Dollar Tree Stock Looks Attractive At $95

Dollar Tree’s stock (NASDAQ: DLTR) is up only slightly to around $95 levels year-to-date, compared to a 6% growth for the broader S&P 500. While Dollar Tree has underperformed the broader markets, we believe it has the potential to grow. This is taking into account the 9% year-over-year (y-o-y) growth in the retailer’s revenues so far in 2020. Dollar Tree, which also owns Family Dollar, specializes in selling $1 items like toys, books, party supplies, and general discount items. We believe the company could continue to benefit from the recessionary environment given that the demand for inexpensive household products will likely remain strong in the coming quarters (which is already helping the struggling Family Dollar store). Dollar Tree’s stock declined by around 12% since the end of 2017. Our dashboard, ‘What Factors Drove -12% Change In Dollar Tree Between 2017 And Now?‘ provides the key numbers behind our thinking, and we explain more below.

Dollar Tree’s stock lost around 12% over the past two years, primarily due to a 52% decline in earnings, partially offset by modest revenue growth of 6%. An almost 55% fall in net income margin from 7.7% in 2017 to 3.5% in 2019, led to the decline in earnings per share. A global helium shortage, higher freight and distribution costs, and higher sales of low-margin goods weighed on the company’s profits during this period. Dollar Tree has been amidst a years-long restructuring following its 2015 acquisition of Family Dollar. The company has invested significantly in renovating Family Dollar stores. In fact, the acquired Family Dollar stores have been a drag on the business overall, turning a retailer with a low teens percentage operating margin into a mid-single-digit one.

Dollar Tree’s P/E multiple grew from 15x at the end of 2017 to 27x by the end of 2019. It is still at the 2019 levels. But we believe DLTR’s multiple will likely grow slightly from 27x levels on the back of its turnaround strategy. This includes the company’s aggressive expansion of new stores. For 2020, the retailer with more than 15,000 stores plans to open another 500 new stores, including 325 Dollar Tree locations and 175 Family Dollar locations.

How Is Coronavirus Impacting Dollar Tree’s Stock?

Covid-19 has proved to be a tailwind for Dollar Tree’s business. In the recent Q2, company-wide same-store sales rose 7.2%, with an 11.6% gain at Family Dollar (as these stores tend to focus more on essentials). In addition, earnings per share grew 45% year-over-year to $1.10, driven by lower merchandise costs, same-store sales leverage, and fewer markdowns. Although the company drew $500 million from its revolving credit line to manage its cash flows, it has $1.75 billion in cash and equivalents – more than sufficient to cover one quarter’s worth of cash operating expenses. Overall, Dollar Tree should likely enjoy higher traffic as consumers seek out value, convenience, and savings while shopping during the ongoing economic uncertainty.

The actual recovery and its timing hinge on the broader containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. Following the Fed stimulus — which set a floor on fear — the market has been willing to “look through” the current weak period and take a longer-term view. With investors focusing their attention on 2021 results, the valuations become important in finding value. Though market sentiment can be fickle, and evidence of an uptick in new cases could spook investors once again.  

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