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Dollar Tree (DLTR) Research Report: Q1 CY2024 Update


Full Report / June 05, 2024

Discount treasure-hunt retailer Dollar Tree (NASDAQ:DLTR) reported results in line with analysts' expectations in Q1 CY2024, with revenue up 4.2% year on year to $7.63 billion. On the other hand, next quarter's revenue guidance of $7.45 billion was less impressive, coming in 2% below analysts' estimates. It made a GAAP profit of $1.38 per share, improving from its profit of $1.35 per share in the same quarter last year.

Dollar Tree (DLTR) Q1 CY2024 Highlights:

  • Announced it is seeking to divest its Family Dollar brand through a potential sale or spin-off
  • Revenue: $7.63 billion vs analyst estimates of $7.67 billion (small miss)
  • EPS (non-GAAP): $1.43 vs analyst expectations of $1.43 (in line)
  • Revenue Guidance for Q2 CY2024 is $7.45 billion at the midpoint, below analyst estimates of $7.60 billion
  • The company reconfirmed its revenue guidance for the full year of $31.5 billion at the midpoint
  • EPS (non-GAAP) Guidance for Q2 CY2024 is $1.05 at the midpoint, below analyst estimates of $1.20
  • Gross Margin (GAAP): 30.8%, up from 30.5% in the same quarter last year
  • Free Cash Flow of $223.5 million, down 44.3% from the same quarter last year
  • Locations: 16,397 at quarter end, in line with the same quarter last year
  • Same-Store Sales rose 1% year on year
  • (4.8% in the same quarter last year)
  • Market Capitalization: $26.25 billion

A treasure hunt because there’s no guarantee of consistent product selection, Dollar Tree (NASDAQ:DLTR) is a discount retailer that sells general merchandise and select packaged food at extremely low prices.

Founded in 1986 and initially selling items priced at $1 or less, the company has since expanded its selection and price points. However, most items are still under $5 with an extensive selection under $2.

While low prices are an obvious benefit to the consumer, the tradeoff is consistency of selection. One day, a shopper may find bottles of name-brand dish soap for $1 that would sell for much more elsewhere. However, that product may not be available weeks later. This is why the Dollar Tree experience is often called a treasure hunt. The company’s sourcing and logistics capabilities are a key reason prices are so low. Shorter-term deals and arbitrage opportunities are prioritized by the merchandising team over long-term supplier agreements.

Dollar Tree is known for party supplies, holiday décor, home goods, toys, and a limited snack selection, but the company also operates the Family Dollar banner. Acquired in 2015, Family Dollar focuses more on food and consistent selection to serve the grocery needs of lower-income households. The concept competes most directly with Dollar General and looks to locate stores in rural or suburban areas not served well by large regional grocery chains or general merchandise behemoths like Walmart.

Discount Grocery Store

Traditional grocery stores are go-tos for many families, but discount grocers serve those who may not have a traditional grocery store nearby or who may have different spending thresholds. Certain rural or lower-income areas simply don’t have a grocery store. Additionally, some lower-income families would prefer to buy in smaller quantities than available at most stores (think one or two paper towel rolls at a time). While online competition threatens all of retail, grocery is one of the least penetrated because of the nature of buying food. Furthermore, those buying small quantities for immediate need are even less likely to leverage e-commerce for these purposes.

Competitors that offer a treasure-hunt experience centered around general merchandise and/or snacks include Five Below (NASDAQ:FIVE), Dollarama (TSX:DOL), and TJX (NYSE:TJX).

Sales Growth

Dollar Tree is one of the larger companies in the consumer retail industry and benefits from economies of scale, enabling it to gain more leverage on fixed costs and offer consumers lower prices.

As you can see below, the company's annualized revenue growth rate of 6% over the last five years was sluggish as its store footprint remained relatively unchanged, implying that growth was driven by more sales at existing, established stores.

Dollar Tree Total Revenue

This quarter, Dollar Tree's revenue grew 4.2% year on year to $7.63 billion, falling short of Wall Street's estimates. The company is guiding for revenue to rise 1.7% year on year to $7.45 billion next quarter, slowing from the 8.2% year-on-year increase it recorded in the same quarter last year. Looking ahead, Wall Street expects sales to grow 2.8% over the next 12 months, a deceleration from this quarter.

Same-Store Sales

A company's same-store sales growth shows the year-on-year change in sales for its brick-and-mortar stores that have been open for at least a year, give or take, and e-commerce platform. This is a key performance indicator for retailers because it measures organic growth and demand.

Dollar Tree's demand within its existing stores has generally risen over the last two years but lagged behind the broader consumer retail sector. On average, the company's same-store sales have grown by 4.8% year on year. Given its flat store count over the same period, this performance stems from increased foot traffic at existing stores or higher e-commerce sales as the company shifts demand from in-store to online.

Dollar Tree Year On Year Same Store Sales Growth

In the latest quarter, Dollar Tree's year on year same-store sales were flat. By the company's standards, this growth was a meaningful deceleration from the 4.8% year-on-year increase it posted 12 months ago. We'll be watching Dollar Tree closely to see if it can reaccelerate growth.

Number of Stores

The number of stores a retailer operates is a major factor of how much it can sell and its growth is a critical driver of how quickly its sales can grow.

When a retailer like Dollar Tree keeps its store footprint steady, it usually means that demand is stable and it's focused on improving operational efficiency to increase profitability. As of the most recently reported quarter, Dollar Tree operated 16,397 total retail locations, in line with its store count a year ago.

Dollar Tree Operating Retail Locations

Taking a step back, the company has only opened a few new stores over the last eight quarters, averaging 1.7% annual growth in new locations. Although it's expanded its presence, this sluggish store growth lags other retailers. A flat store base means that revenue growth must come from increased e-commerce sales or higher foot traffic and sales per customer at existing stores.

