Dollar Tree Breaks the Buck
Demitri is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Working in a business that's entirely organized around a single price point, it had to give Dollar Tree's (NASDAQ: DLTR) management some satisfaction to report earnings last quarter of exactly $1.00 per share. What probably pleased them even more, that figure was 22% higher than the year-ago quarter, and a record high for the company. Better still, that dollar was made up of higher quality earnings, as management booked an increase in operating margin to 10.9%, another first quarter record.
And yet, in the wake of that stellar earnings report, DLTR saw downgrades from three investment banks, who remain impressed with the business but are now concerned that growth like that can't continue for long. Investment banks getting skittish about a great stock may mean a solid buy opportunity for retail investors. So let's take a closer look.
The company
Dollar Tree is a discount retailer operating 4,500 stores mainly in the U.S., but with a growing presence in Canada. The company sells consumable merchandise, like candy and food, and household consumables, such as paper, plastics and household chemicals. Also in this eclectic merchandise mix are toys, party goods, greeting cards and seasonal items.
Increasingly, the company is offering frozen and refrigerated food too, all at the fixed price of $1.00 or less. Key to delivering that price point is DLTR's significant reliance on imported products, particularly from Asia, which make up over 40% of the product mix.
The operation
Earning a gross profit margin of 35%, DLTR is one of the more profitable retailers around. Its operating margin and return on sales figures eclipse those of its closest competitors, Family Dollar (NYSE: FDO) and Dollar General (NYSE: DG), and come in higher than those of more traditional value retailers Wal-Mart (NYSE: WMT) and Target (NYSE: TGT). Cash flow is also strong, enough to fund store expansion and upgrades in addition to significant share repurchases.
Dollar Tree's recent operating margin expansion is particularly impressive as the company's sales mix shifts toward food products, an area that has hurt profitability for most retailers due to rising costs in the industry.
The growth
The tough economy has clearly provided some major tailwinds for this discount retailer. As you might expect, driving growth the past few years has been a ramp up of store openings coupled with strong comparable sales growth as more value-conscience consumers look to trade down from other retailers. That's led to overall sales growth at a CAGR of 12% over the last 5 years.
But productivity at the store level is on the rise, too. The company has been attacking the value grocery business, adding refrigerators and freezers to its stores so that it can stock more food items. As people have increasingly filled many of their grocery needs at Dollar Tree, the result has been an increase in visits per customer, boosting traffic even more, and contributing to yet higher sales per square foot.
Looking forward, two significant growth drivers stand out. First, the company has only added refrigerator capacity to about half of all locations. Planning to upgrade another 15 percent of stores this year, the company has significant efficiencies left to gain from the roll out. Second, the company sees ample room for store growth. It plans on boosting U.S. stores by almost 10 percent this year along with a big push into the Canadian market.
The competition
Central to the bankers' bear worries is the fear that DLTR's competition isn't blind to these growth opportunities and will eventually figure out a way to siphon them off. And it's true that barriers to entry in this market are non-existent and that value, more than loyalty in a particular brand, is what is motivating consumers. All of this suggests that Dollar Tree has a loose hold on its newfound customers that will break as soon as cheaper alternatives surface.
But I think that underestimates Dollar Tree's appeal. Unlike Family Dollar or Dollar General, Dollar Tree's value proposition isn't diluted by a broad "discount" offering. DLTR is alone in this group in offering a wide selection of products -- including groceries -- all at a single price point. DLTR's simple, compelling, and focused strategy means the brand may have more resonance than many people assume.
Bottom line
But after a 500% gain in just the last four years, it is natural to ask whether DLTR's shares have outrun the company's impressive performance. On a P/E basis (22x), the company looks expensive compared to Family Dollar (19x) and Dollar General (19x). Factor in growth projections though, and the company looks like a better bargain, stacking up well against its discount retailer competitors in addition to the grocery value stores it is challenging.
So DLTR is only expensive if you don't believe it can continue growing, at least at the 5-7% pace of the last few years. With grocery upgrades, geographic expansion, a defensible value proposition, and continuing weakness in the economy, I see no reason to buy that argument. DLTR broke the dollar mark on its last quarterly report, but I think that's just the first of many impressive reports to come.
SigmaSwan 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.
