a $2.2 billion insiders sale, Dollar General should not be considered a buy right now. In contrast, Dollar Tree seems to beat its peers in all of our metrics. Its ROE, operating margin and net margin are the highest, and its Debt/Equity is the lowest of the four.

Bottom line

Personally, I think the market overreacted on the soft Q3 forecasted result. With a strong balance sheet, historical strong growth and top-notch operating performance compared to its peers, Dollar Tree can be considered a stock for long-term investors. 

hoangquocanh 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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