Gross Margin & Pricing Power

Gross profit margins tell us how much money a retailer gets to keep after paying for the goods it sells.

Dollar Tree has weak unit economics for a retailer, making it difficult to reinvest in the business. As you can see below, it's averaged a 30.8% gross margin over the last eight quarters. However, when comparing its margin specifically to other non-discretionary retailers, it's actually pretty solid. That's because non-discretionary retailers have structurally lower gross margins as they compete to provide the lowest possible price, sell products easily found elsewhere, and have high transportation costs to move their goods. We believe the best metrics to assess these types of companies are free cash flow margin, operating leverage, and profit volatility, which take their scale advantages and non-cyclical demand characteristics into account.

Dollar Tree Gross Margin (GAAP)

Dollar Tree's gross profit margin came in at 30.8% this quarter, flat with the same quarter last year. This steady margin for a retailer like Dollar Tree, which is structurally less profitable than the typical retail business for the reasons mentioned above, signals that it has stable input costs (such as freight expenses to transport goods) and aims to keep prices low for consumers.

Operating Margin

Operating margin is a key profitability metric for retailers because it accounts for all expenses keeping the lights on, including wages, rent, advertising, and other administrative costs.

This quarter, Dollar Tree generated an operating profit margin of 5.5%, in line with the same quarter last year. This indicates the company's costs have been relatively stable.

Dollar Tree Operating Margin (GAAP)

Zooming out, Dollar Tree was profitable over the last two years but held back by its large expense base. It's demonstrated mediocre profitability for a consumer retail business, producing an average operating margin of 6.3%. On top of that, Dollar Tree's margin has slightly declined, on average, by 1.2 percentage points year on year. This shows Dollar Tree has faced some speed bumps.

EPS

We track the long-term growth in earnings per share (EPS) for the same reason as long-term revenue growth. Compared to revenue, however, EPS highlights whether a company's growth was profitable.

Although Dollar Tree's full-year earnings are still negative, it reduced its losses and improved its EPS by 6% annually over the last five years.

Dollar Tree EPS (GAAP)

In Q1, Dollar Tree reported EPS at $1.38, up from $1.35 in the same quarter last year. Despite growing year on year, this print missed analysts' estimates. Over the next 12 months, Wall Street is optimistic. Analysts are projecting Dollar Tree's EPS of negative $4.59 in the last year to flip to positive $7.19.

Cash Is King

Although earnings are undoubtedly valuable for assessing company performance, we believe cash is king because you can't use accounting profits to pay the bills.

Dollar Tree's free cash flow came in at $223.5 million in Q1, down 44.3% year on year. This result represents a 2.9% margin.

Dollar Tree Free Cash Flow Margin

Over the last eight quarters, Dollar Tree has shown mediocre cash profitability, putting it in a pinch as it gives the company limited opportunities to reinvest, pay down debt, or return capital to shareholders. Its free cash flow margin has averaged 1.5%, subpar for a consumer retail business. Dollar Tree's margin has also been flat during that time, showing the company needs to take action and improve its cash profitability.

Return on Invested Capital (ROIC)

EPS and free cash flow tell us whether a company was profitable while growing its revenue. But was its growth capital-efficient? A company’s ROIC explains this by showing how much operating profit a company makes compared to how much money it has raised (debt and equity).

Dollar Tree's five-year average ROIC was 9.9%, somewhat low compared to the best consumer retail companies that consistently pump out 25%+. Its returns suggest it was mediocre at investing in profitable business initiatives.

The trend in its ROIC, however, is often what surprises the market and moves the stock price. Unfortunately, Dollar Tree's ROIC has stayed the same over the last few years. If the company wants to become an investable business, it must improve.

Balance Sheet Risk

As long-term investors, the risk we care most about is the permanent loss of capital. This can happen when a company goes bankrupt or raises money from a disadvantaged position and is separate from short-term stock price volatility, which we are much less bothered by.

Dollar Tree's $10.35 billion of debt exceeds the $618.5 million of cash on its balance sheet. Furthermore, its 5x net-debt-to-EBITDA ratio (based on its EBITDA of $1.83 billion over the last 12 months) shows the company is overleveraged.

At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Dollar Tree could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.

We hope Dollar Tree can improve its balance sheet and remain cautious until it increases its profitability or reduces its debt.

Key Takeaways from Dollar Tree's Q1 Results

We struggled to find many strong positives in these results. This quarter's print was roughly in line with estimates while its revenue and EPS guidance for next quarter was underwhelming. It also announced it is seeking to divest its Family Dollar brand; it's unclear if this will help or hurt the company. On one hand, it will help Dollar Tree focus on its core business, but on the other hand, it could dampen its scale advantages. Overall, this was a mediocre quarter for Dollar Tree. The company is down 1.6% on the results and currently trades at $118.33 per share.

Is Now The Time?

Dollar Tree may have had a tough quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

We cheer for all companies serving consumers, but in the case of Dollar Tree, we'll be cheering from the sidelines. Its revenue growth has been a little slower over the last five years, and analysts expect growth to deteriorate from here. And while its projected EPS for the next year implies the company's fundamentals will improve, the downside is its relatively low ROIC suggests it has historically struggled to find profitable business opportunities. On top of that, its gross margins make it more difficult to reach positive operating profits compared to other consumer retail businesses.

Dollar Tree's price-to-earnings ratio based on the next 12 months is 16.7x. While there are some things to like about Dollar Tree and its valuation is reasonable, we think there are better opportunities elsewhere in the market right now.

Wall Street analysts covering the company had a one-year price target of $148.30 per share right before these results (compared to the current share price of $118.33).

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