This Discounter Is Making the Right Moves

It’s Friday. Time to give you a stock pick from our sister newsletter, The Spill, so you can think about it over the weekend and maybe make a move Monday morning. While The Juice helps you be better with money across the board, The Spill focuses on stocks financial pros are researching and judges how good of buys they are.

As food-price inflation hit a record high of 13.3% during Christmas, shoppers turned to discount stores to meet their needs. 

Our proprietary Trackstar database picked up on a recent surge in searches for discount stores by both financial pros and retail investors.

This comes after fairly lackluster interest through most of December.

Second on that list of discount-store searches was Dollar Tree (DLTR). Among its peers, it’s the best overall value.

The company is focused on driving traffic to its consumables business, and it’s paying off. 

Despite a challenging year, Dollar Tree produced its highest company revenue in 2022. 

Can it continue its momentum? And more importantly, is it a company investors should add to their portfolios? 

Dollar Tree’s Business

Dollar Tree is a leading operator of discount variety stores under the brands Dollar Tree and Family Dollar. In 2021, it transitioned from selling its lowest-priced items for $1.00 to selling them for $1.25, enabling merchants to enhance value significantly for their shoppers. 

The company has more than 16,200 stores across 48 states and five Canadian provinces.

In addition, DLTR has put a greater emphasis on consumable products. For two consecutive quarters, consumable sales have outpaced discretionary sales at Dollar Tree. The leaders have been food and beverage, snacks, cookies, and candy.  

Discretionary items include nonperishables such as clothing, home goods, and toys.

Dollar Tree also expanded its $3 and $5 offerings into more stores. DLTR believes it’s in its best pricing position in over a decade. 

To further strengthen margins, the company has focused on developing its private brands, which can further enhance brand loyalty. 

Source: Dollar Tree

Family Dollar delivered its strongest quarterly same-store sales increase since 2020 and grew store traffic comparable to Dollar Tree stores’ growth for the first time in 12 quarters, according to the company’s Q3 2022 report. 

Financials

Source: Stock Analysis 

DLTR has a debt-to-equity ratio (a company’s liabilities divided by shareholder equity; a lower ratio means a company is better able to cover its debt) of 1.25x, its lowest multiple since 2018. Meanwhile, the firm’s revenues rose from $22.8 billion in 2018 to $27.7 billion in 2022.

In Q3 2022, the company repurchased 2.86 million shares at an average price of $139.04, which cut its cash from $701 million to $439 million. 

Despite inflationary pressure and higher costs from suppliers, mainly in China, the company improved margins with the price bumps on its lowest-cost items.

It generated $1.1 billion in cash from operations in the last year and is financially stable with a current ratio (current assets divided by current liabilities; the higher the ratio, the better financial position a company is in) of 1.3x.    

Valuation

Source: Seeking Alpha 

DLTR trades at a P/E GAAP (price-to-earnings generally accepted accounting principles) ratio of 19.7x, relatively cheaper than its peers Dollar General (DG) at 23.9x, Ollie’s Bargain Outlet Holdings (OLLI) at 31.1x, Five Below (FIVE) at 42.8x, and Big Lots (BIG) at NM (not meaningful). 

DLTR’s ratio looks high now, but it’s on par with its five-year average, which is around 19.0x.

And that’s not all. Dollar Tree’s price-to-sales ratio of 1.1x is lower than that of its competitors (the lower the better). DG is at 1.5x, OLLI is at 1.6x, and FIVE is at 3.3x. BIG is lower at less than 0.1x, but BIG isn’t profitable like DLTR. 

Furthermore, DLTR has a lower price-to-cash-flow ratio than its peers at 27.2x. DG’s is 29.1x, OLLI’s is 67.2x, FIVE’s is 62.0x, and BIG’s is NM (not meaningful). 

Profitability 

Source: Seeking Alpha

DLTR has a net income margin of 5.8%, lagging DG at 6.5% and FIVE at 7.8%, but better than BIG at -2.6% and OLLI at 5.3%. 

Management plans to improve margins by offering higher-priced items at Family Dollar, offering more consumables at Dollar Tree, and developing private brands. 

Dollar Tree’s management is fairly effective, with a return on equity of 20.8%. Only DG is higher at 38.3%. The company’s return on assets is nearly 8.0%, which only DG beats at 9.0%. 

Growth

Source: Seeking Alpha 

Most discount stores grew revenues modestly over the last year, with FIVE leading the pack at 8.83%. Meanwhile, DLTR grew revenues 6.4%, DG 6.8%, OLLI 0.6%, and BIG -8.1%.  

DLTR is focused on driving sales per square foot, unit sales growth, and transaction growth under a new management team. The company has adjusted prices and enhanced its advertising and marketing, which it believes can lead to further growth. 

Our Opinion 7/10

Consumer behavior is shifting to focus on needs as the economy weakens. 

DLTR has recognized this and is offering consumables and products catered to the shift. 

While it’s smaller than DG, it’s relatively cheaper than its peers from a valuation standpoint.

Yet its P/E ratio compared to its historical average says it’s fairly valued.

We believe DLTR can do well in the current environment and deliver positive returns to investors in 2023 and beyond. 

Shares are $145.88 at writing. They generally look good at $140 and below. 

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