Dollar Tree: A Winning Discount Retailer – Dollar Tree, Inc. (NASDAQ:DLTR)

Dollar Tree (DLTR) is a favorite of traders at BAD BEAT Investing, a name that swings. Besides the reliable trades that can be made, this is a great long-term holding. Well, we are once again eyeing this name with Q3 earnings coming due soon, but the latest swing in DLTR came as shares caught a bid following Q2 earnings to end the summer. Make no mistake, there are still some reasons to be cautious, but we think that on any pullback shares are a good buy. We think through the holidays, provided the Q3 report doesn’t tank shares, and the market holds its own, that this name can easily approach new 52-week highs. Look to buy under $100 if it gets there. Let us discuss.

Source: Dollar Tree

We see an opportunity in Dollar Tree longer term, though there is of course a lot of competition. Make no mistake, Dollar Tree is in a highly competitive segment of retail, and we do expect competition to ramp up in the future. This is not just because of other major discount chains, but also because of online retailers selling discounted items, as well as many local dollar stores.

Competition from direct physical locations will be felt on the pricing end for similar items as well as the all-important battle for location. Big box stores and convenience stores also offer sources of competition. Still, Dollar Tree has held its own, and we believe it will continue to be a top performer in the space. Still, we like the name.

Fundamental discussion and value

Dollar Tree shares currently trade at about 1.10 times sales, which is still below the average 1.13 times sales seen in the last decade, and this remains well below than the five-year average multiple of 1.18 times sales. In addition, the name is favorably priced on several basic valuation metrics relative to years past:

Source: Morningstar

Dollar Tree boasts a multiple of 24 times trailing earnings which is historically very discounted. If we look on a forward basis, we expect $5.10-$5.20 in earnings for fiscal 2019, which puts shares at only about 21 times those estimates, which is also rather attractive for the name, historically. The name is also way below its usual price-to-cash flow metric, and below that of the index, and is also discounted on a price-to-book basis. This is undervalued in our opinion, and would be even more so if shares were to pull back.

One thing to keep in mind is that a discounted valuation could be a result of declining expectations for the future. However, the discount is not extreme here. That is why we would prefer a nice pullback. Now, 2019 is a period of transition for the company with earnings being flat to down. Perhaps this justifies some compression in the multiple. There is also less leverage risk. This is particularly evidenced on a cash basis. Dollar Tree came into 2019 with $422 million in cash, and that continues to grow while debt has been paid down now to just $3.5 billion. This is a huge reduction since the Family Dollar acquisition. Now let’s talk about performance in Q2.

Q2 performance

The company met our sales expectations for $5.69-$5.75 billion. They also beat consensus expectations by $20 million. We think sales were strong as they rose 3.9% to $5.74 billion from $5.53 billion last year. We see this as very positive growth. We do know the company reduced its store base as part of its optimization plan to get Family Dollar up and running again. As such, we want to look at performance of existing shops to get a sense of strength.

When it comes to retail, we like to look at same-store sales. We think for the most part there was good news on this front. As a whole, same-store sales increased 2.4%. Same-store sales for the Dollar Tree-branded shops led the way and increased 2.4% on a constant currency basis, which is incredibly strong. What is more, sales have been positive at Family Dollar and are no longer dragging down performance. Same-store sales for Family Dollar stores were also up 2.4%. We will point out that helium was a headwind for same-store sales, as there remains a global shortage.

Thanks to costs rising however, they offset the rising sales, with gross profit falling to $1.66 billion in the quarter, compared to $1.67 billion in the prior year’s second quarter. The astute investor may note that as a percent of sales, gross margin took a hit due to the promotional activities and markdowns, as well as freight. They decreased to 28.7% compared to 30.1% last year. At the same time, selling and administrative expenses were 24.0% of sales compared to 23.2% of sales last year. Much of that was due to consolidation of store support centers, asset write-offs for closed stores, and payroll costs resulting from higher average hourly rates. Putting it all together, we saw operating income decline.

Operating income fell to $268.9 million compared with $382.5 million in the same period last year and operating income margin was 4.7% versus 6.9% of sales last year. As a result, earnings were hammered. Net income was down $97 million to $180 million with earnings per share of $0.76 compared to $1.15 last year. This result was in line below our expectations for $0.82-$0.85, and was a $0.07 miss versus consensus.

When we look at the quarter as a whole, we felt pretty bearish, yet the stock rallied. We think this is due to revising guidance higher. Consolidated net sales for full-year fiscal 2019 are now expected to range from $23.57 billion to $23.79 billion compared to the company’s previously expected range of $23.51 billion to $23.83 billion. This estimate is based on a low single-digit increase in same-store sales and 1.3% selling square footage growth. While fiscal 2019 EPS will range between $4.90 and $5.11, we are on the higher end of this range with our expectations.

Growing presence

We love the store optimization plan. You really cannot go a few miles without seeing one of the company’s properties, at least here in New York. While comp sales are doing well for the most part, we had long held that there was significant room to consolidate more of the Family Dollar operations which were seeing comps being pressured. In the tight space that is low-end retail, we wanted the company to be aggressive in shuttering losing operations. New stores can and should be opened, but only where the target market makes sense. With the optimization plan, we saw this happen.

We are happy to see the company being much more aggressive in closing down stores that are underperforming. During the quarter, the company opened 150 stores, expanded or relocated 19 stores, and closed 305 stores. This reduction and reorganizing is very positive news in the long term. This is evidenced by same-store sales at Family Dollar now being positive.

Final thoughts

The company is closing losing operations and we are impressed with comp growth. The company is buying back shares. The valuation is discounted, and would be especially attractive if shares could be acquired under $100. Dollar Tree has now delivered 46 consecutive quarters of positive same-store sales, and eight consecutive quarters with two-year stacked comps exceeding 6%. While the earnings will dip from last year, this is a transitional year. On a pullback, we think you can comfortably get long.

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Disclosure: I am/we are long DLTR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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