Dollar Tree (DLTR): Dead Money or Stock Discount?

If anyone was on the fence about consumer weakness before, Dollar Tree’s (DLTR) put that question to rest.

Share plunged almost 20% on the back of Wednesday’s earnings release, adding to the already 10% drop from the week prior.

To put things in perspective, Dollar Tree’s stock hasn’t been this cheap since the pandemic lows.

And it’s got financial pros nervous.

According to our TrackStar data, large money managers searched out the stock immediately after the earnings release, but not to the same degree as retail investors.

It appears funds aren’t ready to pick a bottom while retail is more than happy to try and catch a falling knife.

But with revenues and same-store sales up YoY, who’s right on this one?

Is this selloff overblown or a harbinger of things to come?

We dug into the issue to find out more.

Dollar Tree’s Business

Dollar Tree’s empire of thrift spans over 16,300 stores across North America, tempting shoppers with its trademark $1.25 price point and beyond.

From party supplies to pantry staples, Dollar Tree and its Family Dollar sidekick (whom it acquired in 2015)offer a smorgasbord of affordable goodies. 

While Dollar Tree stores beckon with their ever-changing treasure trove, Family Dollar keeps the home fires burning with everyday essentials. It’s a two-pronged attack on high prices that’s kept wallets happy for decades.

Dollar Tree’s ultra-low prices stem from its massive purchasing power, direct sourcing from low-cost manufacturers, and a focused inventory of rotating items. The company also relies heavily on private label products and smaller packaging sizes to maintain its price points.

Efficient operations are equally crucial, with lean staffing, no-frills store designs, and sophisticated inventory management minimizing overhead. Strategic real estate choices and limited advertising further contribute to cost savings, allowing Dollar Tree to offer remarkably low prices while still turning a profit.

Dollar Tree segments its business into two money-making machines:

• Dollar Tree (54.8% of total revenues) – Offers a wide variety of merchandise predominantly priced at $1.25, with additional multi-price offerings.
• Family Dollar (45.2% of total revenues) – Provides a selection of competitively-priced merchandise in convenient neighborhood stores.

Dollar Tree’s recent quarterly report showed some battle scars, with earnings per share of $0.67 falling short of Wall Street’s great expectations. 

Sales inched up by a modest 0.7% to $7.37 billion, proving that even in the land of bargains, growth can be a tough nut to crack.

Inflation’s bite has forced price hikes beyond the iconic $1 mark. Meanwhile, supply chain hiccups and pricier labor are eating into profits. 

The Family Dollar side of the business is struggling to pull its weight, and savvy shoppers are getting pickier with their purchases. 

With discount rivals nipping at their heels, Dollar Tree’s bean counters are tightening their belts and tempering expectations for the year ahead.

Management is fighting these problems with a multi-pronged attack: expanding multi-price offerings to boost margins, closing underperforming Family Dollar stores, and streamlining operations. 

The company is also doubling down on its value proposition, fine-tuning product assortments to match evolving consumer demands. 

A strategic review of the Family Dollar segment is underway, potentially leading to a sale or spin-off. 

Meanwhile, investments in supply chain efficiency and store renovations aim to cut costs and improve the shopping experience. 

Financials

Source: Stock Analysis

Much of the revenue growth in the past few years has come from higher traffic and consumables, even as the average spend declined as did discretionary spending.

Source: Dollar Tree Q2 2024 Investor Earnings Report

Total debt isn’t aggressively high at just shy of $11 billion. However, the company has very little cash and only generates around $300-$400 million in free cash flow, which is a problem since they’ve been spending around $600 million a year to repurchase stock.

Net income was impacted this year by a substantial one time assessment for:

• Impairment Charges: Dollar Tree recorded a $950 million impairment against the Family Dollar name
• Goodwill Charge: Additionally, there was a $1.07 billion goodwill impairment charge
• Store Closures and Rebranding: Family Dollar also incurred over $594 million in costs associated with closing or rebranding nearly 1,000 stores

Valuation

Source: Seeking Alpha

Here’s the thing about the latest drop in Dollar Tree’s share price. It doesn’t revalue the stock to a level much worse than Dollar General (DG).

Both stocks trade around 12x-14x forward earnings and 5x-6x operating cash flow.

Compare that to Target (TGT), which trades at 16x forward earnings and 8x operating cash flow after posting better than expected results.

Growth

Source: Seeking Alpha

But are we looking at a value trap with forward revenue growth that’s on par with other retailers including Costco (COST) and Walmart (WMT)?

5-year average revenue growth isn’t much worse than the others on this list.

And profitability declines haven’t been as bad either.

Profitability

Source: Seeking Alpha

Given the net income isn’t reliable, we look at the free-cash-flow margin, which simply isn’t high enough.

Dollar Tree spends a lot on CAPEX and isn’t getting the returns for its money.

Without that, it’s stuck in the mud.

Our Opinion 5/10

With consumers spending less and operations that haven’t yielded better cash flows, we don’t see a pathway for Dollar Tree to improve in the near-term.

At some point, the company will need to focus less on store growth and instead improve its operations and get its free cash flow margins up to 2% or higher consistently.

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