Dollar Tree: Small is Beautiful

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 Discount Stores:Five Impressive Years

All Numbers in Percent except PE

Forward P/E

EPS growth past 5 years

EPS growth next 5 years

Sales growth past 5 years

Return on Equity

Total Debt/Equity

Gross Margin

Net  Margin

Dollar Tree

14.1

26.7

17.0

10.8

33.9

17.0

35.8

7.6

Family Dollar

13.7

17.1

14.0

6.4

35.4

42.0

34.9

4.5

Dollar General

14.4

38.2

17.6

10.1

19.4

60.0

31.7

5.7

Costco

19.0

7.5

13.5

8.1

12.9

11.0

12.4

1.7

Target

12.7

6.0

12.6

3.3

19.0

116.0

30.6

4.1

Wal-mart

12.7

9.2

8.8

5.1

23.6

78.0

24.9

3.7

Source: Finviz.com

The 2008-2009 recession and the slowdown hurt many industries, but favored discount retailers. As our table shows, Dollar Tree (NASDAQ: DLTR) had an outstanding five years, growing sales 10.8% each year, the highest amongst its peers.  It also grew profits 26.7%, beating everyone expect Dollar General (NYSE: DG)

Industry Characteristics and Trends

Small is Beautiful: Dollar Tree, Family Dollar (NYSE: FDO), and Dollar General dominate this industry. Each store has an average size of between 8,000 and 10,000 square feet, serving communities of 20,000 or more. Companies need little capital (around $800,000 for remodeling or setting up a single store). A $1 million investment per store means that there are virtually no barriers to entry – a deep-pocketed player like Wal-mart (NYSE: WMT) should theoretically decimate smaller players in this business.

However, much to Wal-mart’s chagrin, the growth to a smaller store has been slow and painful. Wal-mart, which hoped to invade this market by opening 15,000 square feet stores in several locations, has opened only twelve in a year. In a Wall Street Journal article, it seems that Wal-mart is finding it difficult to think beyond its “wide choice at the cheapest price” mindset – a strategy that doesn’t quite fit the express discount store mold. As consultant Leon Nicholas of Kantar Retail puts it, “It is just absurd to see a dozen kinds of jelly or peanut butter when a shopper just wants to get in and out of the store quickly." Target is also moving slowly with its City Target Stores. Contrast this to Dollar Tree, Dollar General, and their competitors, which opened almost 2,000 locations last year.

The moat, therefore, is in the ability to make profits within an average customer purchase of $11, fending off the likes of the bigger Targets and Wal-marts.

Steady Eddies: Dollar General, for example, has 22 consecutive years of sales store sales growth! That’s 22 years, not quarters. And in the new normal of weak, tepid economic growth, this consecutive growth is a huge plus.

Getting invited to the prom: According to a Wall Street Journal article, in 2008 23% of shoppers surveyed felt that such discount outlets weren't for them; by 2012 this number had fallen to only 7% -- dollar stores are definitely getting more love.

Convenience and Location:  If I had a $15-20 purchase in mind, I would not drive 5 miles to the nearest Wal-mart or Costco and brave the lines; instead I would buy it at the Dollar Store less than a half a mile away at comparable prices.

Recommendation

I prefer Dollar Tree over its competitors, because it earns a very high return on equity at 33.9%, has the highest gross and net margins at 35.8% and 7.6% and also very little debt at 17% of equity. Dollar Tree is estimated to grow 17% over the next five years, and has a forward P/E of only 14 -- a great bargain.


poach has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Family Dollar Stores. 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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